Economic Slowdown and Monetary Policy Shift in China
The world’s second-largest economy is now showing clear signs of slowdown as the authorities there reverse their two-year efforts to control inflation and cool the economy. The Purchasing Managers’ Index data released today by China showed that the manufacturing sector shrank in November for the first time since early 2009. PMI fell to 49.0 in November from 50.4 in October against the median estimate 49.8, pointing to a sharp deterioration in business conditions.
Earlier, third-quarter economic statistics showed the lowest GDP growth rate in the past two years. While the real economy and domestic demand remain strong in China, the export sector has suffered tremendously due to drop in demand from US and Europe. Additionally, there are concerns that the actual slowdown may be much worse than that indicated by recent data due to data reporting and collation issues in China.
The biggest concerns emanate from the sagging real estate sector, where falling house sales and prices have resulted in most new construction projects being halted. Liquidity conditions have also worsened recently due to a reversal of capital flows.
The Chinese central bank yesterday reduced the reserve requirements for the banks by 50 bps, in a marked reversal of its monetary policy after more than two years of tightening. The cut lowers the reserve ratio for China's biggest banks to 21%, and frees up some of the banks’ funds for lending, which could help revive the slowing economic growth.
The easing move, which had been expected next year, signals that the Chinese authorities now feel comfortable about the taming of inflation that peaked at 6.5% in July and is expected to come down below 5% for November, but are getting increasingly concerned about the faltering economy.
Increasing the reserve requirements for banks was one of the frequently used monetary policy tool in China since the start of its tightening cycle in 2008, and as a result the reserve levels were at a record high level. By choosing to cut the reserve requirement to increase liquidity in the system rather than using open market operations or “targeted easing,” or quietly persuading the state-controlled banks to make more loans, the Chinese authorities provided a clear signal to the market about the decisive shift in the policy.
It remains to be seen whether the eased reserve requirements will actually result in more loans being made or those funds will be used up in provisions for the bad loans if the real estate market, which appears to be at a tipping point, deteriorates sharply.
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