China’s monetary policy normalization: What has happened so far? What does this mean for the Chinese markets, commodities and global economy
Credit slowdown has been a key feature in China’s debt-stabilizing effort this year, especially when the domestic economic activity has broadly normalized. China’s latest April credit growth continued to moderate as new bank loans and total social financing (TSF) both exhibited slower expansion. Specifically, new bank loans came in at RMB 1.47trillion (trn) (down 13.5% year-over-year (YoY); versus market consensus at RMB 1.6trn) while the aggregate credit measure of TSF flow came in at RMB 1.85trn (down 40.4% YoY; versus market consensus at RMB 2.3trn). If we compare to the pre-pandemic level, the average new bank loans and TSF were RMB 1.4trn and RMB 2.1trn, respectively, in 2019.
This suggests that April new bank loans came in roughly the same as pre-pandemic levels, while TSF did drop amid market concerns surrounding the large state-owned asset manager that missed the March deadline to disclose its 2020 financial results. This may also illustrate signs of policy normalization. In particular, the credit condition, which measures the gap between aggregate credit growth and nominal GDP growth, with 3 months moving average, as illustrated in Exhibit 1, has fallen from the peak of 10.7% in November 2020 to 4% in April 2021.
Coupled with the aggregate credit deceleration, differentiated credit support is the other prominent feature of the current People’s Bank of China (PBoC) monetary policy operation. The PBoC has continued to emphasize targeted support to small and medium-sized enterprises, at the cost of discouraged industries, for example, real estate, polluting sectors and shadow banking activity. This suggests that the central bank continues to influence banks over loan distribution with a strong sector preference, in the name of directing the financial sector to support the real economy and providing low-cost funds to small and medium-sized enterprises.
The recently published 1Q monetary policy report (MPR) further echoes that. This latest MPR also devoted a special column to discuss the reasons for the rise in U.S. bond yields and their outlook. In particular, PBoC views the rising U.S. bond yields and the potential Fed monetary policy adjustments as having limited and manageable impact on China, as China has proven its economic resilience through the pandemic while the flexibility of the renminbi exchange rate has been enhanced.
The recent spike in global commodity prices also received close attention from policy makers. The State Council said it would cope with the rapid increase in commodity prices and the spillover effects. The MPR also addressed this concern and attributed the commodity price rally to 3 key factors: 1) market expectation of improving global demand; 2) supply side constraints due to the resurgence of the pandemic; and 3) continuous accommodative monetary policy, as well as abundant global liquidity. The PBoC thinks that the commodity price rally will be transitory and producer price index will stabilize when global supply starts to recover and the base effects abate. More importantly, the pass-through from rising commodity prices to Consumer Price Index (CPI) inflation has been limited and the PBoC feels comfortable that CPI will stay at benign levels throughout the year.
Overall, the policy messages are in line with our view, which points to a combination of credit slowdown, stable policy rates and targeted support for certain sectors, supplemented by macro-prudential measures to handle structural risks as well as financial stability concerns.
Credit condition has fallen from the peak of 10.7% in November 2020 to 4% in April 2021
EXHIBIT 1: CHINA'S CREDIT CONDITION
Ongoing monetary policy normalization may lead to lower commodity prices
EXHIBIT 2: CHINA'S CREDIT IMPULSE AND COMMODITY PRICES
For global investors, policy normalization might imply further opportunities from higher yields and stronger renminbi. Since global central banks are expected to maintain still-low interest rates for years, the Chinese bond market is offering attractive cash income. In addition, the low correlation between Chinese and foreign bond markets provides the further benefit of diversification. Renminbi appreciation might continue, albeit at a slower pace this year, which will also enhance the return for foreign investors.
There are also concerns that monetary normalization could tighten liquidity conditions and lead to a rise in default risks, both for property developers and state-owned companies and financial institutions. For developers, the stronger players have maintained a strong balance sheet and adjusted their land reserves in expectation of property price-cooling measures. For the broader corporate bond market, Chinese regulators have in recent years tolerated defaults, including state-owned enterprises, to allow credit risks to be properly priced. However, we expect government support would kick in if defaults increase the systemic risks in the Chinese financial system. Onshore rating companies have also been downgrading corporate debt, which is a sign that they are finally making a more accurate assessment of the default risks. Hence, instead of seeing this as a sign of deterioration in credit quality, it should be considered as progress in building a more well-established bond market.
While monetary policy will most likely stay on course, commodity prices have likely been affected by China’s domestic industry policies as China embarks on the carbon neutrality journey. These policies/initiatives have probably led to expectations of lower domestic production as well as added upside pressure for global commodity prices. Hence, avoiding rushed actions and ensuring orderly implementation of de-carbonization measures could help mitigate near-term pressure on commodity prices. The risk of higher inflation driven by higher commodity prices may also be mitigated by China’s ongoing policy normalization. Most of China’s recent commodity demand has been driven by fiscal stimulus directed at infrastructure and property development. Tighter policy on the real estate market could potentially lead to slower demand for industrial metals, thereby dragging down commodity prices.