China’s stimulus centered in reducing the credit crunch of the private sector

• As recent data shows, China seems to be bracing for another difficult year. With downward pressure weighing on the economy, the People's Bank of China (PBoC) has its largest daily liquidity injection on record, showing an increasingly lax monetary policy stance. But this cannot solve China’s woes alone. Despite the liquidity injection, banks are not lending and abundant liquidity is parked in the interbank market. The crackdown on shadow banking also means less credit in the real economy and higher funding costs for small and private corporates. China’s monetary transmission mechanism is simply not working.
• To solve the bottleneck in monetary policy transmission, China will seek for stronger administrative measures to create more credit in the economy. Such “unorthodox” ways can be classified in three arrows.
• Bank lending: China will increase the scale and reduce the cost of bank lending. The China Banking and Insurance Regulatory Commission (CBIRC) suggested targeted loans to private firms accounting for 1/3 of new loans of large banks, 2/3 of new loans of small banks and no less than 50% of new loans in the whole banking system after 3 years. It is also reported that banks are asked to lower new loan rate to small firms by 100 bps.
• Bond issuance: The PBoC will provide RMB 10 billion as initial funds to China Bond Insurance Corporation to support the issuance of credit risk migration warrants (CRMW), a Chinese version of the CDS, for private companies.
• Equity to pledge new funding: Relief funds are set up by the Securities Association of China, local governments and securities firms to ease the risk of the value loss of shares used as collateral. In the same line, the CBIRC will allow insurers to issue products targeted at easing such risk.
• China has woken up to the reality that demand policies alone cannot cushion the economic slowdown. Problems in monetary transmission mechanism, which is long standing in China but aggravated by the crackdown of shadow banking, are being tackled through measures to support the private sector. Public investments will also speed up on the back of abundant liquidity. In the short run, the weak economic data and expansionary monetary policies essentially means more growth, more credit and cheaper funding costs.
• While the current developments are positive for growth in the short run, such measures cannot replace structural reforms that China needs to cushion the fall in potential growth in the medium term. Not only the debt problem will be kicked further down the road, but also the countercyclical measures through more administered lending will cause potential misallocation of credit, i.e. higher moral hazard and a reversal in domestic financial liberalization.

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