In previous monetary easing cycles (2008-2009, 2011-2012, 2014-2015), Beijing used much the same bailout toolkit each time, including:
- Subsidies for corporate investment
- Measures to boost the property market
- Subsidies for household spending on durable goods
- Having the People’s Bank of China (PBoC) pump liquidity and cut interest rates significantly
The idea was that the commercial banks would greatly increase their lending, and that state-owned enterprises (SOEs) and local governments would be more inclined to borrow and invest in infrastructure. In short, the purpose was to boost the quanity of growth.
No déjà vu in the current easing cycle
In the current easing cycle, which started in July 2018, China has been highly selective in the fiscal, monetary and regulatory stimulus it has provided. It is a tactic designed to restore private-sector confidence. Hawkish policy messages that insist that there will be no wholesale reflation have often accompanied the targeted easing measures. This new easing approach shows Beijing’s commitment to prioritising quality growth over quantity via structural reforms and debt reduction. Table 1 summarises the policy differences between this and past easing cycles; it appears that massive liquidity injections are history (see Exhibit 1).
Why the change in the easing tactics?
There are two main reasons. There has been a significant change in Beijing’s policy objective, with the Xi administration prioritising growth quality and financial stability through reduction in excess capacity and debt growth maximisation. And there are also constraints on policy easing. One big difference between the backdrop of this and past cycles is that the economy currently has a lot of debt, the renminbi has weakened and the current account surplus has dropped to around 1% of GDP. In past cycles, by contrast, China had much less debt, a strong renminbi and a large current account surplus.
Productivity to rise modestly
Under this “new normal” policy direction, which aims at keeping GDP growth within a moderate 6.0%-7.0% range while implementing structural reforms and paring debt, China’s total factor productivity (TFP) growth is expected to recover from the decline in the previous years (see Exhibit 2).
Previous debt-fuelled excess investment in upstream industries, property and infrastructure led to sluggish or declining productivity growth. President Xi’s ‘new normal’ policy has shown some initial success, with improving marginal efficiency of debt financing (see Exhibit 3) leading to an improvement in growth quality as seen in the rise in the output-credit ratio (see Exhibit 4).
To maintain the domestic supply chain’s competitiveness, attract foreign direct investment and address the developed world’s criticisms of its trade/investment practices, Beijing has started to cut taxes and loosen foreign ownership restrictions, and has pledged to improve industrial production protection regulations and increase the penalties for property rights violations.
Scepticism about Beijing’s market-reform motives
However, many observers remain unconvinced of Beijing’s willingness to let market forces play a bigger role in the system. Indeed, many of the new policy initiatives seem to be in conflict with market-driven resource allocation. Notably, the CBIRC’s proposal in November 2018 to set a “1-2-5” target for bank lending to the private sector has raised serious concerns about Chinese banks being asked to provide a ‘national service’ to support growth at the expense of their profitability.
The regulators have also asked banks to lend at lower than normal corporate loan interest rates to small and micro-enterprises since July 2018. The market estimates that these initiatives could add RMB 1 to 2 trillion of bad loans to the banking system in three years and that the lower lending interest rate to small businesses is generally unprofitable for banks.
While these new policies aim at overcoming banks’ reluctance to lend to the private sector, the more crucial question is whether banks’ aversion to private-sector lending is a market decision of capital allocation or a result of market failure. It is both, in my view.
Until recently, lending to SOEs has been less risky due to Beijing’s implicit guarantee policy. Private businesses have no implicit guarantee and are smaller and, thus, riskier. So, the banks seem to be making a rational, market-determined, choice. However, the private sector has consistently outperformed the SOEs in their financial returns, and many of China’s most successful businesses are private companies. But banks have denied lending to them, so they have to rely on expensive venture-capital or even shadow financing.
This phenomenon reveals the irony that the supposedly market-driven banks have consistently failed to pick winners. It also suggests market failure in the Chinese banking system and argues for policy intervention to correct the situation. Of course, China needs structural reforms to correct the distorted incentives in its capital allocation process. But these will take time and are harder to implement in the short term. Meanwhile, Beijing has embraced debt reduction, which has hit the private businesses harder than the SOEs.
All this is not to deny the healthy dose of scepticism about Beijing’s market liberalisation motive, which is indeed a conundrum that the Communist Party has yet to resolve. This puzzle, in my view, originates from the fact that the Communist Party’s ideology of centralised control clashes with the economic reform spirit of market freedom. The point is that the new monetary policy and regulatory initiatives to force banks to lend more to the private sector are, arguably, stop-gap measures to reduce the adverse external views of the debt reduction policy.
As Keynes argued, when the market failed the government had to step in. In the next instalment on this topic, I shall explore the change in China’s incentives to make changes. Stay tuned.
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 See “Chi on China: China’s Deleveraging Strategy and Evidence”, 22 November 2017,
“Chi on China: China’s Deleveraging Strategy and Evidence (II) – Rising Credit Spread”, 30 May 2018,
“Chi on China: The Beginning of the End of Excess Capacity”, 24 August 2016,
“Chi on China: The Conundrum of China’s Excess Capacity”, 14 September 2016.
 Total-factor productivity (TFP) is the amount of output produced by the combined inputs of labour and capital. It is estimated here by dividing output (GDP) by the weighted average of labour (including migrant workers) and capital inputs, with the standard weighting of 0.7 for labour and 0.3 for capital.
 The closer to the production source a firm is, the further upstream it is said to be. Conversely, the closer to the end user a firm is, the further downstream it is said to be. Raw material extraction and production are elements of the supply chain considered to be upstream. More generally, firms/industries whose activities affect the producer prices are upstream economic entities. Thus, the primary producers, wholesalers can be grouped as upstream sectors.
 The new China Banking and Insurance Regulatory Commission “1-2-5” lending target proposes that private-sector loans should account for at least 1/3 of new corporate loans at large banks, 2/3 at medium and small banks and 50% at all banks in three years starting from the date of implementation.
 It was reported that banks had lent to small private businesses at an average interest of 6.23% since July 2018, which was 70 bps lower than the normal corporate loan interest rate. Some bank analysts estimated that Chinese banks would need to lend at 7.0% or above to break even or make a profit.
 See “Chi on China: A Binary Choice for China’s New Leaders”, 5 March 2013