American Rescue Plan: China increasingly concerned by US economic policy after Fed maintains loose stance

Frank Tang
·6-min read

Moves by the United States to maintain its loose monetary policy until at least the end of 2023 to support its economic recovery and labour market have reinforced concerns in Beijing as it tries to reduce the risk of domestic asset bubbles by gradually tapering off stimulus policies enacted last year.

The US Federal Reserve on Wednesday reiterated that it would keep its benchmark interest rate near zero and continue sizeable asset purchases to pump liquidity into financial markets, in a so-called quantitative easing.

Chinese economic advisers, though, are increasingly worried that some of the tidal wave of cash released into the market by the US will produce unexpected shocks in domestic financial markets.

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As a result, Chinese authorities are likely to slow the opening of its capital account for fear of massive “hot money” inflows, and instead focus on increasing outbound investment flows and greater overseas use of the yuan for financial transactions as international policy coordination is seen as highly unlikely in the short term, analysts said.

What worries me the most is the next adjustment of Fed policies

Huang Yiping

“What worries me the most is the next adjustment of Fed policies,” said Huang Yiping, a former central bank adviser and now deputy dean of Peking University’s National School of Development.

Huang expressed the concern shared by some in the global financial markets that the massive US economic stimulus will lead to a rapid recovery of the American economy and force the US Federal Reserve to raise interest rates sooner than it now expects. That fear among some international investors has been one of the key driving forces in the sharp rise in US bond yields in recent weeks.

“These measures, along with our strong guidance on interest rates and on our balance sheet, will ensure that monetary policy will continue to deliver powerful support to the economy until the recovery is complete,” said US Federal Reserve chair Jerome Powell.

The US Federal Reserve’s continued loose monetary policy has been coupled with a huge injection of US government funding into the economy. Last week, US President Joe Biden signed the US$1.9 trillion American Rescue Plan into law following the previous US$900 billion stimulus plan passed in December, and the administration is also expected to propose a multi-trillion-dollar infrastructure investment plan later this year.

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“There’s no free lunch,” Huang told a forum hosted by the National School of Development on Thursday. “We all remember what happened in 2014-15. The US [Federal Reserve] is the world’s major central bank. Once it quits quantitative easing and raises rates, we could encounter capital exodus, currency depreciation and falling asset prices. In some cases like South Africa, Russia and Turkey, it led to financial crisis. I don’t think such things will happen to China, but some emerging markets could face disastrous results.”

The US Federal Reserve conducted its loosest monetary policy in history after the 2008 global financial crisis, cutting interest rates to near zero while also engaging in three rounds of quantitative easing.

In October 2014, it ended its third quantitative easing programme, and in December 2015, then-chair and current US Treasury Secretary Janet Yellen raised interest rates for the first time since 2006.

The tighter US monetary policy made investments in the US more attractive and hit emerging markets, including China. The Chinese stock market fell sharply, starting in June 2015, and it took Beijing nearly three years to stabilise the yuan exchange rate after burning through around a quarter of its foreign reserves and imposing draconian capital controls.

Considering the strong winds and big waves outside, it is no longer a good time to open up the capital account

Wang Jun

“That money will have to be taken back eventually,” said Wang Jun, chief economist at Zhongyuan Bank in Henan province, referring to a future tightening of US fiscal and monetary policy.

Given the risks the US liquidity injection poses, China is expected to dial back its efforts to open up its economy to more foreign capital inflows, and instead focus on relieving pressure on domestic markets and the yuan exchange rate.

“Considering the strong winds and big waves outside, it is no longer a good time to open up the capital account,” Wang added.

“[The effort to increase the use of yuan in international payments to replace the US dollar] is now receiving a higher priority … and outbound investment channels should be broadened.”

China’s central bank has gradually started to allow a large amount of outflows, including the restart of Qualified Domestic Institutional Investors programme. It is also said to be planning an increase in the so-called southbound channel of the Bond Connect programme that allows investors to buy more securities in Hong Kong, while also setting up a pilot Wealth Management Connect in the Greater Bay Area that would also allow greater investment abroad.

“This round of Fed loosening could drag the US dollar index into a cycle of weakness for many years, and it will have a continued impact on the yuan, capital flows, growth, consumer prices and trade,” said Xie Yaxuan, chief macro analyst with China Merchants Securities.

The central bank can use its countercyclical macroprudential policies to curtail short-term capital inflows, Xie added.

“The recent comments by [Chinese] policymakers suggest they have learned the lessons of Japan and the US and are set to tolerate greater fluctuations of the yuan exchange rate, and pay close attention to controlling asset prices and the macroeconomic leverage ratio,” Xie said.

Unlike the policy response after the 2008 global financial crisis, when both Beijing and Washington implemented large-scale stimulus to support their economies, China and the US are at different stages of their economic cycles and so their policies are quickly diverging.

Liu Shengjun, head of the Shanghai-based China Financial Reform Research Institute, said US fiscal and monetary policy moves have made it harder for Beijing to conduct its economic policy priorities, notably its process of gradually tapering off economic stimulus.

However, Liu said, “the psychological shock [of this] is bigger than the actual impact”.

China surpassed the US as the largest recipient of foreign direct investment last year, attracting inflows of US$163 billion. Foreign investors also increased their holdings of Chinese government bonds by more than 1 trillion yuan (US$158 billion) in 2020, reflecting the better returns on offer.

The expectation that larger stimulus will lead to stronger US and global recoveries this year have caused many organisations to also revise up their economic forecasts for China.

Swiss bank UBS raised its China gross domestic product (GDP) forecast for 2021 to 9 per cent from 8.2 per cent, driven by a strong domestic rebound and the US stimulus that should drive demand for Chinese exports.

International rating agency Fitch revised up its China GDP forecast for 2021 to 8.4 per cent this year from 8 per cent, citing a stronger outlook for global demand.

China’s official growth target was set at “above 6 per cent”, although virtually all economists expect it to grow by at least 8 per cent this year, helped by the low comparison base with last year’s coronavirus-hit growth rate.

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