American Rescue Plan: China moves to counter ‘turmoil in financial markets’ as policy divergence widens with US

Frank Tang

China’s central bank is stepping up liquidity support for domestic businesses and increasing its monitoring of cross-border capital flows as concerns persist over the side effects of Washington’s massive new fiscal stimulus plan.

The moves by the People’s Bank of China come amid a growing divergence in the recent economic policy responses by the United States and China, with Washington boosting stimulus significantly while Beijing starts to taper off its economic-support policies enacted last year in response to the coronavirus pandemic.

Beijing officials and policy advisers have been highly critical of US President Joe Biden’s newly signed US$1.9 trillion American Rescue Plan, warning that it could cause massive capital flows and imported inflation that could exacerbate domestic financial risks from already high debt levels.

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“The [US Treasury bond] yield hike driven by inflation expectations will lead to a revaluation of asset prices, or even turmoil in financial markets. Domestic markets are unlikely to remain unresponsive,” Zhang Xiaohui, former assistant governor of the central bank, said on Thursday.

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China’s A-share stock market is undergoing a correction after the widely watched yields on 10-year US Treasury notes spiked last week to a 13-month high of more than 1.6 per cent.

“Although [China’s] consumer inflation is relatively controllable, we see an obvious rise in [domestic] asset prices,” Zhang said during a lecture hosted by the Shanghai Pushan Foundation.

Liquidity management is believed to be the first priority, given the prospect of rising market volatility. “The market is very concerned about a turning point in liquidity, as the whole world has entered uncharted monetary and financial territory after the pandemic,” Zhang said.

The sharp rise in US Treasury bond yields is due, in part, to market concerns that rising inflation could prompt the Federal Reserve to raise interest rates sooner than the end-of-2023 time frame that policymakers projected in December. The US central bank meets this week, and market players will be watching closely for any clues about policymakers’ expectations for interest rates.

For now, the Fed is keeping rates near zero while continuing to buy at least US$80 billion per month in US Treasury securities and US$40 billion in mortgage-backed securities – so-called quantitative easing – to pump liquidity into the market.

China did not enact engage in quantitative easing during the coronavirus crisis, but it did pump 9 trillion yuan (US$1.38 trillion) worth of liquidity into the interbank market last year to help the coronavirus-hit economy.

Beijing is proceeding cautiously, seeking to reassure the public that leaders will continue to support the economy while trimming stimulus and refocusing on controlling financial risks.

Amid this policy tension, the People’s Bank of China (PBOC) on Monday rolled over 100 billion yuan (US$15.36 billion) worth of its one-year, medium-term lending facility loans and sold a further 10 billion yuan worth of seven-day reverse purchase agreements to “ensure reasonably ample interbank liquidity”.

Some normalisation of the Chinese government’s economic policy was widely anticipated this year, given that the national gross domestic product is widely projected to grow by 8 per cent or more in 2021.

China urges markets to focus on rates, not liquidity, to avoid ‘misunderstanding’ of monetary policies

However, the withdrawal of monetary stimulus can be a painful process, as shown by the spike in interbank interest rates ahead of the Lunar New Year period in early February after the PBOC drained more liquidity than expected from the market ahead of strong demand for money during the holiday. The PBOC later added additional liquidity to soothe the market’s frayed nerves.

“Considering the overall domestic and overseas financial situation, there’s no reason [for China] to tighten its monetary policy in the short term,” Song Songcheng, former head of the PBOC’s statistics department, said at a recent meeting of the China Wealth Management 50 Forum. “It does no good to economic stabilisation and risk prevention.”

To offset massive capital inflows into domestic financial markets hunting for higher returns, the government is considering allowing Chinese citizens to invest overseas, including by allowing mainland investors to buy Hong Kong-listed bonds through a new “southbound” mainland-Hong Kong Bond Connect channel that would mirror the current northbound route that allows foreigners to invest in Chinese bonds.

On Friday, the State Administration of Foreign Exchange (SAFE) also began a pilot programme that allows multinational companies in Shenzhen and Beijing to make easier cross-border fund transfers.

As seen from price and labour market indicators, we are still some distance from [economic] normalisation

Zhang Bin, Chinese Academy of Social Sciences

Nevertheless, SAFE officials continued to stress the need to conduct risk evaluations and inspections to “effectively prevent the risk of cross-border capital flows”.

Calls for a continuation of supportive monetary policy grew louder during the meetings of the National People’s Congress that concluded last week, especially after the Ministry of Finance – which cut taxes by 2.3 trillion yuan in 2019 and another 2.6 trillion yuan last year to support the economy – was ordered to cut its budget support to reduce “fiscal risks”.

The top legislature lowered the fiscal deficit ratio to 3.2 per cent from last year’s 3.6 per cent and reduced the limit for local government special-purpose bond issuance by 100 billion yuan from last year.

“As seen from price and labour market indicators, we are still some distance from [economic] normalisation. We worry that policy adjustments are coming too early,” Zhang Bin, deputy director of the Institute of World Economics and Politics under the Chinese Academy of Social Sciences, said at the Pushan lecture. “We should set aside room in monetary policy to let the private sector play a bigger role in boosting the economy. There’s no need to normalise it so early.”

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