China has an official new monetary policy instrument: medium-term lending facility (MLF), where it injected about RMB800 bln at a 3.5% rate. This came out in the 3Q monetary policy report. The PBoC also added some new language to the report saying it will provide a “neutral and adequate” policy environment. This probably means that they are not intending to provide a huge stimulus right now and that will feel their way forward. In any case, we prefer to stay away from overanalysing PBoC language –it’s not an important means of communication compared with, say, the statement Fed.
So what does this all mean? Our fist take is that China is trying to find ways to easy polity in a way that is (A) targeting the right sectors and (B) without cutting interest rates.
Why not cut rates? Because they want to avoid outflows from the (regulated) banking system into (little regulated) wealth management products and the shadow banking system.
Here is one really simple way to think about it: (1) Before, banks were against interest rate liberalisation because higher deposit rates would eat their profits. (2) So China had negative real rates for a long time and savers got ripped off, having to buy stuff like property. (3) Then everything started to change when wealth management products came along, and later online money market funds from the likes of Alibaba (see Yu’e Bao). (4) Money flowed out of the low interest rate banking system and scary things started to happen in the financial system. (5) Banks then changed their minds and became in favour of interest rate liberalization to allow them to compete against the shadow banking products. (6) So financial sector reform and clean-up is now supported by banks and by the central government (because the Xi-Li administration knows that any systemic blow up will happen on their watch).
So what’s next? Deposit guarantee is probably coming out really soon. Further developments in the fixed income market should come too. In parallel, the entire SEO system is getting a major shakeup. Assuming all this happens before anything blows up, China is back on track towards a functional interest rate transmission mechanism and a more efficient system of capital allocation.
Then Chinese people live happily ever after.
ETFs: FXI, GXC, CHIX
Courtesy of EM Bits Blog
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