Injecting $188 billion

China managed to extricate itself from the pandemic's effects before the Western world. It is hoping to do the same with its economy. The country has decided to undertake two big changes to its monetary policy in the form of stimuli to revive the economy. Firstly, it is intervening in the financial system or banks. The Chinese Central Bank has decided to relax solvency and capital requisites this week, reducing banks' obligatory cash reserves by 50 base points. This will expand the credit that banks can offer the private sector, mainly in the form of mortgages.

By allowing banks and credit entities to keep less cash on hand, more money can be spent on buying homes and refinancing the property market. This is intended to tackle notorious cases, like the mounting debts of the giant property firm, Evergrande, whose liabilities exceed $300bn.

It is the stuff of financial nightmares

The move to reduce mandatory bank reserves means reduced deposits and more lending to firms and households, which means full-blown monetary expansion. All of this will mean an extra $188bn injected into the Chinese economy to generate productivity and cut the cost of financing for firms and families.

You might say the Chinese Central Bank and government are being too bold, but even with a reduction in mandatory cash reserves, the proportion for Chinese banks stands at 8.4% of all deposits, which is more than acceptable for a country with such pronounced growth rates. Likewise, China's latest annual inflation figure was 2.3%, considerably below Western rates, which mitigates the risks of overheating in the economy. For now, the country has considerable room for maneuver in managing growing liquidity while acting to revive economic growth.

Specter of stagflation

China is also adopting expansive measures in terms of land tender and debt repayment facilities for construction firms. This will ensure work does not grind to a halt because of a lack of liquidity and enable firms to initiate new projects that kickstart a range of economic activities.

Lastly, the Chinese Central Bank is also acting to curb the Yuan's appreciation, by raising banks' obligatory foreign-exchange reserves from 7% to 9%, after raising them in June 2021 from 5% to 7%. The country had not taken such measures since 2007, but its currency has risen 10% against the euro this year and 3% against the dollar, which is bad for exports. In other words, when the domestic economy is affected, the country must refocus on foreign trade, which always does better with a cheaper currency.

Failure brings to mind the dreadful notion of stagflation

Certainly, the Chinese government took restrictive measures early in 2021, like imposing a tax on construction firms to avoid excessive leverage (or borrowing more), often for irrational investments, but also to reduce social inequalities. But that was when the authorities foresaw an 8% annual growth rate, not the current 5%.

China has reacted to signs of stagnation, though it will appreciate that what is valid today may not be so tomorrow. Hopefully, it will attain the right balance between growth, inflation and expanding liquidity, so the same can be done in the West.

Failure here brings to mind the dreadful notion of stagflation: depreciating money without economic growth. To happen in China — which fuels so much of the rest of the global economy — would be the stuff of financial nightmares.