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China's Loose Credit Gambit

While other major economies are taking steps to tighten credit, China is acting to cheapen it, in order to revive its economic activity and help big firms repay their debts. But will it fuel global inflation, or worse, stagflation?

​Chinese walk past the People's Bank of China, the country's central bank, in Beijing

Chinese walk past the central bank in Beijing, China

Manuel Romera Robles


It has recently become clear that Chinese economic growth is losing steam after a third consecutive negative quarter and a fragile 4.9% annual growth rate. This is starkly below China's average historical long-term growth rates and has depressed its stock market values. But China is not a country easily deterred by challenges and has decided to apply the principle that big problems need big solutions.

We are now seeing the world's economic blocks take drastically different approaches. The United States and Europe are envisaging restricting credit flows in the economy by raising interest rates, while China has chosen the opposite: pulling out all the stops to inject cash and increase liquidity.

In recent weeks, we have seen the U.S. Federal Reserve withdrawing stimuli through its feared "tapering" mechanism (purchasing fewer assets) to control an already significant inflation rate. The current year-over-year inflation rate is 6.8%, the highest in 40 years. The European Central Bank (ECB) and its members are also debating how much to cut back on monthly liquidity injections. The Chinese government, however, is devising new monetary stimuli to reactivate its economy.

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.

Pedestrians walk past the Chinese state-owned commercial banking company Bank of China branch in Hong Kong.

Brands and Logos in Hong Kong, China

Budrul Chukrut/SOPA/ZUMA

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.

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