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No Conditions for Chinese-Style QE
 NO. 43 OCTOBER 22, 2015

China's central bank on October 10 announced plans to expand a pilot program on credit assets to nine municipalities and provinces. The program allows banks to pledge assets to borrow from the central bank.

In August, China's top legislature adopted an amendment to the law on commercial banks, removing the 75-percent loan-to-deposit ratio stipulation.

Both measures have been interpreted by some financial institutions as a stimulus of 7 trillion yuan ($1.11 trillion) and a "Chinese-style quantitative easing (QE)" policy adopted by top decision makers.

Such judgment lacks logic. There is neither a so-called 7-trillion-yuan stimulus, nor Chinese-style QE.

However, it is logical to say China's central bank intends to relax the money supply.

The estimated 7 trillion yuan of credit supply is the amount of deposits multiplied by the loan-to-deposit ratio. A maximum of 75 yuan ($12) for every 100 yuan ($16) of deposits can be released for credit after the loan-to-deposit ratio regulation is removed.

The country's current deposits total more than 100 trillion yuan ($15.8 trillion), so approximately 7 trillion yuan in credit could be made available with the money likely going to the stock and real estate markets.

But the loan-to-deposit ratio doesn't constrain the commercial banks' credit supply, because financial institutions' current ratio, particularly in listed banks, is not excessively higher than the limit.

The general loan-to-deposit ratio in Chinese commercial banks is 65.8 percent. Among the listed banks, China Merchants Bank is the only one with a slightly higher rate at 76.88 percent.

The real factors constraining commercial banks' credit supply are the weak financial demands in the real economy and the banks' low appetite for risk.

The intensifying anti-corruption campaign, decreasing investment in real estate and a reduction in manufacturing capacity have all reduced demand for lending.

The overall slowing of the economy has also spurred commercial banks to be more prudent when offering loans.

Credit demand from the real economy is what will stimulate a relaxation in the credit supply.

Facing credit demand, commercial banks will definitely try every route to bypass restraints from the supervisory authority, including the loan-to-deposit ratio.

Therefore, relaxing the loan-to-deposit ratio is aimed at reducing interest rate fluctuations in the market, which has nothing to do with the so-called "7-trillion-yuan stimulus."

Why don't I agree that pledging assets for credit is equal to the Chinese version of QE and a strong stimulus? This is because QE is not what China needs right now.

Usually two conditions are necessary for the use of QE.

First, a huge amount of liquidity is lost during a financial crisis, which pushes up the interest rate in the monetary market.

The central bank has to release more liquidity to curb interest rate fluctuations. Financial institutions are then able to make up for the liquidity shortfall and avoid selling assets or reducing the credit supply.

Second, conventional monetary policy tools don't always work.

For instance, in Japan in 2012 and in Europe in 2014, the benchmark interest rate dropped to almost zero, and the reserve requirement ratio was rendered incapable of helping to release liquidity.

In China, conventional monetary policy tools are still working and there are no uncontrollable risks, despite the Chinese economy facing downward pressure. Therefore, China will not resort to QE in such a hurry.

So what is the policy intention of expanding the pilot program on credit assets?

First, it can serve as a new channel to replenish the monetary base. Second, it can function as a new monetary policy tool to balance the targets of ensuring stable economic growth and transforming the economic growth pattern. Third, it can stabilize loan interest rates.

Since the new reform on the yuan exchange rate began on August 11, the Chinese central bank has been offsetting the impact of declining funds outstanding for foreign exchange through measures such as reverse repurchase, standing lending facility, mid-term lending facility, cutting interest rates and the reserve requirement ratio and expanding the credit asset program. It's obvious that the primary intention is to stabilize interest rates.

This is an edited excerpt of an article written by Li Qilin, chief bond analyst of Minsheng Securities Co. Ltd., and published in National Business Daily 

Copyedited by Jordyn Dahl

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