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UPDATED: November 5, 2014 NO. 4 JANUARY 23, 2014
No Heavy Blow
The U.S. decision to taper quantitative easing will bring hot money out of China, but won't destabilize the Chinese economy
By Lan Xinzhen

EASING INFLATION: Residents buy vegetables at a supermarket in Hefei, capital of Anhui Province, on December 23, 2013 (DU YU)

Starting from January 2014, the U.S. Federal Reserve (Fed) cut its monthly asset buying from $85 billion to $75 billion. To elaborate, the purchase of long-term government bonds has been scaled back from $45 billion to $40 billion and purchasing of mortgage-backed securities has been cut back from $40 billion to $35 billion. The Fed's new move signaled a gradual withdrawal from the unconventional quantitative easing (QE) program, which was launched to support U.S. growth after the global crisis in 2008. The QE program aimed to bring down interest rates and encourage investment by buying billions in bonds and other securities. Monetary policy in the world's largest economy will now be tuned back to conventional policies.

China received large capital inflows because of the QE program, resulting in a higher inflation rate. The country's central bank had to raise interest rates and increase the reserve requirement ratio to curb inflationary pressure. Now, experts are highly concerned whether or not the end of QE will worsen China's liquidity conditions and destabilize the country's economic growth.

He Liping, a professor of finance at Beijing Normal University, said China upholds a prudent monetary policy in general. He suggested that preventing the U.S. QE exit strategy from destabilizing China's financial markets or macro-economy should be a key goal of China's monetary policies in 2014.

Limited impact

Since December 2013, China's stock market has witnessed a continuous drop. Analysts suggested this is related to the Fed's decision to trim its bond-buying program, as a great amount of "hot money"—speculative capital flows between countries in order to earn a short-term profit—fled from China's stock market, leaving behind a pessimistic atmosphere in the market.

He said the pessimism is completely unnecessary. "The U.S. exit strategy will exert a certain impact on China, but won't deal a heavy blow to the Chinese economy, because the United States has a clear logic and timeline in tapering QE."

He gives two reasons why China need not fear the tapering of the QE program. Firstly, it's a mild and gradual exit. Right now, asset purchasing has been cut by only $10 billion a month. This is a decision made after factoring in uncertainties in the U.S. and global economies and fully weighing the impact. Even if the U.S. economy takes an upward swing and economic data meet the required targets, the QE exit will still be mild, He claims.

Secondly, there will be intervals between each cut. Even with rosy economic conditions, the Fed will end QE by the end of 2014 at the current pace of cutting $10 billion each month. Considering downward trends and other uncertainties in the U.S. and global economies, it's likely that the Fed won't entirely exit from QE in 2014, He predicted.

China's economic growth rate bottomed out in the second half of 2013 and has stayed between 7 to 8 percent, which represents a positive growth trend. China doesn't need massive capital inflow to shore up economic growth, as that kind of growth pattern will bring with it a host of uncertainties, He said.

Wang Yong, a research fellow with CITIC Securities, claims the QE exit will result in an outflow of hot money from the Chinese market.

"If the capital flow reversal happens too fast, it may cause a cash crunch in China's capital markets. This will be the biggest impact on the Chinese economy," Wang said. "Even in that case, the stability of China's economic growth won't be compromised as China has hefty foreign exchange reserves that can cushion the impact of any market turbulence."

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