Will China Use All Three Interest Rate Tools Ahead of GDP Announcement?

Lockdown Hits Consumption Hard... Q1 Economic Growth Likely to Plunge to 4% Range
Abundant Funds in M1 and M2 Markets Raise Doubts About Interest Rate Cut Effects

[Asia Economy Beijing=Special Correspondent Jo Young-shin] Ahead of the announcement of the first quarter Gross Domestic Product (GDP) indicator on the 18th, the Chinese government has signaled an interest rate cut. As the domestic and international economic environment rapidly deteriorated due to consumption contraction caused by the resurgence of COVID-19 and the rise in international raw material prices due to Russia's invasion of Ukraine, the government hinted at using monetary policy measures.

[Image source=Yonhap News]

Within China, it is estimated that the economic growth rate for the first quarter will be only around 4.5% compared to the same period last year. This figure is a full 1 percentage point lower than the Chinese government's target of around 5.5% for this year.

According to Chinese media including the state-run Xinhua News Agency on the 14th, Premier Li Keqiang held a State Council executive meeting the day before and instructed to prepare measures to expand financial support to stabilize the real economy.

At the meeting, Premier Li emphasized consumption multiple times, stating that consumption is the driving force behind the economy. He urged immediate provision of necessary funds to industries closely related to people's livelihoods such as the food service industry, retail, and tourism. Premier Li particularly mentioned the reserve requirement ratio (RRR), stating the need to timely utilize monetary policy tools that help the real economy.

◆ Possibility of all three Chinese interest rates being cut = The monetary policy tools used by Chinese authorities mainly include three types: RRR, Medium-term Lending Facility (MLF) loan interest rate, and Loan Prime Rate (LPR), which is equivalent to the benchmark interest rate. The RRR is the cash ratio that commercial banks must deposit with the central bank. Typically, a 0.5% cut creates an additional lending capacity of 1.2 trillion yuan (approximately 231 trillion KRW). Premier Li's mention of the RRR essentially means "lend money to the market."

Another tool is the MLF. The MLF is the interest on policy funds supplied by the People's Bank of China, the central bank, to banks and other financial institutions. It has the effect of reducing the interest burden on banks and financial sectors. Last December, when adverse factors such as rising international raw material prices and coal shortages occurred, the People's Bank of China sequentially cut the RRR, MLF, and LPR interest rates.

The strongest tool is the LPR. While the RRR and MLF target financial institutions as fund suppliers, the LPR targets financial consumers. Although cuts in RRR and MLF interest rates create room for financial institutions to lower their own lending rates, this is limited. Lowering the LPR reduces overall interest rates, significantly expanding credit.

Currently, within China, there is a strong atmosphere that the MLF interest rate will be cut on the 15th, along with a likely RRR cut within this week. Additionally, depending on the GDP results scheduled for the 18th, there is speculation that the government may use the LPR tool on the 20th. This means all three available tools could be used.

◆ China's burden regarding monetary policy = Within China, there is general agreement on the necessity of interest rate cuts, but opinions differ somewhat on their effectiveness. Currently, a flood of special bonds issued by local governments has already released sufficient funds into the market.

In fact, the scale of new yuan loans in the first quarter was 8.34 trillion yuan (1,616.3 trillion KRW), an increase of 663.6 billion yuan compared to the same period last year. This is the largest increase ever recorded for a first quarter.

As of the end of March, the M2 (broad money supply) balance, which indicates cash liquidity in the market, reached 249.77 trillion yuan (48,411 trillion KRW), a 9.7% increase compared to the same period last year. The M1 (narrow money supply) balance also increased by 4.7% year-on-year to 64.51 trillion yuan. This means there is abundant idle capital in the market.

China Minsheng Securities analyzed in a report, "Although the need for an immediate interest rate cut is being raised, the impact of such a cut on the market may be limited." It also noted, "While concerns about internal issues (COVID-19 spread) are significant, concerns about external factors such as global conditions are also considerable." This points to the risk that aggressive monetary policy could lead to side effects such as inflation caused by excessive money supply in the market.

◆ Domestic consumption blocked by lockdowns in China = At the State Council meeting held the day before, Premier Li emphasized five major points related to the real economy, all connected to domestic consumption. He instructed immediate financial support for the food service industry, retail, and tourism; fostering new consumption integrating online and offline; promoting consumption in key sectors such as automobiles (partial easing of license plate regulations) and home appliances; expanding consumption in rural areas; and easing regulations that hinder consumption expansion. This meeting was essentially focused on domestic consumption, a key pillar of the dual circulation policy.

The problem is that the COVID-19 spread is expected to continue until May. The Qingming Festival holiday effect in April disappeared due to the epidemic starting in March, and the upcoming Labor Day holiday from April 30 to May 4 is also unlikely to bring relief. The second quarter growth rate is inevitably expected to fall short.

Wei Jianguo, Vice Chairman of the China Center for International Economic Exchanges (former Vice Minister of Commerce), said, "Among the three pressures China faces (supply shocks, demand contraction, and weakened expectations), consumption will determine China's economy this year." He added, "Since the service industry is likely to be hit hard by the epidemic, more active government support for this industry is necessary."