The Chinese government is whipsawing global financial markets with dueling policy changes as it attempts to navigate perilous economic waters in the transition from a production to consumer economy. On Friday last week, Chinese financial regulators announced that they were tightening margin restrictions and bluntly announced markets would not be allowed to become asset bubbles. This resulted in a worldwide sell off in financial markets, with the Dow Jones, S&P 500 and other major markets all down significantly on Friday.

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Late Sunday, the Chinese central bank announces a new $200 billion lending program to stimulate its slowing economy, and the markets rebounded, making up most of the ground lost late last week.

Coordinated action by China

An article in the Wall Street Journal suggests that the Chinese central bank and securities regulator seem to be taking coordinated action in a delicate economic ballet designed to stimulate but minimize asset bubbles.

On Sunday, China’s central bank announced it was making close to $200 billion available for new lending by reducing the reserve requirement ratio for banks, a stimulus measure that will put more money into the decelerating economy

Of note, the moved by the People’s Bank of China came only two days after the securities regulator cut back significantly on sources of new funding for margin financing (borrowing to buy stocks). Analysts point out that Shanghai’s main stock index is up more than 100% over the last year, fueled by a rush of new investors and rapidly increasing amounts of stocks bought on margin.

If the pas de deux between the two regulators works out well, the dovetailing policies could lead more of the new lending into productive sectors of the economy, and prevent it from being used to drive further asset bubbles in the stock market.

Statement from analyst

“The move was widely expected, given last week’s weak data releases,” noted Qu Hongbin of HSBC in Hong Kong noted in a research note published Sunday. “However, the magnitude of the cut — the largest since November 2008 — signals Beijing’s heightened concerns over the growth slowdown,” he pointed out. Qu suggests the lower reserve requirement will free up 1.2 trillion renminbi ($200 billion) in new funds for lending.

Mark Williams of Capital Economics said in a note to clients:

Sunday’s cut to the required reserve ratio for China’s banks signals a stepping-up of policy support. The 100bp cut was double the usual size and the first move on this scale since late 2008. It is primarily a response to the weakness of recent data. Most of the activity and spending data for March came in below consensus. We suspect this was partly the result of lingering disruption from Chinese New Year. But downside risks to growth appear greater now than they did a month or two ago. Further RRR cuts are likely – perhaps another 150bp before the end of the year – along with at least one more cut to benchmark rates.

Market interest rates have declined recently (see Chart below) but are likely to fall further. Meanwhile, the economic boost that the RRR cut gives by increasing banks’ capacity to lend should be compounded by the signal it sends of the government’s determination to shore up growth. We remain confident that the government can meet its “about 7.0%” GDP growth target. After all, the RRR is still high; there is plenty more room to act.

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