China’s Central Bank Has Better Stimulus Options Than the Fed

The People’s Bank of China could supplement its use of credit channels with the ‘whatever works’ approach of western institutions. This article was originally published in the Financial Times.

Western depictions of the relative performance of the US Federal Reserve and the People’s Bank of China invariably present the former as sophisticated and proactive, while the latter is portrayed as reactive and bureaucratic. If you take a moment to examine these preconceptions, you can see how wrong they are.

The firepower of central banks is under intense scrutiny as countries look for ways to claw themselves out of recession induced by the spread of Covid-19. While the Fed has taken to loading its balance sheet with bonds and taking corporate credit risk for the first time, the PBoC has resisted traditional quantitative easing.

With US equity markets soaring and credit spreads tightening materially, most of the plaudits have gone to the Fed. But when you take a more nuanced look, it becomes clear that the PBoC is successfully engineering a recovery without recourse to unconventional policy and the moral hazard that comes with it. It is also clear that chairman Yi Gang has more options at his disposal than his US counterpart, in the event that the crisis worsens.

In 2014-15 there was a deflationary scare in China, as falling oil and metals prices cut costs for China’s factories. Back then, the policy response was to stimulate the economy by dramatically expanding credit through the system — which the PBoC did in the early months of 2016.

A good way of illustrating this is the so-called credit impulse, which calculates the annual change in new credit as a percentage of gross domestic product, and typically leads economic activity.

On my definition of this measure, the credit impulse increased to 20% in the wake of the 2008 financial crisis and rose again during the sovereign debt crisis of 2012 and the 2015 deflation scare. In periods of relative calm, meanwhile, the credit impulse tends to fall: to -8% in 2011, -7% in 2014 and -6% in 2018.

In this latter period, the PBoC tried to rein in some of the excesses in credit that it viewed as a threat to longer-term systemic stability. The move was largely aimed at the shadow banking sector, which encompasses all loans extended by financial companies that do not typically have a banking licence and do not collect deposits.

Before the onset of Covid-19, I was starting to get more optimistic about a cyclical recovery globally, and one component of it was the diminishing drag from that shadow banking crackdown in China.

Since the coronavirus outbreak, the PBoC has stood apart from the trend seen in many developed economies — and even some emerging markets — to use its balance sheet to buy government bonds. There has been fierce policy debate on this point and, so far, orthodoxy has prevailed.

Instead, the PBoC is reverting to its familiar response, which is to lean on the credit channel to stimulate the economy. Of the 30 or so different policies announced by the central bank over recent months, more than three-quarters relate to credit.

Meanwhile, it is notable that the non-bank share of overall total social financing (‘TSF’), a broad measure of liquidity and credit in the economy, has expanded again. Gains are driven mostly by the issuance of corporate bonds, but even trust and entrusted loans — the bread and butter of the shadow banking system, whereby non-banking institutions lend to one another — have recovered.

This year non-bank financing is on pace to contribute 16% of overall growth in TSF. That is a significant increase from 6% last year, and a negative contribution in 2018. The acceleration should lift the credit impulse and, in turn, economic activity.

Critics will argue that the PBoC is pushing on a string. Maybe, but it was a common argument three months ago that the Fed was out of options. It appears to us that the PBoC has more avenues open to it than its US counterpart, particularly if it supplements its use of credit channels with the “whatever works” approach that seems to be the default mode for western central banks.

It is true that stimulation through relatively opaque, non-bank credit channels might do little to resolve longer-term questions over the structure of the economy. But in a crisis such as this, such concerns must be saved for another day.

In the meantime, the PBoC’s ability to steer the dynamics of its credit impulse may mean China can recover faster from Covid-19, and suffer less economic impairment, than large parts of the west.