3 Reasons Why China Shouldn’t Ease Monetary Policy

Touted by many as the engine for global economic growth, market participants are often on their toes for economic data from China. Unfortunately, recent data from the world’s second economy haven’t exactly been inspiring.

For instance, the country’s exports only rose by 1% compared to a year ago in July. It was reported last week that the country’s trade surplus during the month was only at 25.1 billion USD and fell short of the market’s forecast of 31.5 billion USD.

Industrial production and retail sales for the month also slowed. Output produced by Chinese factories only expanded by 9.2% when it was predicted to tap 9.8% to follow June’s 9.6% growth. Meanwhile, consumer spending continued to slump as the annual retail sales only posted a 13.1% uptick from the 13.7% expansion we saw the month before.

With all these negative reports, it’s easy to see why many have started to worry if China could sustain its growth. Consequently, calls for government action in the form of more monetary easing from the People’s Bank of China (PBOC) have gained steam.

It also helps that the most recent inflation report from China showed that the central bank still has room cut interest rates or reduce the RRR for banks in order to stimulate the economy. The country’s inflation rate only rose by 1.8% following June’s CPI of 2.2% and that’s well below its peak at 6.5% in July 2011!

Slowing growth and lower inflation. It seems like the stars aligned for the PBOC to loosen monetary policy even more, right? Err, making that decision may not be that easy. There are those who say that perhaps further easing isn’t the solution for China.

Here are three reasons why:

1. It could add to more bad loans and possibly worsen the real-estate bubble.

They say that the surge of easy money in the economy would fuel sour debt even more. Bad loans issued by Chinese banks were said to have risen to 18.2 billion CNY for a third consecutive quarter in Q2 2012 to 456.4 billion CNY. It has been estimated that about 35% of these bad loans are related to Chinese property.

With that said, higher liquidity could only worsen the country’s real estate bubble. Demand is still dismal for properties that were built following the government’s 2008 stimulus program that propelled the economy, leaving China with a bunch of ghost-like housing and business developments.

2. It would make China’s rebalancing act more difficult.

In relation to that, further monetary policy loosening would make China’s plan of rebalancing its economy more difficult.

Remember that China has been much criticized for its economic model. Aside from being reliant on exports, it also depends heavily on investment.

Don’t get me wrong. Investments are good news! However, an investment-led growth isn’t as sustainable as a consumption-led one. It’s also a problem for China because a chunk of its investments, as evidenced by ghost town-like cities in the country, have proved to be wasteful.

The country’s GDP for Q2 2012 has already reflected the growing need for the government to rebalance the economy. Data showed that China the slowest pace we’ve seen in three years at 7.6%.

Looking deeper, we see that infrastructure investments that account for 13% of the GDP, was down at an annual rate of 16.6% from 32.9% last year. And although consumption as a part of the Chinese GDP was more than double at around 30%, it comes in just over half of the global average.

3. Its effects are limited on growth.

There are also those who argue that loans brought about by lower borrowing costs have a diminishing effect on growth.

In the years leading to the 2008 financial crisis, economic gurus have estimated that 1 CNY of loan contributed 1.05 CNY to GDP. However, in 2009 to 2011, 1 CNY of loan only generated 0.61 CNY of growth. This has led a few naysayers to question if it the risks associated to more easing would be worth it.

So what should China do? It should focus more on boosting consumer spending. Of course, there are various ways to do this. Some economic gurus say that the government could implement measures to increase consumer income by boosting wages and reducing taxes. Meanwhile, others suggest revaluing the yuan.

Unlike monetary policy easing though, these measures wouldn’t make the country’s GDP look pretty in the short-term. However, in the long-run, they would lead to a more balanced economy which won’t only be good for China, but the global economy as well.

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