3 Reasons Why China Won’t Launch Another Stimulus Program

Investors kinda went loco earlier this week after Premier Wen Jiabao said that “downward economic pressure is increasing” for the world’s second largest economy. They took his words to mean that the Chinese government may soon launch a massive stimulus program, similar to the 4 trillion CNY package it had in place at the wake of the 2008 financial crisis.

With China seeing weaker demand for its exports, a cooling real estate market, and lower bank lending, I guess the reaction wasn’t all that surprising. Almost everyone knows that the country’s economic growth is slowing. Heck, market gurus have estimated that China’s GDP will slip below 8% for the first time in three years for April to June 2012.

And so, it only made sense to think that Chinese officials would want to stimulate growth with another fiscal stimulus program, right? However, they won’t. Here are three reasons why:

Inflation and debt will rise

For one thing, the fiscal package launched back in 2008 led to a sharp spike in inflation and left China with a huge pile of debt. At that time, the ongoing easing programs triggered a wave of speculative real estate developments and surging house prices, which prompted worries of an asset price bubble.

Because of that, annual inflation eventually jumped to a three-year high and led to concerns that the Chinese economy was overheating. It didn’t help that the local governments had to deal with a mountain of debt amounting to more than 10 trillion yuan.

Less-aggressive options are available

With that in mind, China might want to consider other less-aggressive options. Cutting the reserve ratio requirement (RRR), which is the amount of cash banks hold in their vaults, is already a tried-and-tested measure by the PBoC. They could opt to adjust the RRR again in order to increase liquidity in their monetary system, eventually boosting spending and investment.

Another option for China would be to go for a modest increase in government spending, as economic analysts believe that China should be able to spur growth without resorting to excessive stimulus. By implementing more infrastructure-related projects such as building airports, providing subsidies for energy-efficient appliances, and inviting the private sector to invest in railways and other state-own industries, the Chinese government would be able to keep their economy on its feet.

Banking crisis? Not a concern!

Come to think of it, China doesn’t really have to go all out when it comes to injecting more stimulus because a banking crisis is the least of its concerns. After all, China’s banking sector is different from other economies’ since it is mostly owned and controlled by the state. That means, unless the Chinese government finds itself deep in debt and defaults on its obligations, China’s local banks don’t really have much to worry about.

In the short-term, the news of China not launching any immediate and massive stimulus could be bearish for higher-yielding currencies. With Europe sinking into a recession and U.S. economic recovery still looking pretty fragile, China has been one of the brighter spots in the global economy and giving investors reason to seek “riskier” assets.

However, this not-so-old man agrees with Chinese officials that the economy is not in such a dire state that would require another massive fiscal stimulus. But it can’t be denied that the Asian superpower needs to implement some reforms to sustain its economic growth in the long run, not just for its sake, but for the sake of the global economy as well.