Beijing’s lessons for central banks
Contrary to widespread concerns over an imminent hard landing, China will defy the naysayers.
Even after premier Wen Jiabao’s latest warning over a moderate slowing of growth, it is doing a far better job in managing its economy than most give it credit. It even offers some lessons in macro policy strategy that the rest of the world should heed.
Nowhere is that more evident than on the inflation front, where Chinese authorities have waged a very successful campaign against what has long been the nation’s most destabilising economic threat. After peaking at 6.5 per cent in July 2011, the headline consumer price index (CPI) has decelerated to 4.5 per cent in early 2012, with more disinflation likely in the coming months.
This reflects the impacts of three very deliberate policy actions taken by Beijing.
First, administrative measures were put in place to deal with bottlenecks in agriculture – pork, cooking oil, fresh vegetables and fertiliser. Food inflation, which accounts for about one-third of the items on the Chinese CPI, peaked at 15 per cent in mid-2011. It has slowed to about 10 per cent.
Second, bank required reserve ratios were raised 12 times in 2011 to slow credit growth. The results are encouraging. Renminbi bank loan growth decelerated from 19.9 per cent in 2010 to 15.8 per cent in 2011 and renminbi deposit growth slowed even more sharply from 20.2 per cent in 2010 to 13.5 per cent in 2011.
Third, the People’s Bank of China (PBoC) raised policy interest rates five times in 2011. This was particularly important in light of the acceleration of non-food, or core inflation, to a 3 per cent high last northern summer – the sharpest such increase in more than a decade. Had the PBoC not acted, underlying inflationary pressures could have intensified further. Instead, they have now begun to moderate – with non-food CPI inflation easing off to 1.8 per cent in January 2012.
This three-pronged approach – in conjunction with a modest acceleration in renminbi currency appreciation – is an important example of China’s increased prowess in macro policy stabilisation.
Particularly significant was the central bank’s willingness to take its policy rate – the one-year benchmark lending rate – up to the peak headline inflation rate of 6.5 per cent last northern summer.
By doing so, the PBoC not only ended the excessive accommodation imparted by negative real interest rates but it was then able to orchestrate a “passive” monetary tightening – allowing real short-term interest rates to climb to 2 per cent as administrative actions took food price and headline inflation lower in the second half of 2011.
This is classic central banking at its best. China now has plenty of ammunition in its monetary policy arsenal – namely, high required bank reserve ratios and positive real short-term interest rates – to deploy as circumstances dictate. In contrast, the US Federal Reserve, the European Central Bank and the Bank of England are out of traditional ammunition. They have followed the Bank of Japan and taken their short-term policy rates down to the zero bound.
As a result, the world’s big central banks have been forced to rely on untested and dubious liquidity injections as the primary means of monetary control. Where this ends and what it implies for the future – inflation, another outbreak of asset and credit bubbles, or some combination of all that – is anyone’s guess.
In the event of a downside shock to its economy, Chinese authorities have ample scope to ease. With economic activity slowing, they have already taken modest actions in that direction with two recent 50 basis point cuts in the required reserve ratio to a still very high 20.5 per cent. At the same time, with real policy rates at 2 per cent and likely to rise a little further as headline inflation eases, there is plenty of scope for traditional monetary easing if there is further weakening in the economy. The west – out of basis points and with massive budget deficits – has no such option.
In a crisis-prone world, there is a gathering sense of foreboding over China. First it was the US, then Europe. Now there are growing fears the Chinese economy must be next. It’s not just the hand-wringing over inflation but also worries of a huge property bubble, a banking crisis or social unrest.
Those fears are overblown. China is cut from a very different cloth than the advanced economies of the west. Long focused on stability, it is more than willing to accept the short-term costs of a growth sacrifice to keep its development strategy on track.
A successful battle against inflation is an important example of the interplay between China’s tactical imperatives and its overarching strategic objectives. That’s a lesson the rest of the world could certainly stand to learn.
Stephen S. Roach, a member of the faculty at Yale University, was formerly chairman of Morgan Stanley Asia and is the author of ‘The Next Asia’