PBOC cuts RRR to avoid “trade cold war” risk
RRR cut to help ease tight liquidity in the near term, but tackling trade cold war risk requires structural reforms On the last day of October Golden Week, China’s central bank announced that, effective Oct 15, 2018, it will cut the RRR for depository financial institutions by 1pp. The cut is partly to offset the Rmb450bn medium-term lending facility (MLF) maturing that day, and partly to release additional liquidity of Rmb750bn, totaling about Rmb1.2trn. The cut was bigger than expected, which will help to counteract the negative impact of news released during the Golden Week, including the deteriorating trade dispute, lower-than-expected China manufacturing PMI, as well as concerns about falling property prices in a number of cities. Coming ten days after the Fed’s third rate hike this year, the RRR cut sends a strong message of policy easing. Cyclical policy has already bottomed out. However, moving in the opposite direction to the Fed and reacting to trade disputes with cyclical policies now appear a matter of urgency. Only structural reforms such as tax cuts and SOE reform can improve market expectations and confidence.
The disputes between China and the US have escalated to non-trade matters in the past week Looking at past trade wars, the China-US trade disputes could deteriorate in two different directions: from trade to technology and the financial markets, as with the US-Japan trade war, and from economic confrontation to non-economic areas, as during the US-former Soviet Union cold war. The speech delivered by Vice President Pence on Oct 4 has opened the door to a trade cold war, which would be a combination of a trade war and cold war. The US wants to reduce reliance of key global production chains in China as a way of tackling the threat from China as the world’s second largest economy. It also wants to make sure that China’s development occurs within the global order dominated by the US (ideological cold war). We reiterate our view that the trade war between the world’s two largest economies will end with a winner and a loser, and that this may take 5-10 years or more to play out.
China’s reaction to a trade cold war would be key to the direction and outcome of the dispute How the trade disputes will end remains uncertain. China’s responses to US requests will be more important than US responses to China. From a global and China perspective, China’s rise and its trade dispute with the US is a structural issue, not a cyclical conflict. Thus China should react with more structural measures and less cyclical remedies; or cyclical measures (such as RRR cuts) should only be introduced to buy more time to roll out structural reforms. It would be difficult for China and the US to decouple completely, but the two are likely to be less connected, and more regionalized and fragmented going forward. We believe China should open up its economy to the rest of the world further with tariff cuts, and more importantly, work internally to make consumption and innovation new growth drivers of a high-quality development era.
Policy easing without structural reforms could be a source of stagflation and renminbi devaluation Cyclical policy support can help to relax liquidity conditions needed to improve corporate financing and ease the pressure on property prices, while also partly offsetting falling external demand due to the trade disputes. However, the cold war logic illustrated by Vice President Pence’s speech, the poison pill provision of the US-Mexico-Canada deal, rising oil prices and currency depreciation in emerging markets will all put pressure on China’s inflation going forward. Headwinds such as a rising US 10-year treasury yield, RRR cuts and other cyclical measures can neither revive traditional growth drivers nor foster new drivers, which will inevitably lead to stagflation. Policy easing alone can thus add further pressure on renminbi depreciation.