Chinese economists clash over dovish monetary policy
Our briefing on critical developments in China's economy as of Friday, 10 January, 2025.
Our briefing on key economic and financial developments in China as of Friday, 10 January, 2025:
Leading Chinese economists debate the ramifications of Beijing’s plans to loosen monetary policy to levels last witnessed in the aftermath of the Global Financial Crisis.
China’s government debt could rise by 10% of GDP in 2025, on the back of Beijing’s fiscal stimulus plans to bolster the Chinese economy.
Chinese economists clash over impacts of loose monetary policy
China’s plans for major monetary loosening in 2025 have triggered intense debate amongst the country’s top economists.
Many analysts fear the move could undermine the banking sector, which would have dire effects on China’s financial system.
Dovish monetary policy could also crater the value of the yuan, raising the threat of abrupt capital outflows.
Beijing flags biggest stimulus since GFC
China is launching a huge monetary and fiscal stimulus campaign this year, as its economic growth comes under pressure.
In the first three quarters of 2024, China’s GDP saw YoY growth steadily decline, with successive prints of 5.3%, 4.7% and 4.6%.
Beijing believes the chief cause for ailing growth is weak domestic demand, as households continue to grapple with the damage caused by a multi-year property slump.
Pressure could ramp up in 2025, if China’s exports take a hit thanks to Trump’s proposed tariff increases.
In December 2024, the Central Economic Work Meeting announced that China would implement “moderately loose monetary policy” in 2025.
This marks the first time Beijing has used the phrase since 2010, when the world was still grappling with the fallout from the Global Financial Crisis.
Analysts forecast the unleashing of money and credit creation by China’s central government as a consequence.
Monetary loosening plans come under fire
China’s central bank will achieve its biggest monetary loosening since the GFC by two chief means.
The first is cuts to the required reserve ratio - the amount of money that commercial banks need to hold with the central bank. This will increase their ability to lend.
The second is cuts to interest rates, which will reduce the cost of funds for households and companies in China’s real economy. This could make them more likely to borrow, in turn spurring economic activity.
Some Chinese economists have attacked the central bank’s monetary loosening plan, saying it could have grave consequences for the financial system at this current juncture.
They argue that cutting interest rates could imperil Chinese banks, by reducing their loan revenues and undermining profitability.
Net interest margins at Chinese banks have long been under a tight squeeze, significantly narrowing their earnings.
Critics also argue that cuts could weaken China’s official currency, by reducing the returns on assets denominated in the yuan. This could in turn trigger large-scale capital outflows.
They point out that this effect could be very strong given interest rates in the US are still comparatively high, following efforts by the Federal Reserve to crush inflation by means of multi-year monetary tightening.
The argument for China to unleash more cash
Supporters of China’s monetary policy plans say the critics are wrong on both counts.
They believe looser monetary policy will only have positive impacts in 2025, as the country’s economy grapples with uncertain demand both at home and in key export markets.
Zhang Ming (张明), deputy-head of the Financial Research Institute of the Chinese Academy of Social Sciences (CASS), is one of the most prominent economists barracking for dovish monetary policy.
He firstly argues that weaker profits for Chinese banks as a result of lower interest rates could be a positive thing, by putting them under greater competitive pressure to increase efficiencies and search for new sources of earnings.
Zhang also points out that banks can also use coordinated action via industry bodies to reduce deposit rates, if they urgently need to maintain profit levels.
Why rate cuts won’t crater the renminbi
Zhang does not believe dovish monetary policy by China’s central bank will undermine the value of the yuan.
In his estimation, interest rates only have a limited impact on exchange rates.
He argues that the projected growth of national economies is a greater determinant of forecast returns on their financial assets compared to short-term interest rates, and thus also holds greater sway over currency values.
Zhang’s further argues that even if monetary loosening reduces the value of the renminbi, this could still be a positive outcome for China
According to Zhang, “an appropriate depreciation of the renminbi relative to the US dollar would not be a bad thing for the economy,” given what he believes to be current imbalances.
If a large-scale depreciation leads to sudden capital outflows, Zhang also believes the Chinese central bank has a full arsenal of tools at its disposal to stem the exodus, and effectively manage short-term fluctuations.
Zhang’s conviction is that it’s of far greater importance for China to exercise its own sovereign monetary policy, than to stabilise exchange rates and preserve the value of the renminbi.
“If China refrains from further loosening monetary policy in order to maintain the stability of exchange rates, this is a fundamental confusion of priorities,” he writes.
China’s debt could rise by 10% of GDP in 2025
Government debt in China could leap by 10% of GDP in 2025, on the back of its massive stimulus campaign to boost lacklustre growth.
The estimate comes from the Chinese Academy of Social Sciences (CASS) - one of the country’s top think tanks.
Beijing readies huge stimulus to deal with lacklustre demand
Domestic analysts believe the chief reasons for China’s faltering economic performance are weak consumption and investment growth.
The country’s multi–year property slump has caused major damage to the balance sheets of Chinese households.
Monetary and credit data in 2024 indicates that this has resulted in low willingness to borrow money for consumption or investment purposes.
China’s economy could come under even greater pressure in 2025. Strong exports were the one “bright spot” for the Chinese economy in 2024.
This could all change this year, however, with a new Trump administration posing the threat of higher tariffs, and some analysts also warning of trade tensions with rival emerging economies that compete in the same economic sectors as China.
The Central Economic Work Meeting held in December rang the alarm bell on challenges the country faces in 2025.
“At present, negative influences brought by changes in the external environment are deepening, and China’s economic performance still faces numerous difficulties and challenges,” the Meeting said.
According to the Conference, these challenges faced by China’s economy primarily include:
Inadequate domestic demand.
Operating challenges for many Chinese firms.
Pressure on employment and incomes.
The continued presence of multiple risks and hidden dangers.
As mentioned earlier in this briefing, Beijing now plans to launch potentially its largest fiscal and monetary stimulus package on record to deal with this array of issues.
The Central Economic Work Meeting called for “even greater fiscal stimulus” in 2025 - the first time this phrase has ever been employed by Beijing policymakers.
Some Chinese economists anticipate a 10 trillion yuan spending plan from Beijing - 2.5 times the size of the 4 trillion yuan GFC stimulus package in nominal terms.
Beijing’s rescue plan could send debt skyrocketing
The upshot of all this monetary and fiscal stimulus could be a massive increase in Chinese government debt.
CASS’s Zhang Ming expects new government debt this year to equal around 9 - 10% of China’s 2025 GDP.
This additional debt would consist of 5.2 trillion yuan in new deficit spending, plus 4.7 trillion yuan in special local government bonds, and a further 3 trillion yuan in special treasuries - for a total of 13 trillion yuan.
“This scale of broad deficit spending is rarely seen in history,” Zhang wrote.