China explores bond buying in first hint of QE

“Chinese-style’ QE is being considered, but would only happen after a sharper economic slowdown,” said Stephen Greene and Becky Liu from Standard Chartered.

They said the central bank is looking at all options except RRR cuts, and could circumvent a ban on direct financing of government debt by using intermediate buyers. One motive would be find a new source of stimulus as the central bank slows the accumulation of foreign reserves, a policy now deemed counter-productive as holdings near $4 trillion.

Standard Chartered said it would amount to “money printing”, and would be a remarkable turn of events given Beijing’s caustic comments about the “irresponsible” monetary policy of the US Federal Reserve.

“For the Chinese to consider domestic bond purchases would be a significant move,” said George Magnus, a senior adviser to UBS. The authorities might conclude that QE packs more punch than further RRR cuts, and would be a better way to steer stimulus directly into social housing or local government finances where it is most needed without reigniting the lending boom in the wrong places.

Analysts said there may be concerns that cuts in the RRR or other conventional forms of loosening would leak out into the shadow banking system, already over a quarter of China’s $25 trillion credit edifice. The central bank is looking at surgical tools, comparable to the Bank of England’s funding for lending in some respects. “What is significant about this is that QE is not being viewed as last resort, but as a possible way of injecting controlled stimulus,” said one expert.

The authorities seem willing to tolerate to lower growth so long as it does not lead to higher unemployment. This is now a risk as the property market deflates and building projects are cancelled. Construction makes up 10pc of employment directly, and almost 20pc indirectly. It generates 39pc of the government’s total tax revenue through land sales and taxes.

Home sales dropped in China’s 27 largest cities dropped 30pc in January from a year earlier. Inventory has risen above 24 months supply in nine of these cities, according to the property group Vanke.

Zhiwei Zhang from Nomura said the authorities are already switching gears, with the central bank injecting over $30bn a month into the economy through its relending facility, a loan scheme based on collateral. Combined measures amount to a “mini-stimulus” package worth 0.8pc of GDP, led by spending on water projects, railways, and the renovation of shanty towns, though it is small beer compared to the fiscal blitz after the Lehman crisis.“It should defer the risk of a hard landing to 2015,” said Mr Zhang.

The ministry of finance said on Wednesday that it was urging local governments to boost spending and speed up payments. “The economy faces pressure, and some difficulties cannot be underestimated,” it said.

All kinds of skeletons are coming out of the cupboard as the credit bubble deflates. Caixin Magazine reported this week that the state-backed shipping group Nanjing Tanker had been forced to delist from the stock exchange after hiding “a massive amount of debt off its balance sheets”.

Soho China, one of the country’s biggest property groups, caused consternation last week by comparing the Chinese housing market to the Titanic. “After hitting the iceberg, the risks will not only be in the real estate sector. The bigger risk will be in the financial sector,” said the group’s chief executive Pan Shiyi.

The collapse will infect the shadow banking system, causing havoc for trusts and wealth products. “When housing prices fall 20pc to 30pc, these problems will be all exposed,” he said.

There is an intense debate over whether deflation risks becoming lodged into the economy. Producer prices have fallen for the last 26 months, dropping by 2pc in April. Consumer price inflation has fallen to 1.8pc, far below the central bank’s de facto target of 3.5pc.

The balance sheet of the Chinese central bank has already grown enormously since 2008, matching the QE in the US, but it has done so by accumulating foreign bonds to hold down the yuan. Purchasing bonds internally would be leap in the dark, but strange things are happening in China’s economy.

The yuan has fallen 3pc against the US dollar this year. The longer this goes on, the more the suspicion grows that China is protecting the wafer-thin margins of its export industries by allowing the exchange rate to fall.

This is leading to grumbling in Washington and Brussels that China is exporting its excess capacity – and therefore deflation – to the rest of the world. Nobody can object to quantitative easing. Everybody is playing that game now.

more