China to ease policy further as growth cools, trade war weighs

China is keeping all its economic policy tools within reach as the trade war with the United States gets longer and costlier, but still sees more aggressive action like interest rate cuts as a last resort should the dispute get uglier, policy sources say.

Heading off a sharper economic slowdown remains Beijing’s top priority, though officials fear easing too much could fuel debt and financial risks, according to government advisers involved in internal policy discussions.

The Politburo, a top decision-making body of the ruling Communist Party, is expected to meet later this month to discuss economic and policy issues for the rest of 2019.

Barring a trade meltdown or other shock, the most likely options to boost growth in coming months include more fiscal spending and liquidity infusions by the central bank in various forms, sources said, building on similar steps over the past year.

But financial markets may be more focused on what China signals in early August, if the US Federal Reserve cuts interest rates as widely expected on July 31.

While a Fed cut would give China more room to move, possibly with a symbolic trimming of its short-term market rates, Reuters sources said there was no urgency do so, noting there is already ample liquidity in the financial system and asserting earlier stimulus measures are showing signs of kicking in.

“Monetary policy should be a bit looser, we should cut rates after the Fed but the benchmark rate is not very useful,” one said.

But a second source said the central bank could still cut the benchmark if economic conditions deteriorate sharply.

“Under special circumstances - if the external shock is strong, the Fed continues to cut rates and the global economy is bad and trade frictions return - it’s possible to cut (the benchmark) once. The main aim of using this tool is stabilising market confidence.” Further reductions in banks’ reserve requirement ratios (RRR) are likely, freeing up more funds for lending to sectors of the economy facing the biggest strains, the sources said. The People’s Bank of China (PBOC) has already cut levels six times since early 2018.

“We can use other tools if such things (shocks) don’t happen... the room for cutting RRR (for all banks) is not big, the room for a targeted RRR cut is bigger,” the second source said. President Donald Trump said on Tuesday the United States still has a long way to go to conclude a trade deal with China but could impose tariffs on an additional $325 billion worth of Chinese goods if it needed to do so.

The policy sources said China’s government will prevent quarterly economic growth from falling below 6% in the second half, the lower end of Beijing’s 6-6.5% full-year target range.

The State Council Information Office, the central bank and the finance ministry did not immediately respond to Reuters’ requests for comment.

Chinese policymakers have repeatedly vowed not to open the credit floodgates in an economy already saddled with piles of debt - a legacy of massive stimulus during the global financial crisis in 2008-09 and subsequent downturns.

But, after stabilising in 2018, debt is on the rise again as the government ramps up stimulus. The PBOC reportedly told banks recently to stop cutting mortgage rates, amid concerns about the risks of a property bubble.

“The policy room is not that big, as we’ve been doing a lot on both monetary and fiscal policy fronts (already),” said another source.

“We cannot print too much money, that will have big side effects.”

China’s total corporate, household and government debt rose to 303% of GDP in the first quarter of 2019, from 297% in the same period last year, the Institute of International Finance (IIF) said this week.

Debate over whether China needs more forceful easing heightened this week after data showed second-quarter economic growth slowed to a 27-year low, weighed by weak demand at home and abroad amid intensifying U.S. trade pressure. But June factory output, retail sales and investment all grew more than expected, raising hopes that policy loosening over the past year is beginning to pay off.

“I don’t expect any big policy changes,” said the first source. “External demand may weaken in the second half but policies unveiled earlier could help boost domestic demand.” Beijing is leaning more heavily on fiscal stimulus this time round. It has announced tax cuts of nearly 2 trillion yuan ($290.83 billion) and a quota of 2.15 trillion yuan for special bond issuance by local governments for infrastructure projects -- though more issuance would push up overall debt levels.

One option is to let local governments sell even more bonds, but this could only be considered if the economy continues to falter and more funds are needed to keep projects going once the quota is used up, insiders said.

Reuters