Analysis – China has multiple choices to avoid hard landing risk

BEIJING (Reuters) – China faces what could be its worst year of growth in a decade with policy firepower that developed nations can only dream of.
A record-breaking tax take expected to top 10 trillion yuan ($1.6 trillion) in 2011 gives Beijing fiscal scope to support growth and financial system liquidity, while monetary policy is perfectly poised for easing after a near two-year tightening cycle.
Contrast that with deep deficits across Europe and the United States and the orthodox policies forced upon central banks on both continents in a desperate bid to avoid a slide into economic depression.
It adds up to China having every chance to steer its economy safely from its slowest quarter of growth in 2- years, and still avoid a hard landing that would reverberate globally.
“There are caveats, but compared to its counterparts, China has plenty of policy flexibility,” Tim Condon, head of Asian economic research at ING in Singapore, told Reuters.
The release of some 1.2 trillion yuan of fiscal deposits in December signals how roomy China’s policy pockets are.
That injection was the single biggest factor behind a jump in money supply and bank credit in December, according to analysts at China International Capital Corp, China’s biggest investment bank.
Chinese banks extended 640.5 billion yuan in new loans in December, up from 562.2 billion yuan in November, while M2 accelerated to 13.6 percent from November’s 12.7 percent.
CICC reckons the odds of a January cut in the ratio of deposits that commercial banks are required to hold as reserves (RRR) have been dramatically reduced as a consequence.
SYSTEMIC LIQUIDITY
The implications of China’s fiscal strength are crucial for money markets. An outflow of government deposits from the balance sheet of the People’s Bank of China (PBOC) can boost systemic liquidity far in excess of an RRR cut.
“It’s getting increasingly important as the size is getting bigger,” Xu Hong, an analyst with Daton Securities in northern Chinese city of Dalian told Reuters.
Government deposits fell 891 billion yuan in the last month of 2010, 954 billion yuan in December 2009, and 1,045 billion yuan in 2008, whereas a mere 350 billion yuan was estimated to have been injected into the system by the 50 basis point cut in RRR to 21 percent announced on Nov 30, 2011.
Economists polled recently by Reuters forecast a further 200 bps of RRR cuts to come in 2012, but the impact of that would far less than the 1.7 trillion yuan of injections implied if the government has turned an estimated 800 billion yuan surplus in 2011 into the 900 billion yuan deficit originally budgeted.
Released fiscal funds are a key factor underlying accommodative liquidity in the interbank market, according to Zhou Binglin, an analyst with Guosen Securities.
“That’s possibly why fund supply is not too tight despite capital outflows for two consecutive months and the absence of central bank liquidity injection,” he wrote in a client note.
China’s foreign exchange reserves, the world’s largest, fell $20.6 billion in the fourth quarter to $3.18 trillion as the trade surplus shrank and capital flows reversed.
That fall reinforced the views of many analysts and investors that a PBOC policy move was imminent, but a closer reading of fiscal deposit data would have been a better guide.
“It’s a key fact to pay attention to, particularly at the end of a year, and it’s role is becoming more visible,” a bond trader in the interbank market, who declined to be identified, said.
CHANGING DYNAMICS
China’s surging tax flows are also changing credit dynamics at the local government level, with regional banks being cajoled into providing loans to pet projects in return for the promise of a share of soaring fiscal deposits.
A notice on the website of the Rugao government in China’s eastern Jiangsu province said that the allocation of fiscal deposits would be linked to the credit offered by banks.
“Many small banks are in desperate need of deposits, and fiscal deposits are too big to miss, for which they have to make concessions,” a regional banker in Zhejiang province said.
Banks need the deposits because monetary policy settings were tightened so sharply over the last two years to fight the inflationary side-effects of massive stimulus that Beijing launched in 2008 to cushion the economy from the impact of the global economic crisis.
Twin bubbles in real estate and local government debt are still being battled by Beijing, and are arguably the only — if significant — policy constraint faced as the world’s second-biggest economy faces another economic slowdown.
It’s certainly a factor preventing the government using well-stocked fiscal coffers for outright economic pump-priming, or allowing explosive growth in still elevated leverage levels.
But relatively speaking, China has plenty of room to move.
“Every country has constraints. China was almost as unconstrained as it could have hoped for in 2008 when the crisis hit. The response to that has reduced the flexibility they have now, but they have far more than their counterparts in the West have,” ING’s Condon said.
(Editing by Kim Coghill)
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