Fri, 18 Oct 2019

China has "tremendous" room to adjust monetary policy if the trade war with the US deepens, People's Bank of China Governor Yi Gang has said.

"We have plenty of room in interest rates, we have plenty of room in required reserve ratio rate, and also for the fiscal, monetary policy toolkit, I think the room for adjustment is tremendous," said Yi in an exclusive interview in Beijing.

Asked if his scheduled bilateral meeting with US Treasury Secretary Steven Mnuchin would get negotiations with the US back on track, Yi said it would probably be a "productive talk, as always," though the topic of the trade war would be "uncertain and difficult." The two are set to meet at on the sidelines of the Group of 20 gathering of finance ministers and central bank governors in Japan.

That meeting takes place as the two nations escalate their trade war amid a darkening outlook for the global economy, with Citigroup and Morgan Stanley warning this week that it risks tipping the world into recession. This is the first publicly announced meeting since the trade talks fell apart last month and could pave the way for a meeting between Presidents Donald Trump and Xi Jinping, who will likely be in Japan at the end of the month for the G20 leaders' summit.

Mnuchin, along with US Trade Representative Robert Lighthizer, has led the US-China talks while Yi has been a member of China's delegations. The yuan stabilised in recent weeks as authorities voiced support for the currency, following a rapid sell-off that pushed it near 7 per dollar - a level not breached since the global financial crisis. It still lost about 2.5% in May, among the worst in Asia.

"Recently, it's a little bit weaker, because the tremendous pressure from the US side," Yi said. Asked if there's a red line for the exchange rate, Yi said no number is more important than another.

"The trade war would have a temporary depreciation pressure on renminbi, but you see, after the noise, renminbi will continue to be very stable and relatively strong compared to emerging market currencies, even compared to convertible currencies," Yi said, using the yuan's official name. "I'm very confident renminbi will continue to be stable at a more or less equilibrium level."

"A little bit of flexibility of renminbi is good for the Chinese economy and for the global economy because it provides an automatic stabiliser for the economy," he said. "The central bank of China is pretty much not intervening in the foreign-exchange market for a long time, and I hope that this situation will continue, not intervening."

'Golden Level'

Commenting at the end of a week in which the Federal Reserve and European Central Bank sounded more open to easing monetary policy and with Australia and India already cutting rates, Yi said China's monetary policy has "to be in a sober mind position," and the policy stance is prudent.

"I think our benchmark interest rate right now is in right level. I would say in terms of resources allocation at this level, I call it very close to golden level," he said.

Still, more economists are predicting that a worsening trade war and job market outlook could prompt the central bank to take bolder easing steps.

"Looking forward, our base case is that an escalating trade war will push key gauges below the PBOC's tolerance threshold, triggering 50 basis points of rate cuts and another 150-200 bps of reserve requirement cuts by year-end," David Qu, an economist with Bloomberg Economics in Hong Kong, wrote in a recent report.

Fiscal outlook

Yi gave no indication that the government was considering more fiscal stimulus now to counteract the effect of the trade war.

"Our fiscal policy this year is probably the largest and strongest fiscal reform package, in terms of the tax cuts, and also in terms of having more efficient fiscal resources allocation between the central government and the local government," Yi said.

"The current package is able to cover the cases where the situation is getting a little bit worse, but of course, if the situation gets tremendously worse, they will open the discussion. But right now they haven't discussed that scenario yet."

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The government is concerned about the effect on employment from any worsening in the dispute with the US, with Yi suggesting there could be support such as a 100bn yuan ($14.5bn) for short-term vocational training programs for those who have lost jobs.

"The PBOC may reduce benchmark interest rates, if the full-year growth of China's gross domestic product threatens to fall below 6.2% and if the US imposes tariffs on remaining Chinese exports," said Christy Tan, head of markets strategy at National Australia Bank.

Risks of the yuan breaking 7 have elevated along with the escalation of the trade war and the prospect that tension will be prolonged, she said, adding the trigger for such a move could be a lack of progress on negotiations during the G-20 summit.

Here are some other comments from Yi:

State of China's economy

Economic performance in the first quarter was better than expected, though people's expectations turned "negative and gloomy" afterward, amid the uncertainty of the trade war. Still, the Chinese economy is resilient.

On policy options

The PBOC will continue to view price stability as its number one goal, while looking at the employment situation and trying to accommodate the economy to create more jobs.

On financial stability of smaller banks

Some smaller banks have a little liquidity tightness, and that's why the PBOC's policy targets smaller banks. Overall liquidity in the economy right now is plenty Smaller banks' tightness is a "temporary phenomenon," given China has a targeted reserved ratio cut for them, and also given PBOC market activities to channel liquidity to smaller banks and some non-financial institutions. Their funding problem will get better very soon.

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On policy transparency

"One of my thoughts, and also my promotion, is to make my monetary policy more transparent so that the whole society and the world can have the right expectations." That way the transmission mechanism will be more efficient, and global investors will "feel more comfortable, more expected and also that would enhance their confidence".

On financial sector opening

When asked if the trade war could make it harder for US banks to benefit from China's opening up, Yi said he hopes "we can treat everybody fairly, equally and minimise the negative impact of trade war," while adding that it's a two-party game and it's up to the other side to also decide and act in good faith.

On debt cleanup

In the past two years, the overall leverage ratio of the Chinese economy has stabilised at about 250% of gross domestic product. The overall leverage ratio could increase a little bit if the trade war worsens, but not tremendously It would be a more or less reasonable increase to temporarily accommodate the shock, then the PBOC would continue its policy and overall leverage should stabilise.

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