(Yicai Global) Dec. 19 -- Given the decline in global liquidity margin and continuous financial deleveraging in China, all eyes now are on People's Bank of China (PBOC) to see whether it will tighten its monetary policy next year following the Fed's example or not. The observers also wonder whether the rollout of tax cuts in the US lead to more rate hikes and if it will spill over to other parts of the world.

China's monetary policy will be neither too tight nor too loose next year, and will remain stable and consistent, Sheng Songcheng, a PBOC counselor, told Yicai Global. The Fed will hike interest rates several times in 2018, but the impact of the tax reform still remains to be seen, Sheng believes. Tax cuts can boost short-term economic growth and productivity, but they will push fiscal deficits in the US to even higher levels, he said. Furthermore, employment growth resulting from the tax reform may manifest itself in the form of pay rises, which is likely to have an adverse effect on labor demand.

The monetary policy will not be very accommodative, Sheng opined. Solid economic fundamentals in China mean that the bank does not need to relax the monetary policy. "If our economy doesn't do very well, then we might need to loosen money supply, because the monetary policy is a short- to medium-term [macroeconomic] regulation tool. However, judging by the current situation, the economy is performing well," he noted.

Gross domestic product (GDP) grew by 6.9 percent in the first quarter, and by 6.9 percent and 6.8 percent in the second and third quarters. "We project GDP growth to be 6.9 percent, or at least 6.8 percent, in the fourth quarter," meaning that the full-year growth will be around 6.9 percent.

Fiscal revenues outstripped fiscal expenditure in October, so the Chinese government may ramp up investment in November and December, he predicts. In addition, the purchasing managers' index (PMI) rose by 0.2 percentage point last month, and the non-manufacturing business activity index came in at 54.8 percent, up 0.5 percentage point on the month, indicating an uptick in the overall business climate.

Furthermore, consumption and foreign trade will keep up the momentum for short-term economic growth in China. Calculated in the dollar, China's exports grew by 12.3 percent year-on-year last month, an increase of 5.4 percentage points compared with the growth rate in October. Imports jumped by 17.7 percent, 0.5 percentage point faster than in the previous month. "There's no need to loosen the monetary policy, given the solid economic growth figures," he stressed.

Secondly, a neutral monetary environment is conducive to financial deleveraging. The deleveraging policies have started to bear fruit, and "We won't give it up halfway, so the bank is unlikely to loosen its monetary policy next year," he explained.

China needs to align its monetary policy with those of other major economies, he opined. Apart from the US, Canada, Britain and South Korea have also raised interest rates amid signs of an exit of quantitative easing at the European Central Bank. "How can we possibly implement a loose monetary policy when all the other countries are poised to drain liquidity from the markets? This is obviously inadvisable," he said.

On the other hand, "China's monetary policy will not be tightened further either," as the current policy is neutral with a tight bias. Next year, it will remain stable and consistent, neither too loose nor too tight.

The PBOC nudged up the reverse repo rate and the medium-term lending facility (MLF) rate following the Fed's rate hike on Dec. 14. The interest spread between the world's two largest economies has narrowed as a result.

"At present, China's financial market rates are still at a relatively high level," he noted, "with the rise in market rates, we have hiked, albeit indirectly, interest rates by 1.1 to 1.2 percentage points, as compared with 0.75 percentage point in the US."

So far in December, the yield on the 10-year Chinese Treasury bond has increased to almost four percent, and the interest rate of certificates of interbank deposit has topped five percent, with the seven-day Shanghai Interbank Offered Rate (SHIBOR) hovering around 2.8 percent.

"We only need to wait and see how the Fed's new monetary policy and the tax reform play out in the US, and not to let other people lead us by the nose. Any decision must be based on the actual situation in China," he advised.

Chinese financial institutions are increasingly aware of the possible spillover effect arising from changes in monetary policies in the west. It is said that the tax reform proposed by the Donald Trump administration will stimulate the American economy and prompt the Fed to accelerate rate hike, which will in turn result in repatriation of capital back to the US.

Per the tax reform plan, the corporate tax rate is preliminarily set at 21 percent, and the upper limit on personal income tax will be lowered from the current 39.6 percent to 37 percent. The final bill may also abolish the corporate alternative minimum tax, an informed source said.

Sheng believes there are pros and cons to the tax cuts. Overall, they will benefit the high-income class much more significantly than middle-income households, and the tax burden may even increase in the latter's case.

The cut in corporate tax rate from 39.6 percent to 20 percent will help businesses increase after-tax profits and provide incentive to them to repatriate earnings from other markets. However, the effectiveness of the reform still remains to be seen, Sheng emphasized.

The relatively low marginal propensity to consume among high-income people means that only a limited proportion of the reduction in tax revenues will translate into a rise in consumer spending. Furthermore, the tax cuts may backfire on the consumption sector if the growing gap between the rich and the poor cannot be effectively curtailed, he argued.