(Yicai Global) April 20 -- The International Monetary Fund is predicting that China’s fiscal stimulus in the face of Covid-19 will be about 5 percent of gross domestic product, according to the agency’s China Mission Chief.
As the pandemic spreads from country to country, global demand will weaken and China’s exports will fall. This matters in the second quarter and will likely provide headwinds to growth throughout the remainder of 2020, Helge Berger said in an exclusive interview with Yicai Global.
Strong fiscal and monetary policy is needed to bolster demand. China has done a fine job of meeting the twin challenges of fighting the outbreak and supporting the economy, he said. The People’s Bank of China should continue to liberalize borrowing rates, make the Chinese yuan’s exchange rate more flexible and ensure bank asset quality, he added.
The Washington-based IMF expects to see a strong rebound to 9.2 percent growth in 2021 as China returns to pre-Covid-19 levels of economic activity.
Excerpts from the interview are given below.
Yicai Global: China’s economy is projected to grow at a subdued 1.2 percent in 2020, according to the World Economic Outlook report released by the IMF on April 14. For most countries, the disruption wrought by the Covid-19 pandemic is likely to be mainly concentrated in this quarter. What challenges do you see facing the economies in China and the rest of the world?
Helge Berger: The outbreak is a massive shock both to China and to the global economy. There is little doubt that the sudden halt it forced on the Chinese economy in the first quarter will leave its mark. Our new forecast for 2020 sees China growing at just 1.2 percent, down from 6 percent in our January forecast. This is the slowest China has grown since the mid-1970s.
However, we expect a strong rebound to 9.2 percent in 2021 as China returns to pre-Covid-19 levels of economic activity. What is affecting growth this year, is the global nature of the pandemic. As one country after another goes through what China went through earlier this year, global demand weakens and China’s exports drop. This matters right now for the second quarter and it will likely provide headwinds to growth throughout the remainder of 2020. Thankfully, there is also a strong policy effort, with both fiscal and monetary policy supporting demand.
YG: Although Beijing’s room for monetary policy is much smaller than in previous easing cycles the market is still expecting a big stimulus package to deal with the unprecedented shock, including the issuing of central government special bonds. What is your view on China’s stimulus policy? What should be the top priority?
HB: Overall, Chinese policymakers have struck a good balance between meeting the twin challenges of fighting the outbreak and supporting the economy. They worked hard to contain the virus, marshaling resources to help the most affected regions. They channeled aid and credit to the most vulnerable sectors and to smaller firms to mitigate the impact on the economy. And now that businesses are getting back to work, the government and the PBOC are stepping up support for the recovery of demand. This is the right approach.
In our forecast for this year, we are assuming a sizable fiscal stimulus of about 5 percent of GDP. And more fiscal and monetary support may be needed if growth should disappoint. For example, if domestic demand falls short or if external headwinds strengthen.
YG: Major central banks are adopting a ‘whatever it takes’ strategy. So-called helicopter money such as corporate bond purchases seem not to be an obstacle anymore. How can the PBOC remain flexible enough to help the economy through the travails of Covid-19 while not sowing the seeds for a subsequent crisis due to high levels of debt and leverage?
HB: The PBOC has played an important role in a number of ways: it has injected sufficient liquidity into the banking system and financial markets; it has cut policy rates; and it expanded its relending and rediscounting facilities to channel targeted help to smaller enterprises.
All this has helped to stabilize financial markets, mitigate the economic impact of the outbreak and support recovery. Also keep in mind that, without the PBOC’s efforts, fiscal stimulus would push interest rates higher and crowd out private investors. So by keeping interest rates low, the PBOC is enhancing the effectiveness of the fiscal stimulus.
At the same time, monetary policy so far has taken a measured approach and tried to avoid adding to long-term financial vulnerabilities from already high private sector leverage and property market risks.
YG: In China, lenders are being encouraged to temporarily defer loan and interest payments for eligible small and medium-sized enterprises. China’s M2 broad money growth surged to 10.1 percent in March from the same period last year, overshooting expectations for 8.8 percent. The IMF suggests that bank asset quality should be closely monitored to determine whether fiscal support, such as equity injections, is necessary, particularly if the downturn persists. What is your assessment of the resilience of China’s banking sector?
HB: This has been an important topic for us for some time. The financial vulnerabilities in China’s small and medium-size bank sector deserve attention. Of course, the authorities are aware of these issues and they have made progress in addressing them. At the same time, bank buffers remain weak in some segments and asset management sector risks are still elevated.
The Covid-19 outbreak and the slowdown it has imposed on the economy are bound to make things worse by lowering asset quality and putting pressure on capital. To us, this only highlights the urgent need to comprehensively address any weaknesses in the banking sector. This means boosting capital and liquidity buffers, curbing risky financing arrangements with asset management products and introducing a bank resolution framework that takes into account international best practices.
YG: What is your view on China’s efforts to liberalize borrowing rates? Last August, the PBOC introduced a reformed loan prime rate benchmark to help cut financing costs for businesses. How should the PBOC relax the deposit rate side?
HB: The recent reform aims to make the LPR more market based. This is a step in the right direction and should be extended to all outstanding loan pricing. This would make it even more transparent how loan rates are set and will strengthen the PBOC’s operational independence. One way is to increase the role that banks and markets play in determining credit volumes and credit rates and avoid the use of directives in this area.
Over the medium term, another method would be to phase out the benchmark deposit rate to further improve monetary policy transmission. To avoid unintended consequences, this would have to be well prepared, such as by taking steps to increase bank capital, strengthen bank governance, further develop interest-rate hedging instruments and minimize the gap between deposit rates and rates for deposit-like products.
YG: If the Chinese yuan continues to appreciate against the currency basket, it will weigh on exports to non-US markets. What do you suggest is the best way for China to proceed with regard to exchange rate reform? Foreign assets have been pouring into China’s equity and bond market in the last few months. Do you see this being a sustained trend?
HB: Firstly, we are glad to see the increased flexibility of the yuan and we encourage the authorities to continue in this direction. This flexibility helped to mitigate the impact of the outbreak and worked to buffer the economy against external shocks. Indeed, the recent yuan appreciation is an example of the exchange rate market reacting as it should, in this case to the drop in US interest rates.
Looking ahead, we encourage the authorities to press on with reforms that support even greater exchange rate flexibility, including reducing the use of the counter cyclical adjustment factor in daily yuan fixing.
Secondly, we see the recent portfolio flows mostly as a reflection of investors’ global arbitrage between interest rate levels and an increase in global risk aversion. For example, Chinese government bonds offered higher yields at little risk relative to many other government bonds and China therefore saw more inflows into these bonds especially in February. But as macro conditions and risk sentiment change, these portfolio flows will adjust as well.
YG: The G20 is set to agree on a kind of debt restructuring and relief plan for developing countries and least-developing countries in which China plays a big role. As a major creditor, should China join the Paris Club to help negotiate solutions for debtor countries with payment difficulties? Or should the IMF push for another joint platform?
HB: We very much welcome the G20’s support for the time-bound suspension of debt payments from low income countries that require tolerance. China is an important part of this discussion, both as a G20 member and a major creditor.
The creditor landscape has changed considerably over the past decade. This includes the rising importance of non-Paris Club creditors, which includes China and other countries. The key here is to make sure that creditors have an efficient way of coordinating. When debt restructuring is required, timely resolution is of the essence. It lowers costs for both the debtor and creditors. The IMF’s role is to help our member countries resolve their debt sustainability problems, and the Fund can work to support the modalities for coordination chosen by creditors.
YG: Are you worried about how China-US relations might affect the global fight against the pandemic?
HB: The pandemic is a very powerful reminder of the need for policy coordination and solidarity in an interconnected world. We will only get on top of the pandemic if we work together. Thankfully, we are seeing international cooperation in many key areas, such as the provision of liquidity through swap lines, and fiscal policy is being rolled out in a growing number of countries.
But there is more to do. Policymakers must step up efforts to help the most vulnerable and low-income countries by providing enhanced funding as well as debt service relief to ensure that scarce resources are dedicated to disease prevention and treatment. Policymakers should also avoid trade restrictions, particularly of medical supplies, and address the impairment to global supply chains. Finally, if the recovery needs support once the global outbreak abates, coordinated fiscal stimulus may be needed to boost demand and restore growth.
YG: The IMF’s World Economic Outlook report projected that China will grow at 9.2 percent in 2021. Does this mean you are confident that the virus will disappear next year, or do you think it will continue to exist around the world?
HB: If we all work on this together, my hope is we will indeed see the strong recovery we are predicting under our new forecast. But it would be naïve to ignore the many downside risks, whether they stem from the pandemic or the economy.
Editor: Kim Taylor