Standard Life Investments

Published Article

Citywire - Chinese equities face revaluation if dragon unleashes QE


 

Rumours continue to propel China’s stock markets. Each week it seems like a “leaked” news story provides a catalyst to spark strong buying across the Shanghai and Shenzhen exchanges. Recently markets jumped following a report detailing the People’s Bank of China’s (PBOC) supposed plans to engage in quantitative easing (QE), with analysts trying to rationalise valuations in the wake of such news.

Chinese “QE” has long been mooted. The possibility first came on to radar screens when the pledged supplementary lending (PSL) and medium-term lending (MLF) liquidity injection schemes were announced last summer. The most recent speculation is derived from reports that the PBOC will soon initiate a round of “Chinese QE” to support the upcoming local government debt swap programme. There are differing accounts as to what the PBOC is planning to do – some reports centre on balance sheet expansion through direct purchases of commercial bank assets (rumours now disputed by the PBOC). Other reports discuss a LTLRO-type program that would allow commercial banks to use local government bonds as collateral for low-interest short term loans from the central bank. Chinese monetary policy is clearly in a period of transition as it seeks to determine its “new normal”. Policymakers need to maintain just the right amount of monetary stimulus to avoid a hard landing or acceleration in capital outflows and a spike in defaults, without prompting a dangerous increase in system-wide leverage. To be sure, China has always used quantitative measures to regulate financial conditions. Moreover, the newly reported measures do not constitute a major monetary expansion but are more an effort to support money supply growth in the face of smaller inflows. Indeed, the reported PBOC plan is merely an expansion of the PSL program launched last summer, with the tweak of allowing commercial banks to use local-government bonds as collateral. It is therefore not QE in the traditional sense. Once finalised, this newly-expanded PSL will add to other measures introduced recently, including the $62 billion recapitalisation of policy banks.

China is walking a tightrope as it is trying to deleverage the economy. A cornerstone of the government’s plan is to swap high-interest local government debt with municipal bonds; however this has had a slow start following last week’s cancelled bond issuance. Liquidity injections, not outright QE, will likely be used alongside more traditional monetary policy tools to lower interest rates and ensure local governments can issue bonds. It is possible the market may react to reports of “QE” as a cue to speculate on equities, but recent measures are primarily aimed at deleveraging local governments, not significant easing.

Alex Wolf, Emerging Markets Economist, Standard Life Investments

First published in Citywire Wealth Manager – May 2015