China Signals Targeted Policy Support as Growth Risks Climb

(Bloomberg) -- China’s top leaders signaled more targeted support for the economy as they look to cushion growth in the face of resurgent pandemic risks, fueling a rally in bonds.

The much-watched Politburo meeting Friday indicated authorities will likely take more steps to help struggling small businesses, boost fiscal spending and possibly reduce the reserve requirement ratio for banks again, according to economists from Citigroup Inc., UBS AG and Oversea-Chinese Banking Corp.

“The policy efforts to support the economy will likely step up,” Citigroup’s economists led by Liu Li-Gang said in a note Monday. “In particular, we see more targeted measures underway to help small and medium-sized enterprises, as indicated by the mid-year Politburo meeting.”

The 25-member Politburo meeting, chaired by President Xi Jinping, preceded data showing factory production, which has underpinned the economy’s recovery, coming under pressure in July. The official manufacturing purchasing managers’ index fell to a weaker-than-expected 50.4, while the Caixin index, which captures sentiment of smaller private firms, dropped to 50.3 from 51.3 in June.

China bonds rallied Monday on signs of the slowdown and possibility of more policy easing. The yield on 10-year sovereign notes slid five basis points to 2.8%, the lowest since June 2020.

The recent coronavirus outbreak in the eastern city of Nanjing has spread to other parts of the country, adding further risks to consumption and production as cities like Beijing tighten transportation restrictions. Fourteen provinces have been affected so far with 328 cases nationwide this month, almost equaling the amount of cases reported in the previous five months combined, according to the National Health Commission.

The Communist Party’s top leadership signaled that fiscal spending through the issuance of local government special bonds will accelerate in the second half to support the economy.

Economists also noted the Politburo’s statement omitted the phrase that there’ll be “no sharp turn” in policy, indicating the end of the tightening stance. The central bank could cut the RRR again after a surprise reduction earlier this month, UBS Group AG economists led by Wang Tao said in a note Saturday, although a decline in interest rates are unlikely. Credit growth in the second half will probably stabilize, they said.

At a separate meeting to discuss second-half priorities, the People’s Bank of China said it will guide actual lending interest rates to a stable and lower level through reforming the rates market, according to a statement published Saturday.

Another sign that the policy tightening phase has come to an end is the Politburo’s dropping of language around “taking advantage of the current window period of low growth pressure.” However, it’s too early to shift to a loosening stance, according to Macquarie Securities Ltd.

“It’s time for policy fine-tuning, but too early for outright easing,” Macquarie analysts said in a note Friday, adding that growth pressure will increase next year ahead of the Communist Party’s twice-a-decade national congress, which is expected to be held in the second half of 2022.

In a nod to external pressures, the Poliburo vowed to increase the autonomy of macroeconomic policies, implying the Federal Reserve’s upcoming tapering of stimulus will have limited impact on the pace of China’s monetary policy.

What Bloomberg Economics Says...

The emphasis of macro policy autonomy in Friday’s statement is in line with our view that the People’s Bank of China is ready to go separate ways from the Federal Reserve.

For 2H, this means the PBOC will probably ease policy relative to the Fed to counter downward pressure on China’s economy, while a continuing robust U.S. recovery allows the Fed to begin to ponder policy normalization.

Chang Shu, chief Asia economist

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The Politburo also referred to the need for “cross-cyclical” adjustments and coordinating policies this year and next year. That contrasts with the “counter-cyclical” policies advocated in the past, signaling authorities will avoid using up the easing room during the rest of 2021 so that it can still handle risks next year, according to Guotai Junan Securities Co Ltd.

“The biggest difference of cross-cyclical adjustment from a counter-cyclical one is that both the tightening and easing of policies will be more moderate in magnitude,” Guotai Junan analysts led by Dong Qi said in a note Monday.

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