Stimulus should be small

Loose monetary policy would result in rising housing prices and be detrimental to healthy development of economy

The recent upturn in economic data have led some market analysts to believe that China's slowed economy has bottomed out and will be on a rising trajectory in the fourth quarter.

To give a boost to economic growth, they argue, the country's central bank should adopt some forcible stimulus measures, such as loosening domestic monetary policy.

But under the current economic circumstances at home and abroad, China's monetary authorities should make no big changes to the established monetary policy.

China's economic deceleration over the past year has not only been a result of weakened external demand, it has also been caused by its ongoing economic structural adjustments. That means any short-term stimulus measures will be unlikely to bolster long-term economic growth.

There are worries that a drastic economic deceleration, if unchecked, will increase China's macroeconomic risks and possibly result in the widespread bankruptcy of State-owned enterprises, a large-scale laying off of employees and an increase in bad bank loans, and could cause a serious financial or economic crisis. Thus it is argued the central bank should launch a loose monetary policy to return the national economy to fast-track growth, by cutting interest rates, maintaining market expectations for the yuan's appreciation, privatization of some State-owned enterprises and other short-term stimulus measures.

Nevertheless, such an economic prescription is based on two judgments. One is the current pricing mechanism in the Chinese market can elevate the investment enthusiasm of enterprises. The other is bad effects will emerge if China's economic growth is not fast. In fact, no effective pricing mechanism has so far been established in the financial market. The Chinese mainland's fast-growing economy over the past years has been built on a decade-long real estate boom and such a housing-pegged growth momentum cannot be endlessly sustained.

The 1.9 percent Consumer Price Index growth in September, which is at a comparatively low level, and the worrisome 3.6 percent decline in its Producer Price Index mean there is not much space for the central bank to lower interest rates. The low-running PPI in recent years has been a result of the country's years of housing market regulations and the sector's overcapacity. The excessive dependence on the housing market for economic growth has overdrawn its future growth potential. Once such growth decelerates, overcapacity will inevitably emerge, which will correspondingly cause a full PPI decline.

Therefore the country should not be excessively worried about its current decline in PPI growth. It should look upon such a decline as the start of economic recovery and recognize that the current high housing prices are the biggest concern to the national economy. The swollen housing bubble, if not effectively squeezed, will remain forever a headache to the Chinese economy.

China's CPI is expected to rise in the coming months. Food prices, which constitute a dominant component of the country's CPI, are expected to rise again with the onset of winter, a season during which grain and vegetable output declines. Besides, pork prices, after a year of a low-price operation, are expected to regain a rising momentum, which will push up the CPI. All these factors mean that China's current low CPI is temporary. External factors, such as the easing monetary environment and high oil prices will also put pressure on prices in China.

This explains why Yi Gang, vice-governor of China's central bank, has warned that "taming inflation still remains our top priority" and "the central bank should continuously alert governments at various levels to the risk of inflation".

At a time when the country's production environment remains pessimistic, turning again to a relaxed monetary policy is unlikely to promote economic growth.

Despite enjoying low borrowing costs, enterprises will not be motivated to expand their investment if no increased orders are on the way. Besides, declining profit margins among enterprises will also stunt banks' willingness to lend more as they seek to control risks.

Despite the lack of obvious effects in boosting bank credit expansion and spurring economic growth, a loose monetary policy would in all likelihood reverse the country's years-long housing market regulations and result in rebounds in housing prices, which will be particularly detrimental to the sector itself and the healthy development of the national economy.

In the face of the economic slowdown, it is understandable and also reasonable for China to work out some appropriate and well-tailored stimulus measures. However, they should be kept to a scale that will not trigger a new round of price rises.

The author is a researcher with the Institute of Finance and Banking under the Chinese Academy of Social Sciences.

(China Daily 10/19/2012 page8)