Roundtable Discussion on China’s Economy
On October 1，China celebrated the 70th anniversary of the founding of the People’s Republic of China. Over the course of 2019，the country made steady progress in its economic development despite domestic setbacks and a complex global environment. But people are concerned about a number of uncertainties in China’s economy. Those issues include prices，especially for pork，as well as the impact on the real estate market from reforms in domestic interest rates. Additionally，there is much debate about the influence of further opening-up measures in finance and foreign trade on China’s stock market，the trend in the renminbi exchange rate and which types of assets promise the best returns on investment.
Sino-US trade friction and interest rate liberalization were among the key issues examined at a recent roundtable discussion organized by China Forex. Zhang Ming，researcher at the Institute of World Economics and Politics of the Academy of Social Sciences and chief economist of Ping An Securities，and Zhou Daochuan ，former director of the research and strategy department and managing director at Yunfeng Financial Group，gave their views on these and other topics at this roundtable moderated by Zhong Wei，deputy editor at China Forex. The following is an edited version of this discussion.
Zhong Wei: First，I’d like to welcome our two guests. Since the beginning of 2019，prices in China have been rising but they have generally remained under control. As far as the Produce Price Index (PPI) is concerned，the prices of non-ferrous metals have fluctuated，and international oil prices have been unsteady. In terms of the Consumer Price Index (CPI)，the prices of pork，fruits and vegetables have been volatile. Of particular concern are surging pork prices. In your opinion，how long will it take before pork prices start to edge lower in this hog cycle? Will monetary policy be used to cushion the effects of volatile pork prices?
Zhang Ming: The rise in pork prices appeared in the middle and late stages of this hog cycle. A turning point is unlikely before the end of this year but year-on-year growth in pork prices is expected to ease significantly in the first half of 2020.
Monetary policy is not expected to be used as a tool to halt the unusual climb in pork prices. There are three reasons for this conclusion. Firstly，monetary policy is normally used in response to substantial changes in the core inflation rate，which excludes items such as food and energy. China’s core CPI has seen slower growth since the beginning of 2019. Additionally，the PPI in China has shown negative growth despite the moderate rise in CPI growth. Moreover，China’s CPI and PPI are likely to grow more slowly in 2020. In conclusion，the main issue with China’s economy is not inflation，but insufficient aggregate demand. As such，we are more likely to see tighter monetary policies.
Zhou Daochuan: The current hog cycle will last until the end of 2020 at least. China has experienced four complete hog cycles since 2000，with pork prices taking two to three years to go from trough to peak. The current hog cycle began in June 2018，and it is likely that peak prices will be reached in the second half of 2020. To address rising prices，more than 20 policy measures were taken following the August 21 executive meeting of China’s State Council. Local authorities scrapped bans and restrictions on hog raising. In addition，preferential policies were extended to the transportation of piglets and chilled pork to reduce costs. Also，China will offer more preferential loans and insurance as well as boost subsidies for pig farming in order to ensure stable supplies of pork. In spite of these measures，it is estimated that hog prices will not decline until there is a sharp recovery in the supply of pigs.
Pork has had a weighting of 2.1% to 2.5% in the CPI basket this year - not a high percentage. Other components of the CPI — including beef and mutton，vegetables，fruits and crude oil prices — are expected to remain relatively stable. However，there is a possibility that crude oil and pork prices will fluctuate over the short term and push the CPI above China’s target level of 3%.
Nevertheless，monetary policymakers do not need to respond to pork price fluctuations unless inflation surges. Presently，amid the global interest rate cuts and the Sino-US trade tension，China is expected to focus on its objective of ensuring steady economic growth in setting its monetary policy.
02
Zhong Wei: The People’s Bank of China (PBOC) has been taking measures to deepen market-oriented reforms of domestic interest rates. It has announced across-the-board and targeted cuts in the reserve requirement ratio (RRR) and launched the Loan Prime Rate (LPR). The combination of measures is aimed at reducing financing costs of the real economy，particularly costs of medium- and small-sized enterprises. In your view，what roles will the merging of interest rates play in deepening the transmission channels for monetary policy? And what effect will this have on the real estate sector?
Zhang Ming: The recent lending rate reform merges deposit and lending rates with money-market rates. In this latest move on the interest rate front，China linked bank lending rates to the LPR，which in turn will be determined by the central bank’s medium-term lending facility (MLF) interest rate. Compared with the benchmark lending rate in the past，the LPR will more closely reflect changes in money-market interest rates. Thus，this will help establish a policy transmission mechanism that functions more smoothly. In view of the fact that price pressures in big cities are not strictly a factor of supply while risks in the property market are not decreasing，the central bank and the China Banking and Insurance Regulatory Commission have set a targeted rule for real estate lending. Neither the lending rate for real estate developers nor the personal mortgage rate can be set below the new mechanism. If this stipulation remains in place，the real estate sector faces a substantial adjustment.
Zhou Daochuan: Under China’s “two track” interest rate system in the past，rates in the money and bond markets were basically determined by market forces，while deposit rates were based upon a benchmark rate set by the central bank. That kept funding costs high for the real economy，even when PBOC policies pushed money market rates lower.
The LPR mechanism is an important step in the effort to liberalize interest rates. It pushes banks to use the LPR as a reference when pricing new loans and apply this as a benchmark for floating-rate loan agreements. It also requires banks to link their LPR quotations to the MLF rate，which reflects the average marginal capital costs of the banks. The LPR is then determined by factors including the cost of capital at each bank as well as credit supply and demand and risk premiums. In this way，the MLF interest rate can be easily transmitted to the credit market.
Currently，the LPR consists of rates with two maturities — one year and five or more years. The personal mortgage loan rate is linked to the five-year LPR. It is expected that in view of the policy objective of discouraging speculative investment，there will be “window guidance” for the five-year LPR. This will result in more flexible adjustments in the mortgage loan rate and could pave the way for a rise in rates on personal housing loans. It is reasonable to say that loans in the real estate sector are unlikely to benefit from the new interest rate mechanism.
03
Zhong Wei: Financial policies in China and abroad have diverged since the beginning of this year. Twenty countries have cut interest rates，and some have even employed negative rates. In China，there is an effort to deepen the opening up of the economy. Measures include a further opening of the financial industry and reforms of the Shanghai and Shenzhen stock markets. In addition，there have been reforms in the capital and financial transaction accounts. This，plus the inclusion of China’s stocks and bonds in major global benchmark indexes has led to unprecedented enthusiasm about the Chinese market among foreign investors. Against this background，what do you see for the Shanghai and Shenzhen stock markets?
Zhang Ming: China has expanded its opening to foreign investors，and this is likely to bring a short-term increase in capital inflows. Yet，as we can see from past experience，domestic and foreign capital flows may not offset each other. That is to say，an opening up of the financial system may result in new investment inflows，but it also may