Kevin Yao

BEIJING, (Reuters) – China’s central bank is likely to be cautious about loosening monetary policies in order to boost the economy. Slowing economic growth and soaring inflation are fueling concerns over stagflation.

New curbs against COVID-19 epidemics, power shortfalls at factories and a real estate debt crisis are some of the reasons momentum is waning in the second-largest country.

According to internal policy discussion sources, although chances of a rate reduction look low, the central bank could decide to reduce the cash reserves banks have to protect their loans in the event of growth, according to those involved.

The fourth quarter is expected to see economic growth slowing further from the 3.9% recorded in the previous quarter. According to an official survey, factory activity declined for the second month of October. However, output growth slowed to its lowest level since March 2020 due to power rationing, environmental restrictions, and high raw material prices.

After a July-wide RRR reduction, the People’s Bank of China has decided to defy market expectations and focus instead on deleveraging as well as preventing property bubbles.

Although some economists thought that the central bank would reduce interest rates in this year’s budget, they now believe that stagflation, which is the combination of rising prices and low demand, is an issue.

According to a Reuters poll, producer price inflation rose since July. It is likely that it will accelerate further in October. That would make October the most expensive month since 1995.

They said that the U.S. Federal Reserve’s tapering of policy is unlikely to have any impact on the PBOC. The PBOC’s policies are largely based on China’s growth prospects and inflation outlook.

Sources say that there is potential to reduce interest rates and RRR but this could be constrained by the rising prices of produce.

Reuters reached out to the PBOC for clarification but they did not respond immediately.

STAGFLATION RISKS

Citi analysts wrote in a note that “as a consequence of power rationing, and associated supply constraints”, the characteristics of’stagflation have become more apparent and would limit near term policy options.”

Citi anticipates that fourth quarter GDP growth will fall to 4%, while Nomura predicts that growth will drop to 3.0% due to both supply shocks and demand shocks.

However, some Chinese economists believe that China is far from the level of stagflation seen in the U.S. during the 1970s. Instead they prefer “quasi-stagflation”, which describes an economic situation that’s more complicated.

Analysts anticipate that the producer price inflation will decrease into 2022 and consumer inflation (which is expected to reach 1.4% in October, versus 0.7% September) could slowly pick up.

Most analysts are lowering their forecasts for rate reductions or rates cuts through 2022 in response to the public caution.

“It is highly unlikely that the central banks will cut RRR and interest rates within the current year. We need to monitor if PPI falls next year and watch how the Fed policy,” Tang Jianwei (senior economist, Bank of Communications) told Reuters.

According to Reuters, fixed income analysts forecast that there would be no benchmark rate cut for November. Only 23% expected a reduction in RRR over the next three-months.

Some government economists however urge the PBOC’s faster response.

“We should think about a wide-based RRR reduction in the fourth quarter, to pump out more funds and support growth,” Xu Hongcai (deputy director of China Association of Policy Science’s economic policy commission) told Reuters.

For small businesses who are hit hard by rising costs, a reduction in the RRR would prove to be very beneficial.

At a December meeting, Chinese leaders will be laying the foundation for the future economic direction of 2022. Policy insiders suggested that stability could be the key word for the next year as the ruling Communist Party announces major leadership changes.

“Stability is the highest priority in 2022,” Xu declared. She expects that economic growth will slow down to between 5%-6% in 2022 after an increase of about 8% this past year.

($1 = 6.3980)