© Donna Kwok
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More rate cuts are necessary and we expect the next cut approximately in March/April. Declining inflation means real interest rates have risen rapidly, resulting in a "de facto" tightening of monetary conditions. In the Q4 2014 monetary policy report, the PBC called for "close monitoring" of and "responding with comprehensive measures" to tackle deflationary pressures. It also anticipated more downward pressures to come and pointed out that disinflation could further affect market expectations and economic agents' behaviour.
We believe January's below 1% CPI (along with a subdued core CPI) has already alarmed the People's Bank of China, likely triggering another rate cut, if the weakness lasts beyond January. Although we expect February's CPI to rebound notably, it will likely head down again in March. Therefore, we think the next rate cut could come as early as March or April and continue to expect at least two more rate cuts this year or as necessary to prevent real rates from rising too much.
Interest rates in real terms, which are monitored by the PBOC, have increased further. Some economists consider the PBOC will likely cut benchmark rates by 25 basis points as early as this month, in order to avoid a tightening of credit conditions. Do you believe them to be right?
Weaker growth and declining commodity and energy prices should lead to a further easing of inflation in 2015. As deflationary pressures mount in China's industrial sector, real interest rates will rise higher. We expect an additional 40- 50 bps of benchmark lending rate cuts in 2015, which should help lower financing costs and slow the pace of nonperforming loan formation. Although the government wants to avoid exacerbating economic imbalances with excessively expansionary monetary policy, it also needs to prevent passive tightening in light of slower FX inflows and tightening shadow banking rules.
Narrowing interest rate differentials and increased capital outflows can help drive the RMB modestly weaker (to 6.35 by the end of 2015) against a strengthening USD amid heightened volatility. Further RRR cuts and liquidity operations may be needed to maintain steady credit growth and contain financial risks.While the RRR cut on February 4 helped to replenish interbank liquidity amid capital outflows, we expect capital outflows to continue in 2015, as RMB appreciation expectations fade and the onshore-offshore interest rate differential narrows further. Therefore, to keep domestic liquidity stable and prevent monetary conditions from getting too tight, the PBOC will need to further cut the RRR and use other liquidity facilities throughout 2015.
While today's weak inflation data has a positive side, it may trigger more stimulus. The negative side is that, we are seeing the economy is weaker than expected. Do you agree that monetary easing may help in the short term, but we can not substitute monetary easing for structural reforms?
We do not think monetary policy alone is sufficient for supporting growth, to buffer the economy from the impact of the ongoing property downturn or for resolving the many structural imbalances in China's economy, which only reforms can solve. Moreover, we expect reforms to accelerate in 2015. As the government moves toward systematic "rule by law" and the property downturn persists, more space will open up and pressure increase for economic reforms to accelerate.
We see three themes for China's reforms this year: growth support, risk containment & rebalancing. In other words, reforms that can unlock new sources of growth and bolster domestic demand, reduce economic and financial risks, or diminish structural imbalances should advance most. Thus, we agree that it is not possible to substitute monetary easing for structural reforms.