The Chinese government is planning to flood its banking system with new liquidity in an attempt to offset the negative effects of the unexpected devaluation of its currency, the yuan, according to Chinese officials and advisors to the country‘s central bank, as reported in the Wall Street Journal.
The planned step will result in a lowering of the deposits banks are required to hold in reserve. This is an indication that the devaluation of the yuan during the past weeks has not had the desired effect, in fact quite the opposite. One of the effects of a weaker currency has been to send more money offshore and the new measures are aimed directly as a counter to this.
The move, which could come before the end of the month, amounts to a return to a policy of the same financial easing measures that have thus far failed to stimulate the economy. The plan is to reduce the bank's reserve requirement by half a percent which could potentially free 678 billion yuan ($106.2 billion) and make it available for bank loans.
The same measure has been used twice previously without achieving the desired result. Another option, said to be under consideration by the People’s Bank of China, is to target the cut in the deposit reserve to banks that lend primarily to small and private businesses, deemed as the key to future Chinese growth. Previous use of this strategy as a means of channeling capital to that segment of industry has not proven very effective.
While the Chinese economy is still growing at a faster rate than the Western economies, its current target of 7% growth for 2015 would be the slowest in about 25 years. The worrying fact for the Beijing authorities is that they no longer seem to have the same control over the economy as demonstrated in the past. Governmental inability to deal effectively with the current financial crisis is a case in point.
China is sitting on $3.7 trillion of foreign exchange reserves, which is a large stockpile that can no doubt help it weather the current financial crisis. One of the problems facing Beijing is that it had hoped to use a stock market that was in a strong rallying phase to channel funds to indebted companies, but when stocks started falling in June, the frequent ineffective interventions in the market presented an impression of leaders losing control.
Fraser Howie, co-author of “Red Capitalism: The Fragile Financial Foundations of China’s Extraordinary Rise” said, “the world is starting to realize China is not nearly as competent as thought, especially in the economic sphere where everyone gave it good grades.”
The Chinese economy, valued at $10.3 billion, is 5 times larger than it was 10 years ago. Management of an economy of this size means that many of the tools traditionally used by Beijing to support growth are no longer effective as they come up against the structural inefficiencies of a much larger economy.