Blog Post

Are financial conditions in China too lax or too stringent?

The pronounced slowdown in China’s GDP growth in recent years has raised the important question of what might be its principal causes.

By: Date: August 5, 2014 Topic: Global Economics & Governance

The pronounced slowdown in China’s GDP growth in recent years has raised the important question of what might be its principal causes. The usual suspects are many and might include rebalancing pains associated with China’s domestic and external imbalances, less favourable demographics resulting in a stagnant labour force, fewer low-hanging fruits in market liberalisation, a less-accommodating global economy that no longer serves as a ready outlet for China’s surplus savings, and even the ongoing anti-corruption campaign that might have slowed government outlays and hit sales of luxury goods.

Could tighter Chinese financial conditions be another, unusual suspect contributing to the marked growth slowdown in recent years? If the recent economic slowdown was primarily structural, lax financial conditions would not help and might even worsen the structural problems that dragged down economic growth in the first place. Indeed, China over the past few years has witnessed concurrently weaker growth and rising credit as a ratio to GDP, in contrast to a ‘creditless recovery’ in the euro area.

I recently made a case for China to ease its monetary policy in the face of slowing economic growth and benign inflation. Moreover since the global financial crisis, the Chinese central bank until recently maintained a tighter monetary policy relative to its international peers such as the US Fed, the European Central Bank, the Bank of Japan and the Bank of England, on the basis of both the real policy rate and the real effective exchange rate.

However, whether a different monetary policy is to have a meaningful effect on economic agents depends in part on transmission channels. Europe’s half-asleep banking sector is a case in point.

To better assess the financial environment that actually influences economic behaviour in China, I construct a crude ‘financial conditions index’ (FCI) that is a weighted sum of five key financial asset prices — policy rate, one-year treasury yield, ten-year treasury yield, effective exchange rate and benchmark stock market index. Higher readings denote tightness for the first three rates and the effective exchange rate, so I use the inverse of the stock market index to capture changes in equity prices.

I place an equal weight of 20 percent on each of the z-scores of these five financial prices. Thus, increases in interest rates, the effective exchange rate and the inversed stock market index all result in a rise in the FCI, indicating a tightening of financial conditions. I will focus on the post-crisis period from January 2007 to March 2014 before the latest Chinese monetary easing. A positive FCI reading suggests tighter financial conditions than the period average.

Let’s consider two versions of the FCI, one based on nominal interest rates and the effective exchange rate and the other on their real (ex post) counterparts. It is also useful to construct the FCIs for the US, euro area, Japan and Britain using the same consistent methodology, so that the Chinese FCI can be compared both over time and to its peers.

The central message from these FCIs is that China’s financial conditions have tightened the most among the major economies since the global financial crisis (Graph 1). Also, China started with relatively lax financial conditions, but post-2011 tightened considerably, at least until the second quarter of 2014. By contrast, financial conditions in the G4 generally became less stringent over the same period, as shown by both the nominal and real alternatives.

Moreover, all of the five asset prices underlying the Chinese FCI indicate an unmistakable financial tightening over this period — rising short- and long-term interest rates, a strengthening renminbi and a languishing Shanghai stock market that lost 27 percent of its value during this episode.

Finally, the paths of the nominal and real FCIs have differed somewhat for these big five economies in the post-2007 period, but all indicate tighter financial conditions in China both over time and relative to its international peers. While the real FCIs of the five major economies have shown noticeable swings, their nominal counterparts except China’s display steady, large and synchronised declines, indicating considerable easing of the financial conditions outside China.

In sum, China’s financial conditions have become unmistakably tighter since the global financial crisis. Intuitively, this revealed financial tightening, both over time and relative to its international peers, could have meaningfully contributed to China’s recent slower economic growth. Puzzlingly, our price-based FCI seems to sharply contrast with the observed Chinese credit boom in the wake of the global financial crisis.

In any case, Chinese policymakers ought to take notice of such marked, sustained and broad-based tightness of the financial conditions. A good starting point would be to better understand the underlying causes behind the tighter Chinese financial environment. For instance, a rigid 75 percent regulatory cap on the bank loan-to-deposit ratio and a punitive 20 percent reserve requirement both might have added to financial tightness, prompting policymakers in Beijing recently to tweak these rules in an attempt to loosen the domestic financial conditions.

Assistance by Giulio Mazzolini and Noah Garcia is gratefully acknowledged.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article

Opinion

What can the EU do to keep its firms globally relevant?

There is a fear that EU companies will find it increasingly difficult to be on top of global value chains. Many argue that EU-based firms simply lack the critical scale to compete and, in order to address this problem, that Europe’s merger control should become less strict. But the real question is where the EU can strengthen itself beyond the realm of competition policy.

By: Georgios Petropoulos and Guntram B. Wolff Topic: European Macroeconomics & Governance, Innovation & Competition Policy Date: February 15, 2019
Read about event

Past Event

Past Event

Is the European automotive industry ready for the global electric vehicle revolution?

How can Europe catch up on the global electric vehicle race?

Speakers: Eric Feunteun, Jacques Pieraerts, Julia Poliscanova, Simone Tagliapietra and Reinhilde Veugelers Topic: Energy & Climate, Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: February 12, 2019
Read about event More on this topic

Past Event

Past Event

The world’s response to China’s Belt and Road Initiative

This event will look at the Chinese Belt and Road Initiative as well as the response from the rest of the world.

Speakers: George Cunningham, Uri Dadush, Jean-Francois Di Meglio, Theresa Fallon, Alicia García-Herrero and Guntram B. Wolff Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: February 8, 2019
Read article More on this topic More by this author

Podcast

Podcast

Director's Cut: Reflections on five years of China's Belt and Road Initiative

Bruegel fellows Alicia García-Herrero and Uri Dadush join Guntram Wolff for this Director's Cut of 'The Sound of Economics', focusing on the progress made by China's Belt and Road Initiative, how it will continue to develop, and the reactions it has stirred across the world.

By: The Sound of Economics Topic: Global Economics & Governance Date: February 7, 2019
Read article Download PDF More on this topic

Working Paper

Countries’ perceptions of China’s Belt and Road Initiative: A big data analysis

Drawing on a global database of media articles, the authors quantitatively assess perceptions of China’s Belt and Road Initiative (BRI) in different countries and regions. They also identify the topics that are most frequently associated with the BRI.

By: Alicia García-Herrero and Jianwei Xu Topic: Global Economics & Governance Date: February 6, 2019
Read article More on this topic More by this author

Blog Post

Chinese growth: A balancing act

China’s GDP growth in 2018 was 6.6%, its lowest annual growth rate in more than two decades, and the rate is expected to slow further this year. What is driving the slow-down in Chinese growth and what are the implications for Chinese policymakers and the global economy? This post reviews the blogosphere’s take.

By: Konstantinos Efstathiou Topic: Global Economics & Governance Date: January 28, 2019
Read article More by this author

Blog Post

What 2019 could bring: A look inside the crystal ball

Economic performance prospects in Europe, the US and Asia in 2019. We start off by reviewing commentaries and predictions about the euro zone, which many commentators expect to perform below potential as uncertainties continue to dampen a still robust recovery.

By: Michael Baltensperger Topic: European Macroeconomics & Governance, Global Economics & Governance Date: January 14, 2019
Read article Download PDF More on this topic

Policy Contribution

The Belt and Road turns five

Five years after its launch, Michael Baltensperger and Uri Dadush reflect on China’s Belt and Road Initiative. The plan to revive ancient trade routes has the potential to enhance development prospects across the world and in China, but that potential might not be realised because the BRI’s objectives are too broad and ill-defined, and its execution is too often non-transparent, lacking in due diligence and uncoordinated.

By: Michael Baltensperger and Uri Dadush Topic: Global Economics & Governance Date: January 10, 2019
Read article More on this topic More by this author

Opinion

Lose-lose scenario for Europe from ongoing China-US negotiations

Without an expectation of a larger market for European exports in the absence of additional opening up by Chinese authorities, European exporters should not enjoy the ongoing China-US negotiations.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: January 9, 2019
Read article More on this topic More by this author

Podcast

Podcast

Deep Focus: Europe's auto industry and the global electric vehicle revolution

Bruegel fellows Reinhilde Veugelers and Simone Tagliapietra elaborate on the recent Policy Contribution they co-authored on the European automotive industry in the light of the global electric vehicle revolution.

By: The Sound of Economics Topic: Innovation & Competition Policy Date: January 8, 2019
Read article Download PDF More on this topic

Policy Contribution

Is the European automotive industry ready for the global electric vehicle revolution?

This Policy Contribution investigates the position of the European automotive industry in a scenario in which electrification substantially progresses. Europe cannot follow China in the adoption of centrally-planned industrial policy measures. But it certainly can and should do more to stimulate the transformation of its automotive industry through more ambitious policies.

By: Gustav Fredriksson, Alexander Roth, Simone Tagliapietra and Reinhilde Veugelers Topic: Innovation & Competition Policy Date: December 20, 2018
Read article More on this topic More by this author

Opinion

China’s view of the trade war has changed—and so has its strategy

The truce agreed on by China and the United States at the sidelines of the recent G-20 meeting in Buenos Aires doesn’t really change the picture of the U.S.’s ultimate goal of containing China. The reason is straightforward: The U.S. and China have become strategic competitors and will continue to be so for the foreseeable future, which leaves little room for any long-term settlement of disputes.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: December 19, 2018
Load more posts