China recently made a fresh effort to boost its flagging economy with cash injections by its central bank but signs are mounting that the monetary stimulus is not working. The debt ridden companies don’t have the appetite to borrow more even at low rates.
Last week, Bank of China pumped in $81 billion into the economy via loans to the five biggest banks. They changed the loan to deposit ratio rates, by loosening it and gave them freedom to expand lending.
Lesson 1:
Even though funds are available, the borrowers are reluctant to take loans at lower rates. This is due to weak demand for goods.
This raises that spectre that China may slip into a so called “balance sheet recession”. In this, highly indebted companies concentrate on paying down debt and refusing to borrow even when the interest rate is falling.
A survey among the manufacturers showed that they are extremely pessimistic about the economic future. To confirm this finding, the bank loan outstanding rose only by 15.3% year on year in August, the weakest pace since 2005.
Lesson 2:
The banks when loaded with cash are unable to find potential borrowers use their funds either to buy the government bonds or use the reverse repo to deposit funds with the central bank.
The massive debt financing launched by the Chinese Central Bank has increased the overall debt to GDP ratio to 251%. This when compared to 2003 debt to GDP ratio of 147% clearly indicators that balance sheet recession will sooner or later become a reality.
Lesson 3:
When private sector refuses to borrow and instead engage in fixing their balance sheets, the government must fill the gap with fiscal spending.
China did that already with limited success. A better strategy will be for China to accept the new reality and accept lower economic growth.
For all countries which take the route of achieving higher growth by pumping money into the system, how long can you sustain it? What if the expected demand keeps slowing down and pumping money in the economy ultimately returns to the central bank?
RBI in India is currently pumping in large sums of liquidity. This excess money is keeping the consumer price inflation at a very high level. The businesses are clamoring for more liquidity and lower rates of interest. RBI is generally conservative and so will not fall for hue and cry from the industries. Ultimately, it is the consumers who will call the shots. If they decide to hold back their consumption, the government by itself cannot pull the economy out of a recession. However, they can put some money in the infrastructure. That is what China did. They are currently over built. The real estate prices have been coming down in the last 4 months. Analysts expect much further drop in prices in the months to come.
Lesson 4:
The economic growth of a country cannot be maintained unless consumption by public continues to be buoyant.
By Dr. BOBBY SRINIVASAN AND Dr. SUDHAKAR BALACHANDRAN
Great Lakes Institute of Management
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