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Article11 May 2021

China Economics: Proceed to the Exit With Caution

China’s exit from an accommodative monetary policy won’t be as straightforward as it was after the Global Financial Crisis (GFC), according to economist Li-Gang Liu. In this summary, we distil Li-Gang’s view that significant structural changes in the economy in the past decade mean that a policy exit now will require a holistic approach that reflects both domestic and external conditions.

The PBoC’s monetary policy exit in 2010 post the GFC was relatively uncomplicated. This time, such an exit is unlikely to be as straightforward. Structural changes in the past decade mean that policy decisions now need to take into account domestic factors such as a high debt level, the risk of a property bubble, the opening of financial markets and reduced PBoC policy independence, along with extremely loose external monetary conditions.

  • Debt: China’s overall debt ratio (including contingent liabilities) soared from 141% of GDP in 2008 (pre-GFC) to 315% in 2020. Higher interest rates would now have a greater impact at the corporate, government and household levels. For corporates, for instance, the weighted average lending rate was above 5% at end-2020, while bank lending rates for private enterprises were much higher at 7-9%, significantly above their pre-tax profit margin.
  • Property prices. On a simple average, property prices nationally have doubled since 2010. Yet prices at primary locations in first- and second-tier cities during the same period could have increased at least 5x and 3x, respectively.

Figure 1. Corporate Lending Cost vs Profit Margin

Figure 2. Average Property Price for 100 Cities by Tier

Source: CEIC Data Company Limited, Citi Research

Source: WIND, Citi Research


  • Capital markets: China’s capital markets are now much more open to foreign institutional investors, while the remittance of investment income is more convenient. With the domestic markets now part of the world’s major capital market indexes, foreign institutional investors will be increasingly obliged to increase their exposure commensurately to China's stock and bond markets. Interest-rate differentials between the RMB and other leading currencies will become a bigger determinant of capital flows to China and of the RMB exchange rate.
  • PBoC’s policy independence. China’s monetary policy is becoming more susceptible to external monetary and financial conditions, narrowing the PBoC’s room for maneuver. As most controls on the capital account are being removed, the central bank has a choice of accepting a truly free floating exchange rate or compromising its policy independence. The latter looks the more likely outcome.
  • External monetary conditions. Global liquidity is far more excessive than during the GFC. The US Fed’s balance sheet, for example, has soared from US$4.2trn in February 2020 to almost US$8trn now. Unprecedented interventions by the Fed and other central banks may have been necessary, but their spillover effects are likely to be considerable.

Against this challenging backdrop, Li-Gang Liu argues that a China policy exit that relied entirely on traditional fiscal and monetary policy tools would risk unpleasant shocks. Instead, he believes a holistic approach will be required to achieve the desired policy goals:

  • Empirical evidence does not support the view that higher mortgage rates would subdue overheating property prices, which more reflect structural factors (rapid urbanization, inadequate public rental housing, among several). Potentially more effective would be a set of macro-prudential policies, such as raising down-payment ratios and restricting bank lending to the property sector.
  • Higher interest rates could lead to corporates engaging in financial speculation, the returns on which might seem more attractive than those on physical investment. Thus, paradoxically, monetary tightening could lead to asset bubbles. As such, China’s policy exit will require effective coordination and cooperation among different sets of policy-makers.
  • The PBoC may need new policy tools to address future default risks, among both systemically important SOEs and private enterprises. Short-term liquidity constraints that risked corporate defaults that in turn endangered financial stability might require direct intervention by the PBoC, though in ways that avoided creating moral hazard.
  • Excluding contingent liabilities, China’s overall government debt (central/local) at 45.9% of GDP is still very low compared to those of the likes of Japan and the US. This leaves considerable head-room room for fiscal stimulus by the central government. More investment in education, science & technology and health care could help maintain growth momentum. Whittling away the very high levels of SOE debt would likely require decisive reform for SOEs and local government financing vehicles.

For more information on this subject, please see China Economics: China’s Monetary Policy Exit Dilemma.


Citi Global Insights (CGI) is Citi’s premier non-independent thought leadership curation. It is not investment research. The comments expressed herein are summaries and/or views on selected thematic content from a Citi Research report. For the full CGI disclosure, click here.

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