China's Policy Dilemma: Is Boosting Credit Deflationary?

• China's central bank faces a major hurdle in quelling the threat of deflation. Deteriorating asset quality from the property crisis and local government debt woes are pressuring central bankers to release liquidity into the banking system by cutting reserve requirements to fend off any risks of a funding crunch.
• The People's Bank of China (PBOC) is under pressure to cut interest rates as falling prices raise real borrowing costs for private businesses and households, curbing investment, hiring, and consumer spending. The PBOC's predicament highlights the need for the government to accelerate structural reforms that boost consumption, addressing a long-standing deficit in policies promised for 2023.
• However, both moves share a common problem: demand for credit in China mainly comes from the manufacturing and infrastructure sectors, whose overcapacity issues are exacerbating deflationary forces in the economy.
• Weak private sector demand for credit, reflected in falling money supply ratios, emphasizes the necessity for policies that enhance private business confidence. Despite the PBOC's efforts to ease monetary policy, weak private sector demand, rising real borrowing costs, and structural imbalances pose challenges.
• Additional monetary easing may carry the risk of increasing deflationary pressures, and analysts emphasize the importance of a comprehensive approach involving fiscal policy, and structural reforms to stimulate demand and economic growth.

(Source: Reuters)