The central bank of the world's second-largest economy is winding down the big round of stimulus, and that's going to have a ripple effect on the rest of the world, as well as in China.

China is starting to turn off the taps of monetary stimulus made to protect the economy amid the COVID-19 lockdowns, but any slowdown in the world’s second-biggest economy should be a “soft landing,” according to PIMCO, the US-based fixed income house.

The People’s Bank of China has started to unwind stimulus measures and this will prove to be a larger force for other developed countries to deal with than is realised, Gene Frieda, global strategist, and Carol Liao, China economist, said in a note yesterday. 

“The move is part of Chinese policymakers’ renewed focus on risk control, which reflects a belief that in order to sustain high quality growth, market discipline must be brought to bear on the weakest parts of the economy, including some state-owned enterprises, local government financing vehicles, and over-leveraged property developers,” Frieda said.

Frieda said that such policy tightening is already causing slower private credit growth and less government bond issuance. And this could put some stress on China’s corporate debt, making some segments more volatile. 

The decision by the central bank to tighten policy coincides with strong fiscal stimulus and improving mobility in the developed economies – a different pattern to earlier examples of when credit was squeezed in 2011-12 and 2014-15, Liao said.

Soft landing
The Chinese economy should achieve a soft landing for three main reasons, the writer said:

The prior round of credit tightening in 2017-18 made the economy more efficient and less sensitive to future stimulus withdrawal. It reduced excess low-end (and often unprofitable) manufacturing capacity. Simultaneously, policymakers took measures to bring hidden risks within the shadow credit sector back onto banks’ balance sheets and, in turn, pressured banks to raise capital and clean up their balance sheets. Banks are now well-placed to cope with a more neutral liquidity stance at a time when nonperforming loans are likely to rise.

The pandemic’s economic effects have largely run their course. The authorities managed the pandemic so well that the private sector is in a reasonably good position to carry the growth baton after the role played by the public sector in 2020.

Structural changes in the economy point to a less credit-intensive growth model than before. While the traditional manufacturing and investment-driven growth model has heavily relied on credit, the new economy is increasingly driven by the services sector and consumption. These sectors rely more on human capital and productivity, instead of credit.

Investment implications
PIMCO reckons there may be opportunities in holding parts of the Chinese bond market. Also, the Chinese renminbi looks attractive as a foreign currency. 

“On its own, the lower turn in the credit impulse does little to change our near-term constructive view on the renminbi. As with the economy itself, the renminbi tends to lag shifts in the credit impulse by two quarters. We also see potential currency upside from any US tariff relief,” Liao said.