How Much Policy Room Is Left?

China Fiscal Stimulus

Today is a pretty “light” day data-wise, which might explain why there is so much focus on a delay in China’s activity and foreign trade numbers – presumably due to the timing of the 20^th Communist Party Congress. Anyway, while leaders and officials are busy thinking about the country’s development path for the next few years, the IMF’s Fiscal Monitor raises more immediate questions about the extent of China’s fiscal stimulus during the pandemic, and how much policy room China may still have in this area going forward. China’s stimulus might have been targeted – as opposed to the “wall of liquidity” approach in major developed markets (DM) – but these small measures can still add up. The IMF projections shows that China will run the largest primary deficit (as % of GDP) among major emerging and developed markets both in 2022 and 2023 (see chart below). China is also among a handful of economies where primary deficit is set to widen in 2022 – and this widening (again, as % of GDP) is the second largest after Russia (which is financing the war in Ukraine).

China Growth Slowdown

China has so far been reluctant to use monetary policy space – the rate cuts were tiny and the 1-year medium-term lending facility rate was kept on hold last week. Further, China’s interbank rates are already quite low, so it is not clear whether additional rate cuts would make a difference. Finally, China’s falling interest rates worsen the differential with the U.S. – the 5-year differential is now very negative (-171bps) – putting additional pressure on the currency, and creating more policy challenges for the central bank. As regards domestic activity, the strongest headwinds are related to housing sector instability and the zero-COVID approach, and we hope to get more clarity on these issues once the party congress is over.

Global Rate Hikes

China is not the only economy, where market participants question the available policy space – the recent policy U-turns in the U.K. is a fascinating (and scary) example. Major central banks, however, continue to sound hawkish – recession concerns notwithstanding – supporting the market expectations of large rate hikes in the next month or two. Swap curves price in the terminal rates of about 5% in the U.S. and the U.K., and above 3% in the Eurozone. In emerging markets (EM), this week’s focus will be on Turkey – which is expected to cut the policy rate once again (to 11%, with inflation climbing to 83.5%), testing the market’s patience and authorities’ ability to rely on macroprudential measures in the run up to the elections. Stay tuned!

Chart at a Glance: Fiscal Deficits During and After Pandemic

Source: IMF Fiscal Monitor, October 2022.