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  • Ann Listerud

Why China's GDP Has the Central Bank Worried

[People's Bank of China Governor Yi Gang]

Over the last two years, I’ve written pieces for this blog about how debt accumulation and slowing consumption are affecting China’s GDP. Ten years ago, to counteract the 2007-2008 Global Financial Crisis, China’s central government encouraged local governments to carry out construction and stimulus programs. While they were successful in avoiding economic downturn, local governments took on large amounts of debt, which China’s central government is still unsure of how to handle. In order to prevent market panic while simultaneously tackling non-performing loans, China’s financial regulators have taken a slow, methodical approach, reducing the number of bad loans taken out and marshaling resources to digest loans that under-performed.

While this approach worked well when all other things were stable, 2018 and 2019 proved to be anything but. Households took on increasing amounts of debt, African swine fever was decimating farmers and household grocery lists, and trade tensions with the United States created political uncertainty and anxiety. With the addition of a slowing real-estate market and several historic high profile bank bailouts, 2019 left regulators with precious little maneuverability to quickly boost GDP.

Then a new respiratory virus emerged shortly before Spring Festival.

Stemming the spread of COVID-19 requires temporary but significant behavioral change from all of society and has affected countries across the globe. Every sector in every major economy is or will be impacted. However, insofar as economic response is concerned, China’s regulators need to be mindful of not only the short-term emergency response but also China’s long term trajectory.

The People’s Bank of China (PBOC) is one of the primary gatekeepers in regulating China’s financial system, and plays an important role in managing interest rates, bank reserve requirements, and levels of money in circulation. While they are not the only regulatory body focused on the economy, the PBOC is becoming the entity most visibly balancing emergency action versus long-term policies aimed at reducing and alleviating existing debts.

As the full brunt of COVID-19’s impact on China’s GDP emerges, pressure is mounting on the PBOC to curb measures meant to prevent non-performing debt accumulation in favor of stimulating GDP. Maintaining this balance will determine China’s economic future for the coming decade.

Economic Planning After an Unlikely Devastating Event

It is difficult to perform an economic risk-benefit assessment of how China’s government handled the virus due to the many unknowns associated with it. Were we to assume only the best intentions from all parties, it would not have been possible to estimate crucial details about COVID-19 such as contagion rate or fatality before scientific assessments had been made. Actions taken in the early days of the outbreak, even assuming utmost rigor and responsibility, were done with incomplete information.

What we can more accurately compare is China’s economic outlook now versus what would have been likely were there no virus. Had COVID-19 not occurred, China’s economy would have exhibited (as Xi Jinping and other leaders have described) “changes amidst stability, challenges amidst changes” (稳中有变,变中有忧). Though a phase-one agreement with the US had been signed, plenty of domestic pressures from rising inflation to sluggish employment meant there were ample incentives to start stimulating.

There are creative stop-gap measures and compromises that can be carried out to boost GDP and facilitate growth without resorting to massive stimulus. Yet before the outbreak of the virus, those alternative methods were already strained. Taxes and fee reductions for consumers and businesses were reduced by 2 trillion RMB ($280 billion) in 2019 alone. To make up for the lost tax income, government land sales reached a record high in 2019, with initial reports from 50 major cities citing over 4 trillion RMB ($570 billion) in land sales as of late December. Additionally, the PBOC can reduce banks’ reserve requirements allowing them to further invest in the economy; from early 2018 to late 2019 the PBOC reduced reserve requirements seven times.

Local governments habitually turn to construction to stimulate GDP. The massive non-performing debts China accumulated came about through a construction spree that carried the national economy through the Global Financial Crisis and kept GDP high into the 2010s. Regulators in Beijing are focused on moderating and controlling the rate of funding going towards construction. To that end, in 2018 central government regulators began leaning on “special purpose bonds,” bonds issued by local governments with the approval of the Ministry of Finance earmarked for special projects such as infrastructure. Demand for special purpose bonds has been high. By December 2019, nearly 50 percent of the bonds for 2020 totaling 1 trillion RMB ($140 billion) had been allocated so as to, “ensure we can see results early next year...and the economy can be effectively boosted as soon as possible.”

Then the virus broke out; creating massive ripple effects on production and consumption in every industry.

Were a miracle cure or vaccine to be administered tomorrow it would not undo the change that has occurred. Humans change their outlook and behavior in response to crisis events. While it would be difficult to give a dollar estimate to the long term effects on consumer outlook thanks to COVID-19, it has already had a major effect on Chinese consumer preferences with most households becoming more cautious, cutting spending, and purchasing different products to reflect new fears and realities. As life returns to normal in many areas after a sharp drop in spending during the outbreak, customers are slowly beginning to spend again. If consumption doesn’t pick up faster, 60 percent of businesses will be out of cash in six months.

Behavioral changes can have an equally large impact on employees. Figures from China’s Ministry of Industry and Information Technology report that as of early March only 45 percent of small and medium enterprises had resumed operations; by early April consultants at Trivium calculated small and medium enterprises were operating at 76 percent of normal levels. Manufacturers meanwhile are just as concerned about overseas orders, since COVID-19’s spread is affecting overseas client behavior at the exact moment Chinese manufacturers are returning to work.

All of these changes are consistent with research on past epidemics. The World Bank attributes as much as 80-90 percent of the negative economic impact incurred during the 2002-2004 SARS epidemic and the 2009 H1N1 flu epidemic to behavioral changes (such as reduced contact with other people, reduced transportation, etc.). Given the rise in personal debt that had been well underway in China, it’s possible reduced consumption was in the cards already for 2020. But COVID-19 has not helped. With reduced consumption both at home and abroad leaving companies forced to shut down, GDP will plummet.

Limited Edition Loans

What can banks do? A great deal actually. By lending capital especially in essential industries, banks can soften the economic impact of the virus and incentivize businesses to focus on healthcare and health needs.

Central banks cannot function as healthcare resources but they can channel funding toward companies and industries that do and ease the financial impact on businesses. If employees and customers are staying home to avoid contact and transmission, companies that were once thriving could struggle to make up for the sudden loss of production and income. Companies that were struggling could go underwater entirely. By making credit available, businesses and individuals can make choices that prioritize public health rather than worry about staying afloat once the crisis is over. For companies that produce healthcare products like surgical masks or life essentials like food, being able to have credit during a crisis becomes essential to allow these businesses to remain open and contribute to combating the virus.

The PBOC rolled out a special, limited time only loan program for businesses involved in essential functions and virus prevention. The central bank began offering inexpensive loans to banks across 10 provinces (mostly state owned banks). Banks in turn invest this money to businesses through a new product called “virus bonds,” which have an expedited approval process, below market interest rates, and businesses must use at least 10 percent of the resulting funds to fight the virus. 300 billion RMB ($42.5 billon) was made available on February 10, raised to 800 billion RMB ($113 billion) on February 26. If used properly, these bonds can tide businesses over until the economy can return to normal using fiscal support that, while not insignificant, is considerably smaller than large scale stimulus would be.

Despite efforts to limit and target support, China’s long-term debts cast a long shadow. A myriad of companies, from coal manufacturers to local government financing vehicles, reportedly applied for virus bonds to take advantage of the new source of low interest credit. The PBOC tightened virus bond eligibility requirements in response but ensuring funds are used as the central bank intends remains a challenge. Analysts at Reuters estimate only one third of virus bond financing is going toward combating the virus and the Wall Street Journal reports companies are using most of the proceeds from virus bonds to refinance prior debts.

Other methods the PBOC is taking to ease the economic impact of COVID-19 include reduced reserve requirements for banks that meet certain targets for lending to farmers, students, and small enterprises. Though the central bank has employed this method three times this year to free up capital, the PBOC seems cautious about employing wider forms of stimulus.

Tug of War

Historically there has been a tension between centrally-based technocrats who want to limit monetary supply to prevent inflation versus regional or general political actors who want to expand money supply to accelerate investment-led growth (which readers should note from past entries in this series produce short term GDP boosts and long term non-performing debt). There’s no reason to think this tension does not exist today, especially amid an atmosphere of crisis.

Local governments intend to boost infrastructure building, announcing in early March plans to spend as much as 34 trillion RMB ($4.8 trillion) over the next few years. This was bolstered by an announcement on March 31st by the state council to raise special purpose bond caps for local governments. But centrally-based policy advisors have attempted to level expectations. The chief economist at the State Information Center told Caixin that of the original 34 trillion RMB, actual new infrastructure will amount to about 1.2 trillion RMB ($170 billion) and will focus on 5G and advanced technologies. Other high-level technocrats have released statements saying new technologies should be funded by the private sector and that the government should prioritize employment rather than building.

Rather than boost infrastructure development, the economy could get a temporary lift through property markets but here too the PBOC is reluctant to push forward. After years of central policy makers trying to curb runaway housing price growth, housing prices fell to their slowest pace in 18 months this January. Though official statistics are not yet out for February, preliminary reports say housing prices continued to fall to only 10 percent of what they were the year before. Though a number of local governments have implemented policies to stabilize property markets, the PBOC has remained long-term oriented in its outlook and has explicitly stated it will not use the housing market to counteract the economic impact of COVID-19.

One option the PBOC could take is to increase the nation’s supply of money; it’s an option that the PBOC has taken in the past, and other nations have taken under times of extreme stress. This was the core of the US Quantitative Easing policy in the wake of the 2008 Global Financial Crisis.

However, the entity least interested in taking on quantitative easing is the central bank itself. Official announcements repeatedly say that liquidity is at a sufficient level and that the bank will not engage in mass stimulus (often referred to in statements as “big flood irrigation,” 大水漫灌). This decision may seem strange in isolation yet it is highly rational given the broader context of China’s GDP growth and debt. Increasing liquidity allows entities to have cash to quickly invest in projects. The primary problem facing China’s economy in 2019 wasn’t a lack of cash to invest but directing existing cash away from wasteful infrastructure or bloated state-owned enterprises and towards small enterprises and social safety nets. Quantitative easing for the purposes of increasing GDP for GDP’s sake alone without regard for the real economy could push China into a full blown financial crisis.


The economic problems posed by COVID-19 may be hitting China first but they are not exclusive to China. As the virus spreads and people reduce contact with one another to combat it, economies across the globe are being affected. The International Monetary Fund has earmarked $1 trillion to help member countries withstand the economic impact of the virus. The US Federal Reserve rolled out new forms of support nearly every week throughout March, including reducing benchmark interest rates to near zero and opening a “Money Market Mutual Fund Liquidity Facility” to make loans available to eligible financial institutions. The New York Fed started offering short-term loans to banks to ease pressure on small businesses and announced it would purchase $75 billion worth of Treasuries and $50 billion of mortgage-backed securities each day for a week. The EU Central Bank approved a 750 billion Euro ($820 billion) spending package despite already negative interest rates.

What is unique to China is the state of the economy before the virus broke out. As iterated in previous installments in this series, after several decades of high speed investment led growth China is currently struggling to find replacement drivers of growth while simultaneously being dragged down by debts incurred during the investment binge. Though the PBOC found an approach to dealing with non-performing loans that worked well enough during times of calm, that calm has been disrupted. Economists estimate that China’s GDP growth will fall to 4.5 percent in the first quarter of 2020; dropping from 6 percent in the fourth quarter of 2020. Some speculate that China’s annual growth will fall below 5.5 percent this year due to the first quarter alone.

2019 was not kind to China’s banking system. In an unprecedented turn of events, four different private Chinese banks received government bailouts last year. This additional strain was not needed. Real-estate bankruptcies are on the rise. These were all areas of concern at the end of last year but the virus outbreak has added sharp pressure to every sector.

Even with the aforementioned measures to provide credit and liquidity amid the virus outbreak, statements from the PBOC have emphasized maintaining “stable” monetary levels. In other words, even with these targeted measures the PBOC is signalling no large scale quantitative easing at this time.

What to Do

In isolation, COVID-19 is not going to permanently damage China’s economy. China’s financial regulators are practiced and adept at responding to short-term problems. The problem is responding to the economic impact of the virus makes it harder to stop accelerating towards a financial crisis due to regional bad spending, which centrally-based technocrats who have been trying to put the brakes on.

It would be hard to say what Xi Jinping himself thinks on this matter. One could speculate Xi’s focus is on short-term return to normalcy and reaching the 2020 anti-poverty goals, but that he is willing to back (or at least not interfere with) PBOC’s policies.

Having laid out just a brief outline of the policy options and costs facing China’s regulators, it is difficult for me to say what policy approach would be advisable. I have the luxury of considering this from a quiet office with no stakes (aside from my pride and reputation once this is published.)

It may do us well to imagine for a moment PBOC Governor Yi Gang’s (易刚) life for the past few months. Stressed and exhausted, faced with a choice between uncertain short term GDP growth and equally uncertain long term stability, he thinks again about how to manage the nation’s money supply. After a year of struggling to curb borrowing, he has been told to help support (i.e. promote lending to) businesses. He hears whispers that politicians up and down the chain of command are wondering why we don’t just build our way out of this like we did in 2008. This house of cards was able to survive in the breeze, but now it must withstand a gale. What should he do?


Ann Listerud is a research consultant with CACR. She previously served as a research assistant with the U.S.-China Economic and Security Review Commission, a research associate at CSIS, a researcher and translator for Industrial Bank of Japan, Leasing Co. Ltd., and an English teacher for Henan University and the Shenzhen public school district. Her research interests include Chinese economic policy, state-owned enterprise reform, and aging populations. Ms. Listerud earned her MA in International Affairs from the University of California, San Diego, and her BA from Beloit College, where she double majored in international relations and East Asian languages. She speaks and reads Mandarin Chinese and Japanese.

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