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Thursday, July 01, 2021
The Increasingly Divergent Economic Policies of China and the United States
ANBOUND

The People's Bank of China (PBoC) has vowed to maintain a prudent monetary policy in the second half of the year, stressing the need for flexible and precise implementation of monetary policy and the balance between economic recovery and risk prevention. This policy stance signifies that the PBoC has "normalized" monetary policy, putting it at a distance from the U.S. Federal Reserve's ongoing loose policy. This has raised many concerns about whether the PBoC's monetary policy will be affected in the event of a possible tightening policy by the Federal Reserve, and how China should deal with the policy differences between the U.S. and China.

As for the policy differences between China and the United States, it has actually been quite obvious as far as the easing policies in response to the pandemic are concerned. The scale and intensity of the U.S. stimulus package were unprecedented. Since the Biden administration took office, various stimulus policies have been introduced in the U.S., further widening the gap between the two countries' fiscal and monetary policies. The scale of China's fiscal stimulus was about 3.3% of GDP and interest rates fell by 30 basis points. The U.S. launched three fiscal stimulus packages, equivalent to 23% of GDP, and the Federal Reserve cut interest rates by 150 basis points and conducted USD120 billion in monthly asset purchases.

Since the second half of last year, as the U.S. persisted with massive fiscal and monetary stimulus in response to the pandemic, China has begun to withdraw stimulus measures in response to the pandemic. This year, China has begun to slow the pace of its fiscal support and stabilize leverage by reining in credit. Such differences between China and the United States have brought about fluctuations in the RMB exchange rate in China, which has inevitably impacted and affected China's economy. Especially since the beginning of this year, the loose policy and economic recovery of the United States have led to the rise of commodity and energy prices, which has had an impact on China and, to some extent, affected China's economic recovery in the post-pandemic period.

Unlike the post-2008 global policy coordination under the influence of the Federal Reserve, the current divergent economic circumstances between China and the U.S. indicate that policy coherence between the two countries is not very feasible. In fact, the current monetary policy differences between China and the United States are the result of the different levels of pandemic and economic recovery between the two countries. For China, the economy has already had a rapid rebound in the first quarter of this year due to the early containment of the pandemic, the rapid recovery of production, and the early start of economic recovery, providing a basis for the normalization of monetary policy by the PBoC. Although the U.S. economy began to recover under gradual vaccination progress, and the overall demand increased significantly, bringing inflationary pressure, the economic recovery is still in its infancy, and still facing employment pressure. That leaves the Federal Reserve with the need to maintain stimulus in the short term. As China's economic growth returns to its long-term trend, there may be a need for policy adjustments in both countries while the U.S. side maintains a strong recovery momentum.

In the face of rising inflation in the United States, the Federal Reserve has begun to withdraw dollar liquidity, and may accelerate the withdrawal of stimulus policies in the future and consider raising interest rates. China, in the case of economic growth rate being "high at the beginning of the year, while it lower afterwards", is still affected by structural problems and excess capacity. Therefore, interest rates are unlikely to rise, and China will continue to guide market demand through controlling the total amount of social financing and structural adjustment.

Recently, with the RMB exchange rate fluctuating significantly in response to changes in the U.S. dollar index, ANBOUND has pointed out that the need for China to distance the RMB from the USD and noted that Chinese monetary policy needs to be more independent. Of course, given the Federal Reserve's global dominance, China has little room for policy adjustment. A recent Bloomberg article noted the divergence in growth prospects between the U.S. and China, while arguing that the time for the PBoC to follow the Federal Reserve's lead is over and that PBoC's policy will be more domestically focused.

As a result, the impact of future tightening of U.S. policy on China will be much less than the pressure China faces due to its own economic structural problems. For this reason, China's monetary policy will gradually distance itself from that of the United States. Bloomberg's research suggested that once the Federal Reserve starts raising rates, China's monetary policy should be relatively loosened relative to the U.S.'s, even as the PBoC adjusts policy by gradually raising or cutting interest rates in response to domestic demand. In any case, this means that interest rate differentials between China and the U.S. are likely to narrow in the coming years, returning to pre-pandemic levels. At that point, the PBoC will not necessarily follow the Federal Reserve's lead in deciding its next move. In fact, the PBoC is likely to keep interest rates stable for the next few years, with a downward bias.

In the future, the narrowing interest rate differentials between the U.S. and China and the relatively "divergent" policies will affect the economies of the two countries respectively. The problem facing the U.S. is the rising inflation and how to withdraw the loose policies introduced in response to the pandemic. For China, the most significant impact is on the RMB exchange rate. China is aware of the impact of the changing international environment, as evidenced by the statements made at the PBoC's monetary policy meeting. The monetary policy meeting of the PBoC proposed to deepen the market-oriented reform of the RMB exchange rate, enhance the flexibility of the RMB exchange rate, guide enterprises, and financial institutions to adhere to the concept of "risk neutrality", strengthen expectations management, promote internal and external balance, and maintain the basic stability of the RMB exchange rate at a reasonable and balanced level. Its main policy stance remains to increase the two-way fluctuation of the RMB and avoid the formation of one-way expectations. This means that China will allow greater fluctuations in the RMB exchange rate to mitigate speculative trading brought about by policy differences. Moreover, it hopes to maintain the stability and growth of the economy and maintain the fundamentals of the RMB exchange rate, so as to guarantee the stability of the RMB exchange rate and resolve the risks caused by policy differences.

Final analysis conclusion:

The post-pandemic period has seen an uneven economic recovery in China and the U.S., which has gradually "diverged" the fiscal and monetary policies of the two countries, and the RMB exchange rate will be the focus of contradictions in all aspects. China will allow greater exchange rate fluctuation while maintaining economic fundamentals to cushion the pressure. The focus of China's monetary policy will remain on solving domestic economic problems.

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