China has lots of policy room if trade war worsens – Yi Gang

China has “tremendous” room to adjust
monetary policy if the trade war with the US deepens, People’s Bank of China
Governor Yi Gang has said.

“We have plenty of room in interest rates, we
have plenty of room in required reserve ratio rate, and also for the fiscal,
monetary policy toolkit, I think the room for adjustment is tremendous,”
said Yi in an exclusive interview in Beijing.

Asked if his scheduled bilateral meeting with US
Treasury Secretary Steven Mnuchin would get negotiations with the US back on
track, Yi said it would probably be a “productive talk, as always,”
though the topic of the trade war would be “uncertain and difficult.”
The two are set to meet at on the sidelines of the Group of 20 gathering of
finance ministers and central bank governors in Japan.

That meeting takes place as the two nations
escalate their trade war amid a darkening outlook for the global economy, with
Citigroup and Morgan Stanley warning this week that it risks tipping the world
into recession. This is the first publicly announced meeting since the trade
talks fell apart last month and could pave the way for a meeting between
Presidents Donald Trump and Xi Jinping, who will likely be in Japan at the end
of the month for the G20 leaders’ summit.

Mnuchin, along with US Trade Representative Robert
Lighthizer, has led the US-China talks while Yi has been a member of China’s
delegations. The yuan stabilised in recent weeks as authorities voiced support
for the currency, following a rapid sell-off that pushed it near 7 per dollar –
a level not breached since the global financial crisis. It still lost about
2.5% in May, among the worst in Asia.

“Recently, it’s a little bit weaker, because
the tremendous pressure from the US side,” Yi said. Asked if there’s a red
line for the exchange rate, Yi said no number is more important than another.

“The trade war would have a temporary
depreciation pressure on renminbi, but you see, after the noise, renminbi will
continue to be very stable and relatively strong compared to emerging market
currencies, even compared to convertible currencies,” Yi said, using the
yuan’s official name. “I’m very confident renminbi will continue to be
stable at a more or less equilibrium level.”

“A little bit of flexibility of renminbi is
good for the Chinese economy and for the global economy because it provides an
automatic stabiliser for the economy,” he said. “The central bank of
China is pretty much not intervening in the foreign-exchange market for a long
time, and I hope that this situation will continue, not intervening.”

‘Golden Level’

Commenting at the end of a week in which the
Federal Reserve and European Central Bank sounded more open to easing monetary
policy and with Australia and India already cutting rates, Yi said China’s
monetary policy has “to be in a sober mind position,” and the policy
stance is prudent.

“I think our benchmark interest rate right now
is in right level. I would say in terms of resources allocation at this level,
I call it very close to golden level,” he said.

Still, more economists are predicting that a
worsening trade war and job market outlook could prompt the central bank to
take bolder easing steps.

“Looking forward, our base case is that an
escalating trade war will push key gauges below the PBOC’s tolerance threshold,
triggering 50 basis points of rate cuts and another 150-200 bps of reserve
requirement cuts by year-end,” David Qu, an economist with Bloomberg
Economics in Hong Kong, wrote in a recent report.

Fiscal outlook

Yi gave no indication that the government was
considering more fiscal stimulus now to counteract the effect of the trade war.

“Our fiscal policy this year is probably the
largest and strongest fiscal reform package, in terms of the tax cuts, and also
in terms of having more efficient fiscal resources allocation between the
central government and the local government,” Yi said.

“The current package is able to cover the
cases where the situation is getting a little bit worse, but of course, if the
situation gets tremendously worse, they will open the discussion. But right now
they haven’t discussed that scenario yet.”

The government is concerned about the effect on
employment from any worsening in the dispute with the US, with Yi suggesting
there could be support such as a 100bn yuan ($14.5bn) for short-term vocational
training programs for those who have lost jobs.

“The PBOC may reduce benchmark interest rates,
if the full-year growth of China’s gross domestic product threatens to fall
below 6.2% and if the US imposes tariffs on remaining Chinese exports,”
said Christy Tan, head of markets strategy at National Australia Bank.

Risks of the yuan breaking 7 have elevated along
with the escalation of the trade war and the prospect that tension will be
prolonged, she said, adding the trigger for such a move could be a lack of
progress on negotiations during the G-20 summit.

Here are some other comments from Yi:

State of China’s economy

Economic performance in the first quarter was
better than expected, though people’s expectations turned “negative and
gloomy” afterward, amid the uncertainty of the trade war. Still, the
Chinese economy is resilient.

On policy options

The PBOC will continue to view price stability as
its number one goal, while looking at the employment situation and trying to
accommodate the economy to create more jobs.

On financial stability of smaller banks

Some smaller banks have a little liquidity
tightness, and that’s why the PBOC’s policy targets smaller banks. Overall
liquidity in the economy right now is plenty Smaller banks’ tightness is a “temporary
phenomenon,” given China has a targeted reserved ratio cut for them, and
also given PBOC market activities to channel liquidity to smaller banks and
some non-financial institutions. Their funding problem will get better very
soon.

On policy transparency

“One of my thoughts, and also my promotion, is
to make my monetary policy more transparent so that the whole society and the
world can have the right expectations.” That way the transmission
mechanism will be more efficient, and global investors will “feel more
comfortable, more expected and also that would enhance their confidence”.

On financial sector opening

When asked if the trade war could make it harder
for US banks to benefit from China’s opening up, Yi said he hopes “we can
treat everybody fairly, equally and minimise the negative impact of trade war,”
while adding that it’s a two-party game and it’s up to the other side to also
decide and act in good faith.

On debt cleanup

In the past two years, the overall leverage ratio
of the Chinese economy has stabilised at about 250% of gross domestic product.
The overall leverage ratio could increase a little bit if the trade war
worsens, but not tremendously It would be a more or less reasonable increase to
temporarily accommodate the shock, then the PBOC would continue its policy and
overall leverage should stabilise.