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The key question for 2022 remains what will be the right level of economic growth, assuming that policymakers won't have to resort to a massive fiscal stimulus as in 2008. Can this be done? If so, what tools will be utilized? Uncertainties brought about by the new Omicron variant have clearly reinforced the existing tough policy on Covid-19 protocols in China with zero tolerance of any cases. Needless to say, the economic cost (e.g., travel and restaurants, to name a few) is high, but in the grand scheme of things, the majority of Chinese citizens support such strict measures because normal life has ensued amid some inconveniences. Such strict protocols may well go up a notch soon as China prepares to host the Winter Olympic Games in February. Industrial activities will certainly be affected in Beijing and Hebei province over the next two to three months, and the National Bureau of Statistics has even acknowledged that factories will be shut down in order to improve air quality in Beijing during the games, although its overall impact will be limited. Tighter Covid-19 mitigation measures might prompt certain restaurants to close operations for a longer period than normal (the Winter Olympics coincides with Chinese New Year) due to rising costs associated with Covid-19 tests. Meanwhile, the impact of the Evergrande fallout is likely to be felt by the broader property sector. Judging from economic performance from H2 of 2021, a greater dose of stimulus is indeed warranted should 2022 GDP growth be maintained around 5%, an implicit target.
Recent cuts to the reserve requirement ratio on December 10 2021 has sent two signals: 1) the PBOC will undertake a different direction from that of other major central banks in developed countries (e.g., the Fed and Bank of England); 2) the PBOC would like to stabilize the property market. The most recent reduction of the lending rate (from 3.85% to 3.80%) by the PBOC on December 20 2021 has underscored policymakers' commitment to reflate the economy amid more hawkish stances by the Fed. So the divergence between the PBOC and the Fed could therefore be more pronounced in 2022. Would such a divergence be a significant factor causing the RMB to give back its immense gains in 2021 against the dollar and most other currencies? In our view, the answer is yes, but that should hardly be a concern. Why? If the PBOC continues on its course of improving liquidity with the main goal of revitalizing investment in the property sector whose growth will clearly be a determining factor of GDP growth for 2022 which is projected at around 5%, interest rate differentials between the RMB and the dollar will surely be widened. A slightly more competitive RMB would bring down interest rates in real term because additional demand for the RMB. Again, such a calibrated change to the exchange rate will be aimed at making the intended monetary policy more potent, but a weaker RMB would serve as an insurance for China's export machine in the medium term.Given that inflation is not expected to be a problem, a slightly weaker RMB will be necessary to compensate for the limited room of rate cuts from the standpoint of monetary easing. On fiscal policy, China will have to ramp up its fiscal deficit in areas of fiscal reliefs and potentially increase fiscal transfers to those local governments who may experience difficulties (local governments' finance has been linked to land auctions). So Beijing does have tools for reflating the economy. However, policy mixes matter in the post-Covid era for several reasons. First, supply chains in China have proven to be more resilient. Second, Omicron has compounded challenges faced by SMEs who may not benefit much from monetary easing. Third, consumers will be expected to carry growth if property investment does not rebound. So the policy implication is that tax cuts and subsidies should be targeting to SMEs and those enterprises who are more vulnerable to travel restrictions and social distancing.
In an almost unprecedented manner, the widely watched Central Economic Work Conference flagged six stabilities (employment, finance, trade, foreign and domestic investment, and expectations). Employment should naturally be given top priority for social stability. Exports have been doing well despite a strong RMB and therefore trade should not be a concern. Stability of expectations is linked to the finance and investment. The key to ensure stability around expectations is policy clarity. As such, a stronger signal of preventing spillovers from Evergande to the real economy will be the first step in stabilizing expectations.