China’s monetary policy and regional strategy

China’s orthodox monetary policy continues to be in stark contrast to the G7 world. It has also continued to attract inflows into its bond market though inflows have slowed in the short term given the narrowing of the spread between the Chinese 10-year and the US Treasury 10-year, Chris Wood, internationally renowned for his weekly research newsletter GREED & fear and Global Head of Equities at Jeffries, said in his May 26 piece. 

Foreign holdings of Chinese bonds have increased by Rmb361bn or 11% in the first four months of this year to Rmb3.62tn at the end of April, following a Rmb1.07tn or 49% increase in 2020. From an inflow standpoint, China overtook America in 2020 as the world’s top destination for foreign direct investment, just as it now enjoys a record share of world exports, Wood says.

China FDI inflows rose by 4% to US $163bn in 2020, while America’s FDI inflows declined by 49% to US$134bn, according to the United Nations Conference on Trade and Development (UNCTAD).

But in a classic balancing act capital outflows have also risen.

In fact China last year reported for the first time since 2015 a capital account deficit totalling US $106bn. This is reflected in the fact that foreign exchange reserves represent a declining percentage of Chinese international assets totalling US $8.7tn at the end of 2020.

Out of this total 28% is accounted for by FDI assets and 23% by “other investments” comprising mainly lending and trade credits. While reserve assets accounted for 39% of the total, down from 71% in 2009.

Much of this stock of lending in the “other investment” category may well be related to financing the Belt and Road Initiative (BRI) which, along with the Greater Bay Area, are two of President Xi Jinping’s key signature policies.

The Greater Bay Area is a region which comprises Hong Kong, Macau, Shenzhen and other eight municipalities in Guangdong Province.

There is no official data breakdown on BRI lending.

Still, one way of gauging it is by monitoring the foreign lending activity of China’s two main policy banks, the China Development Bank and the Export-Import Bank of China. By 2019, the two banks had lent US $463bn offshore, according to data compiled by the Boston University Global Development Policy Center.

But the growth in lending has slowed sharply in recent years, a process doubtless accelerated by the Covid pandemic. Thus, annual overseas lending by the two banks declined from US$75bn in 2016 to only US$4bn in 2019.

But that does not mean that the BRI initiative has ended.

Indeed such infrastructure projects should be expected to accelerate after the pandemic given that many recipient countries’ economies will need all the help they can get post the health crisis.

There is also clearly a strategic motive on Beijing’s part.

Thus Pakistan, which has been probably the biggest recipient of BRI funding, last year reprioritized the flagship China-Pakistan Economic Corridor (CPEC).

China also signed in late March a 25-year economic and security cooperation agreement with Iran worth reportedly up to US $400bn.

Another way of gauging BRI activity is the offshore activity of China’s leading construction companies.

China’s biggest construction company officially reported in its year-end earnings report new foreign contracts worth US $29.7bn last year, up 4.7% YoY in spite of the pandemic, and US $136bn worth of foreign projects under construction, the piece said.

For China the BRI agenda has two objectives.

The first is commercial, namely to expand its supply lines while keeping its construction companies busy at what they do best.

The second is strategic.

For example, access to the Indian Ocean via the building out of the seaport of Gwadar in southern Pakistan reduces the dependence on shipping oil via the Strait of Malacca.

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