It is common knowledge that China’s economy has been slowing over the past few years, leaving behind decades of double-digit growth.
However, recent economic data has shown that China’s economy might be slowing at a faster rate than expected, highlighting weak domestic demand and subdued manufacturing activity. China’s economy is on the rocks, prompting the Chinese Central Bank to cut interest rates for the third time in six months. This is intended to ease the heavy debt burdens of companies and governments.
Economists at RBS estimate that more than $300bn in funds has left China’s shores over the past six months, partly from the strength of the US dollar and partly from ebbing confidence in the Chinese economy. More money could flow out if defaults keep rising, drying up funds for lending. In addition, the rise of bad loans is crimping banks’ profits at a time when they are being called upon to make credit more accessible.
There have been suggestions that the cut in interest rates will not suffice to breathe life into the economy and, despite protestations from China’s central bank to the contrary, predict that a policy of quantitative easing may need to be instituted.
What is Quantitative Easing?
Under quantitative easing, a central bank creates money electronically, which it then uses to buy securities, such as government bonds, from banks and other institutions such as pension funds.
The idea is that, once quantitative easing has taken bad loans and debts off the balance sheets of these institutions, their debt burden will ease thereby making them more likely to lend to consumers and businesses – this is in turn intended to stimulate economic activity.
How effective is QE in practice?
Both the Federal Reserve (US) and the Bank of England both instituted their own quantitative easing programmes following the onset of the financial crisis of 2008.
The most recent example is the ECB’s €1.1 trillion QE programme announced in January.
Recent economic data has shown the Eurozone recovering, with 0.4 per cent growth in the first quarter of 2015. Although there are several underlying reasons for this increase, one of them is that exporters are being helped by the sharp depreciation in the euro, in part as markets anticipated the adoption of quantitative easing by the European Central Bank. Also, business confidence has improved as a direct result of QE announcement and subsequent implementation.
QE is not a panacea
However, on a cautionary note, QE should not be seen as a panacea that cures all ills, because there are many that perceive this policy as merely ’kicking the can down the road’ and avoiding having to deal with fundamental structural issues in the economy.
Therefore, although QE may provide a shot in the arm for economic growth and a temporary reprieve, it is not a substitute for wholesale restructuring of the economy to ensure sustained and durable growth. This state of affairs was reflected in the intense debate leading up to the decision about whether QE should be implemented in the Eurozone at all.
Bernard Mustafa is president of BPP’s Commercial Awareness Society
You might also be interested in…