Financial reform must be promoted in an orderly way, State Council says

The central government said on Wednesday it will continue its prudent monetary stance while the world's second-largest economy slows down, with the market seeing its worst cash crunch in at least seven years.

In a statement after a meeting chaired by Premier Li Keqiang, the State Council, China's cabinet, said the economy is generally stable. The prudent monetary stance should persist to reasonably manage money supply, and curb new credit for unauthorized construction projects in industries with severely excessive capacity.

The State Council said it has outlined measures aimed at enhancing financial support for the ongoing economic adjustment and upgrading, and highlighted the need to deepen market-oriented reform of the financial system while maintaining stability and continuity of macro policies.

"We must promote financial reform in an orderly way to better serve economic restructuring ... while the economy faces up to many difficulties and challenges," said the statement published on the government website.

Credit support for the consolidation of industries with excessive capacity should be encouraged, such as special lending to finance mergers and acquisitions, it said.

It also called for more loans for advanced and strategic industries, the agricultural sector and small businesses, while vowing to promote interest rate liberalization and to increase participation of private capital in the financial system.

Qu Hongbin, chief China economist at HSBC, said the government has sent a clear signal to the market that it wishes to release the potential of consumption and private investment by promoting reform and stabilizing economic growth.

"As government leaders become increasingly tolerant of a slowdown in economic growth, the willingness to spur the economy through short-term investment stimulus is waning," Qu said.

He said he has cut the GDP growth forecast for this year to 7.4 percent from 8.2 percent, as new measures need time to take effect, and policies focusing on the medium and long term will probably have a negative impact on demand.

"With reforms taking effect gradually, we predict growth will start to warm up in 2015."

Qu said there is still room for a 25-basis-point cut in interest rates this year, before another cut of 25 basis points in 2014.

But the authorities seem unwilling to announce a loosening policy. At odds with market expectations, the People's Bank of China, the central bank, did not inject more liquidity into the market after the Dragon Boat Festival holiday last week, despite the liquidity crunch that ensued.

Reflecting unexpected tightness in the interbank market, interbank interest rates started to rise toward the end of May, with the overnight rate reaching 5 percent on June 6 and rising to 9.7 percent on June 8. They subsequently receded, but picked up again on Tuesday to 5.5 percent.

Louis Kuijs, chief China economist at the Royal Bank of Scotland and a former World Bank economist, said, "We think the PBOC's stance is in line with the government's overall stance, with senior leaders exhibiting little appetite for stimulus."

He said the government can keep this stance despite sluggish growth and calls for stimulus measures as long as economic growth is unlikely to weaken below its comfort zone of around 7 percent and the labor market holds up reasonably well.