China needs to further boost its domestic demand while addressing weak links in its financial system in order to prepare for any potential misstep by the U.S. Federal Reserve that could worsen the recent banking turmoil, policy advisers and experts said on Thursday.
They noted that the risk of a substantial economic slowdown and more bank failures in the United States is rising as the Fed walks a tightrope between curbing inflation and ensuring financial stability, although a global financial crisis remains unlikely.
As mounting external uncertainties could dampen China's export growth and roil investor sentiment, it is necessary for policymakers to maintain adequate support for domestic demand and take preemptive steps to strengthen the domestic financial safety net with smaller banks, real estate enterprises and local government debts in focus, they said.
On Wednesday, the Fed raised its benchmark interest rate by 25 basis points, to the range of 4.75 percent to 5 percent, signaling its priority to bring down inflation even as aggressive rate hikes in the past year triggered the collapse of Silicon Valley Bank and Signature Bank.
As the Fed continues to increase interest rates, the combination of higher borrowing costs and reduced access to credit has raised the chances of a hard landing for the U.S. economy, said James Knightley, chief international economist at Dutch bank ING.
According to Knightley, the stress created by the SVB failure could make U.S. banks more nervous about whom they lend to, and thus hamper U.S. credit expansion and economic prospects.
If the risk of a substantial U.S. recession materializes, China's exports and economic recovery could come under pressure, said Hu Zhihao, deputy director of the National Institution for Finance and Development, a Chinese think tank.
"While this situation is not the baseline scenario, it is still important for China to put its policies to expand domestic demand on standby and launch more measures to boost market players' confidence," Hu said.
In a sign that policymakers are stepping up efforts to protect economic recovery from external uncertainties, the People's Bank of China, the country's central bank, will cut the reserve requirement ratio on Monday to replenish banking system liquidity and facilitate credit growth.
Wu Liyuan, a researcher at the Chinese Academy of Social Sciences' Institute of World Economics and Politics, said it is also necessary to ramp up efforts to address the weak links in China's financial system, which could bear the brunt if the overseas bank turmoil leads to a crisis in other areas.
Wu said that speeding up the restructuring of the real estate industry and providing liquidity support to smaller banks that are under stress would be particularly helpful, and called for efforts to boost the funding for deposit insurance and improve relevant legislation and regulations.
Experts noted that the spillover of the U.S. banking upheaval should be manageable for China, considering the actions taken by U.S. authorities to reduce risk contagion and the robustness of China's large banking institutions.
Wang Qian, Vanguard's Asia-Pacific chief economist, said that risks of a full-blown banking crisis appear small, given that U.S. and European banks are well capitalized overall.
Moreover, China's prudence in capital account opening and limited exposure to overseas banks can help restrict a financial risk spillover, said Wang, who has maintained the projection of the nation's annual economic growth at 5.3 percent.
"Just as we think the recent developed market financial stress is contained, so is the fallout on China's macro outlook," said Louise Loo, lead economist at British think tank Oxford Economics.