An Assessment of China’s Future Monetary Policy and Implementation
On October 17, the People’s Bank of China (PBoC)’s open market operations, which was the focus of concern of the market, showed some results. The Chinese central bank announced that it will carry out RMB 500 billion of medium-term lending facilities (MLF) operations and RMB 2 billion of open market reverse repurchase operations on the same day. The October MLF interest rate remains unchanged for the second consecutive month. Previously, the PBoC adjusted the medium and short-term policy interest rates in August, and on August 15, the winning rates for the MLF operation and the open market reverse repurchase operation fell by 10 basis points respectively. Since RMB 500 billion of MLF will expire this month, the central bank hedged by renewing the same amount in the same month.
This MLF equivalent sequel has special significance in the market. Previously, the PBoC shrank RMB 200 billion in MLF operations both in August and September, sparking market concerns about the central bank’s tightening of liquidity. However, it increased the scale of reverse repurchase operations in September to cope with the peak demand for funds at the end of the quarter. In October, the number of reverse repurchases fell again, and short-term liquidity began to recover. This equivalent sequel to MLF means that the central bank still tends to maintain the current eased liquidity, to the relief of the market. Judging from the latest market interest rates, the deviating policy interest rate remains low, reflecting that market liquidity is slightly loose. Some market participants believe that this is a sign that monetary policy is loosening again, and that monetary easing might be further promoted by lowering the reserve requirement ratio and interest rate.
In regard to the future trend of China’s monetary policy, researchers at ANBOUND believe that the operation of the PBoC’s MLF equivalent sequel shows that the scale of maintaining sufficient liquidity remains unchanged, and the same amount of sequel is to avoid the interference of the previous shrinking MLF on market expectations. However, the PBoC does not appear to have a strong willingness to further relax, as the focus of monetary policy will still focus on the implementation of structural policies. As it stands, the Chinese central bank will still use structural tools to drive monetary aggregate so as to maintain the overall stability of monetary policy. This can provide a relatively stable and predictable monetary environment for the previous rounds of stimulus policies.
Under the condition that the monetary growth rate remains high, the growth rate of the social financing scale recovered in October. However, the seasonal fluctuation trend of credit scale and social financing has also become obvious, indicating that the overall financing demand was not stable. Researchers at ANBOUND have previously pointed out that, driven by the policy that promotes investment, the improvement of monetary and social financing reflected more of the growth of government infrastructure investment and state-owned enterprise investment. This shows the effect of macro policies that the credit demand of small and medium-sized enterprises, as well as private enterprises, has yet to fully recover. It also makes the flow of credit funds possibly experience further differentiation in the future. Indeed, credit “stalls” have repeatedly occurred in recent months. Whether the future credit growth rate can become stable or not is still the main indicator if the economy can be stabilized. The differentiation of credit shows that the transmission from loose money to loose credit remains rough. This also shows that the structural tools of monetary policy need to play a greater role to promote investment and financing in emerging or strategic areas, and further enhance the overall relaxation of market credit. In addition, the increase in infrastructure investment at the end of the year and the early issuance of local special bonds for the new year will continue to support social financing.
As China’s domestic inflation level as shown in the consumer price index (CPI) continues to rise and is gradually approaching the policy target of 3%, further monetary easing is not conducive to maintaining inflation stability. There are both internal and external factors that constrain the adjustment space of monetary policy. The gradual recovery of the economy has also reduced the urgency of further easing of monetary policy. Considering that RMB 1,500 billion of MLF will expire in November and December, the PBoC may still replace MLF with long-term liquidity through RRR cuts, but this replacement does not mean a further easing of the total amount. If the central bank considers the flexibility of policy space, it is more likely to adopt the method of continuing the MLF. It should be pointed out that the current core inflation remains low, and the PPI index has fallen sharply. From the standpoint of macro-economy, this means that the recovery of terminal demand is still not sufficiently significant, and the structural contradictions on the production side remain prominent. Under such a circumstance, following the Federal Reserve’s tightening policy will not be a wise option. Changes in the inflation situation indicate that China’s monetary policy still needs to focus on stability, and excessive stimulus or excessive tightening will have adverse consequences for stabilizing growth.
In addition, many market participants are aware that the current monetary policy in China is facing more and more external pressure, and the continuous devaluation of the RMB exchange rate has an increasing impact on the Chinese domestic economy and finance. In particular, the new round of depreciation of the RMB exchange rate caused by the previous cut in interest rates has yet to be stabilized. With this, monetary policy needs to maintain both internal and external balance. Therefore, it is not feasible for the PBoC to adjust interest rates again in the short term and further loosen monetary aggregates, as this could easily cause unexpected fluctuations in the RMB exchange rate. From this angle, the policy uncertainty brought about by various interest rate cuts is relatively huge, and its overall effect may not be conducive to the country’s economic recovery.
As the People’s Bank of China needs to consider both internal and external factors, its monetary policy still requires to focus on stability to avoid the interference of unstable policy expectations on the real economy.
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