Assessing Chinese Central Bank's Prudent Monetary Policy
Judging from the monetary data recently released for January, the pace of monetary aggregate expansion in China is slowing down. At the end of January, China's M2 money supply stood at RMB 221.3 trillion, up 9.4% year-on-year, 0.7 percentage points lower than that at the end of last month, and 1 percentage point higher than the same period last year; M1 money supply stood at RMB 62.56 trillion, up 14.7% year-on-year, 6.1 percentage points higher than the end of last month and 14.7 percentage points higher than the same period last year; M0 money supply stood at RMB 8.96 trillion, down 3.9% year-on-year. The net cash injection for the month was RMB 531 billion. Judging by these figures, it shows that the People's Bank of China (PBoC)'s monetary policy has changed, with monetary policy returning to "neutral", as predicted byANBOUNDat the end of last year.
Figure: Social financing and money supply growth rates in China
Source: People's Bank of China website
The PBoC has recently released its monetary policy implementation report for the fourth quarter of 2020, re-emphasizing the tone of a prudent monetary policy. It also reiterated that the prudent monetary policy must be flexible, timely, precise, and reasonably moderate. It added that the prudent monetary policy should maintain a reasonable abundance of liquidity, keep the growth of money supply and social financing scale in line with nominal economic growth, and maintain stable macro leverage ratio.This means that on the one hand, the PBoC is quite satisfied with the way the policy implemented in 2020, and it is more confident to stick to the neutral monetary policy this year. On the other hand, from the second half of 2020, the return of prudent monetary policy will continue until "market rates" return to the level of "policy rates". As a result, this year's neutral monetary policy has become a sure bet. For now, the only uncertainty is the pace of the return to a neutral monetary policy, although the PBoC's emphasis on "stability" suggests that the process will not be too hasty and will be adjusted in response to changes in the economic and financial environment.
In terms of changes in broad money, the growth rate of M2 began to slow down gradually from June last year, and began to decline sharply after November. By the end of January this year, the growth rate had been lower than 10%. This is just the opposite of the pace of economic recovery, reflecting the gradual withdrawal of stimulus policies as the economy's internal momentum strengthens. By contrast, growth in the stock of social financing, after hitting a high of 13.7% in October last year, also began to slow down month by month and fell to 13% by the end of January this year. As far as the trend is concerned, as indicated by some previous market analyses, this means that the overall credit expansion cycle has turned. In the future, there will be "stable leverage" and structural "deleveraging", while the monetary policy will still adhere to the structural operation to promote the change of economic structure.
The growth rate of M1 showed an unusual change in January. In terms of size, M1 barely grew in January, about the same size as at the end of December. This means liquidity for households and businesses was unchanged in January. Historically, there have been several monthly contractions in M1, reflecting cyclical factors such as "Spring Festival","tax payments", etc. There may have been "distortions" in M1's data at the beginning of this year, as well as the impact of the COVID-19 outbreak spreading again in northern China. However, this should have more to do with the significant withdrawal of market liquidity by the PBoC so far this year. In terms of M1, it may indicate that the future household consumption and production activities of businesses may be affected.
On the other hand, as Ma Jun, a member of the Monetary Policy Committee of the PBoC, has previously warned, the rapid growth of the capital market and the real estate market in early 2021, as well as the rising prices of raw materials and food, have made the PBoC concerned about the excessive money supply. Out of the concern for inflation, it made the PBoC further strengthen the control of monetary aggregates, which objectively accelerated the return of the neutral monetary policy. The PBOC stressed that in the medium- to long-term, China's economic performance is stable and sound, the overall supply and demand are basically balanced, and there is no basis for long-term inflation or deflation. This is the basis of China's current monetary policy.
As the PBoC has been stressing recently, the current data on monetary and social financing may not be in line with the actual economic conditions due to last year's pandemic.Therefore, one cannot simply extrapolate the economic recovery in the first quarter of this year from the change in the size of the monetary aggregates. Given last year's slow economic growth, economic growth in the first quarter of this year is bound to be significantly higher than last year. Yet, both cannot be used as a basis for judging the economic trend and it needs to be accessed in terms of 2019. The current M2 growth rate is approaching the level of 8.4% in January 2019, which means there is not much room for M2 growth to continue to decline in the future.
The PBoC's monetary policy report mentioned that "the trend of short-term interest rates depends on whether there is a change in the policy rate, and the rate of PBoC's seven-day reverse repos, hence one should not be overly concerned about the number of open market operations." This suggests that the intermediate target of the PBoC's monetary policy will not only take into account the long-term money supply and the scale of social financing, but its short-term target will also "peg" the reverse repo rate, keeping it in line with the policy rate. This also means that the PBoC will not consider the adjustment of interest rate or the deposit reserve ratio for quite a period of time. It has no intention to significantly loosen or tighten monetary policy, and will rely on open market operations for "precise regulation".
Final analysis conclusion:
The current changes in the monetary aggregate and the scale of social financing imply that the role of policy factors in supporting China's economic growth is diminishing. However, if the impact of the COVID-19 pandemic cannot be completely eliminated and economic activities such as consumption and investment failed to recover, economic growth will still be under pressure in the future.
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