China's Monetary Policy Likely Returning to Neutral Stance
The People's Bank of China (PBoC) has recently released monetary and financial data for the month of March, showing that both the growth rate of money supply and the growth rate of social financing have fallen. At the end of March, the broad M2 money supply stood at RMB 227.65 trillion, up 9.4% year-on-year, with a growth rate 0.7 percentage points lower than the end of last month and the same period last year; the M1 money supply, or narrow money, stood at RMB 61.61 trillion, up 7.1% year-on-year, with a growth rate 0.3 percentage points lower than the end of February and 2.1 percentage points higher than the same period last year. Meanwhile, the stock of social financing at the end of March stood at RMB 294.55 trillion, up 12.3% year-on-year, with the growth rate down 1 percentage point from 13.3% in February.
Figure: Changes in CPI and several monetary indicators in China
Source: People's Bank of China website, National Bureau of Statistics. Graphic: ANBOUND.
Compared with the strong recovery of China's overall economy, the above monetary and financial data indicate a different policy indication, showing that there is the return of a "neutral" monetary policy stance, including the PBoC's policy adjustment. According to researchers at ANBOUND, given the strong economic recovery, the delicate point of monetary policy this year lies in the scale and pace of its implementation. In our judgment, the monetary policy may return to a neutral stance, i.e., if the economy improves, monetary policy will be tightened; if the economy is bad, the monetary policy will be less tightened or unchanged.
Since the second half of last year, researchers at ANBOUND have noted that the PBoC's monetary policy has shifted toward neutrality as China's economy gradually recovers. Although the PBoC has repeatedly stressed that the monetary policy remains "prudent" and "will not make a sharp turn", the PBoC has also begun to withdraw liquidity from its open market operations in January this year against the background of the global economic recovery in the post-pandemic era. From January to March, net withdrawals from the PBoC's open market operations reached RMB 171 billion, RMB 314 billion, and RMB 10 billion, respectively. So far in April, the PBoC has racked up a net withdrawal of RMB 50 billion with its multi-day reverse repurchase operations. From this point of view, the PBoC's return to neutral policy stance shows no signs of cessation, and is still in the process of "fine-tuning adjustment".
The PBoC's net withdrawal policy has yet to bring about a rise in interest rates, and there is no sign of tightening market liquidity yet. As indicated in the data, the weighted average interbank lending rate was 2.01% in March, 0.05 percentage points lower than the previous month, and 0.61 percentage points higher than the same period last year. The weighted average interest rate on pledged repos was 2.01%, 0.09 percentage points lower than last month and 0.57 percentage points higher than a year ago. As a result, the PBoC's monetary policy is simply withdrawing the large amount of liquidity that was injected into the market during the pandemic, which means that the economic growth relies more on its own momentum.
In addition, researchers at ANBOUND believe that the decline in social financing growth is related to the base effect. Since March last year, the PBoC has increased the money supply to deal with the pandemic. On the other hand, the change of social financing is related to the slowed down in local government bond issuance. The announcement of the local government bond issuance quota this year was significantly later than that of last year, which made the issuance of local government bonds in the first quarter mainly focusing on the renewal of existing bonds. The issuance of new local government bonds started in March, which dragged down the increase of the social financing scale. For the whole year, the increase in social financing should be about the same as last year to reflect the "prudent" policy, but in this case, the growth rate of social financing will be lower than that of last year.
Judging from the latest economic data, financial indicators are not consistent with the positive growth momentum of the real economy. Indicators such as consumption, industry, imports, and exports in the first two months, as well as price indicators such as CPI and PPI, all indicate that China's economy will maintain a strong recovery momentum this year. The slowdown in monetary and social financing growth does not mean that economic growth will slow down. Rather, it is an adjustment of stimulus policies adopted in response to last year's pandemic. However, the return of neutral monetary policy has a great impact on the capital market, causing fluctuations in the stock market and bond market, which reflects that the capital market is adjusting to the impact of the neutral monetary policy.
Recent statements by PBoC officials indicate that the PBoC's monetary policy has shifted its focus from supporting economic growth to paying equal attention to maintaining economic growth and preventing financial risks. This statement indicates that this year's monetary policy will be adjusted as the economic situation changes. Under the low base effect and the global recovery effect, China's overall economy should not be bad this year. In this regard, monetary policy is likely to return to a neutral stance. On the one hand, monetary policy is in a window of time to return to a neutral stance, and will be "precisely" adjusted based on macroeconomic trends to maintain appropriate support for economic growth and prevent economic overheating. On the other hand, the PBoC's modest withdrawal during this window of time is leaving room for manoeuvre on future monetary policy, which will allow monetary policy to respond flexibly if economic growth weakens in the next year or two. Under this logic, it is unlikely that the PBoC will further cut the required reserve ratio and interest rates this year, and it is more likely to maintain neutral market liquidity through open market operations. As Sun Guofeng, director-general of the monetary policy department of the PBoC, said earlier, "For the next step, China's monetary policy will stick to a neutral stance and give priority to stability".
ANBOUND has previously mentioned the need for a "three-year review" of China's economic growth, i.e., looking at the economy of the three years as a whole, so as to smooth out the economic fluctuations caused by the pandemic and formulate macro policies effectively. This year's strong rebound lies on the low base effect. In 2022 and beyond, China's economic growth could return to the long-term slowing path that preceded 2019. The PBoC has previously mentioned that monetary policy needs to establish a "cross-cycle" policy framework, which is commensurate with the "three-year review". In general, the PBoC will not change the existing policy tone because of the changes in the financial indicators. The monetary policy is likely to return to a neutral stance, which will leave room for manoeuvre on future counter-cyclical monetary policy.
Final analysis conclusion:
The slowdown in the growth rates of money supply and social financing is mainly the result of the proactive adjustment of monetary policies, which reflects the PBoC's adherence to maintaining economic growth and risk prevention. With the overall monetary policy returning to a neutral stance, this year's monetary policy implementation will be characterized by a "take-it-as-it-comes" approach. As long as economic growth does not go wrong this year, it is believed that the PBoC is willing to take advantage of the window of global and Chinese economic recovery, make a moderate return to neutral monetary policy, and leave room for manoeuvre on monetary policy in the next few years.
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