Treading Lightly For Fast Growth

China’s monetary policy should take cautious steps to prevent a rebound in inflation and housing prices By Lan Xinzhen

Treading Lightly For Fast Growth

China’s monetary policy should take cautious steps to prevent a rebound in inflation and housing prices By Lan Xinzhen

The Chinese Government announced in early 2012 that the country would continue implementing the proactive fiscal policy and prudent monetary policy to support a steady and relatively fast economic growth. On August 2, the People’s Bank of China, China’s central bank, released the Report on the Implementation of Monetary Policies in Q2 2012, showing the policies’effectiveness.

During the first half of 2012, the central bank intensified its efforts to fine-tune the monetary policy, make full play of the leverage function of interest rates, maintain the appropriate growth of monetary credit and sustain a reasonable scale of social financing.

Outstanding loans from financial institutions had totaled 63.3 trillion yuan ($9.95 trillion) by the end of June, up 15.9 percent year on year and 0.4 percentage point higher than the end of last quarter.

However, a housing price rebound appeared as the economy cooled, complicating matters for the next phase of the policy. A slowing economy needs to be spurred by a loose monetary policy. However, injecting liquidity into the market will water down the macro-control efforts in the real estate sector.

Right now, the central bank’s stance is to support the real economy, keep overall price levels stable, and maintain a steady yet relatively fast economic growth.

The need for stimulus

Since the financial crisis in 2008, most of the world’s economies have taken a loose monetary policy. China was no exception.

The country launched a 4-trillion-yuan ($635-billion) stimulus package for economic recovery. However, since the second half of 2010, the country has been tightening its monetary policy in a bid to fight inflation, and its economic growth slipped from 9.8 percent in the fourth quarter of 2010 to 7.6 percent in the second quarter of 2012. Questions have been raised among economists on whether more stimulus is needed.

There is no need to further loosen the monetary policy or adopt new stimulus policies, said Fan Jianping, Director of the Department of Economic Forecasting of the State Information Center.

“Positive changes took place in two major fields that have vital impact on the Chinese economy. First, investment in infrastructure construction reversed its declining trend which was caused by obstacles in local government financing and began increasing in the second quarter of 2012. Second, housing sales increased from the previous month in July, helping reduce the negative influence of the property market on economic growth. Both changes can offer momentum for China’s economic recovery,” Fan said.

Slowed economic growth is closely related to the Central Government’s macro-control mindset. The Chinese Government prefers a healthier economy and plans to steer the economy away from high-polluting and energy-depleting industries through structural adjustment. China is now encouraging hi-tech and high value-added industries to take off. Strategic emerging industries have become key components in the government’s support and subsidy plans.

The National Development and Reform Commission is determined to make the proportion of strategic emerging industries against the GDP rise to 8 percent by 2015 and 15 percent by 2020 from less than 4 percent in 2010. It will make strategic emerging industries a major driving force for China’s economic development, said Fan.

Facing slowing down pressures of economic growth, the central bank should still choose a prudent monetary policy for two reasons. First, although the consumer price index, a major gauge of inflation, rose 1.8 percent year on year in July, the slowest since February 2010, the country still faces uncertainties, including natural disasters, rising labor costs, housing price rebounds and a possible oil price hike. Pressure from inflation has made a prudent monetary policy necessary, said Xie Taifeng, Dean of the School of Banking and Finance at the University of International Business and Economics.

“We should also learn from the lesson during the post-crisis period in 2008. Back then, as part of the anti-crisis efforts, lots of currencies were injected into the market, a major causality for the inflation in 2010 and 2011,” said Xie.

However, a report from Huatai Securities said the central bank will continue relaxing the monetary policy, in line with the Central Government’s call for sustained growth. Dwindling orders from Europe and other trade partners have sapped China’s exports, and the decline of the yuan’s counterparts in foreign exchange reserves will force the central bank to further cut the reserve requirement ratio, the amount of funds that commercial banks must keep in reserve.

In the first half of 2012, the reserve requirement ratio was cut twice, down 0.5 percentage point on February 24 and May 18 respectively, to add to liquidity. It’s highly possible that the central bank will further lower the ratio, said a report from Huatai Securities.

Monetary Policy in H1 2012

● Steady and moderate growth of money supply. M2, a broad measure of money supply that covers cash in circulation and all deposits, grew by 13.6 percent from the previous year to reach 92.5 trillion yuan ($14.54 trillion) at the end of June. The growth rate is 0.2 percentage point higher than that at the end of March and almost the same as that at the end of last year.

● Overall renminbi settlement in cross-border trades. In the first half of 2012, yuan-settled cross-border trade totaled 1.25 trillion yuan ($196.8 billion), up 31 percent year on year. Among the total, 868.7 billion yuan ($136.56 billion) went to goods trade and 383.3 billion yuan ($60.25 billion) to service trade and other regular items.

● Increase of yuan’s flexibility. At the end of June, the central parity of the yuan against the U.S. dollar was 6.3249, down 240 basis points and depreciated for 0.38 percent compared with the end of 2011. Since its exchange rate reform in 2005, yuan has appreciated for 30.86 percent against the dollar by the end of June 2012.

No major changes

China’s monetary policy is facing complications, in which it has to sustain growth, prevent inflation and support the country’s structural adjustment.

In light of this, the central bank pointed out that it would continue a prudent monetary policy by making it more forward-looking, targeted and effective. The ultimate goal is to create a stable yet moderate financial atmosphere for China’s structural adjustment, said the central bank.

That’s to say, China’s monetary policy won’t see major adjustments in the upcoming several months. Even if adjustments are necessary, the central bank will take a very cautious approach to them.

China has a high-level interest rate and reserve requirement ratio, which creates room for making cuts. But interest rate adjustments should depend on three elements: economic growth, inflation and interest rate differences between China and other countries. The adjustment of the reserve requirement ratio mainly depends on the liquidity of currencies, but the yuan counterparts of foreign reserves are still uncertain in the second half of 2012.

There are five highlights for the monetary policy in the next few months, according to the central bank report released on August 2.

First, the amount of credit will be increased to maintain a reasonable level of social financing. The central bank will guide financial institutions to support the real economy in a more targeted and forward-looking way.

Second, efforts will be intensified in structural adjustment, as in supporting laborintensive and strategic emerging industries like environment protection, media, modern service and high-end manufacturing, and restricting lending to industries with high energy consumption, pollution and overcapacity. The Central Government will also prohibit bank loans to speculative activities in the property sector.

Third, the central bank will push marketbased reform of interest rates and the reform of renminbi’s exchange rate formation mechanism. It will expand renminbi settlement in cross-border trade and investment and widen channels for its outflow and inflow.

Fourth, the central bank calls for carrying forward financial reforms and pledges to give financial support to the reform of local financial institutions.

Finally, authorities at all levels should maintain a stable financial system and avoid system-wide risks. The central bank will urge all financial institutions to strengthen internal control and their risk-control systems. Besides, it will intensify supervision over local governments’ financing platforms, financial institutions’ off-balance-sheet activities and financial risks of the property market. Right now, loans of local governments’ financing platforms are a main source of risks for financial institutions.

China’s monetary policy in the coming months will be more prudent. Without system-wide financial risks, the main direction won’t be altered, according to a report by GF Securities.