China Shows Signs of Relaxing Monetary Policy

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Aug. 17 – China’s tight monetary environment in effect since last October may be heading for a change, as the government worries the declining money supply and loan issuance, together with the uncertainty of the global financial market, may lead to an economic slowdown.

The People’s Bank of China (PBC) has released capital with a net amount of RMB165 billion to the country’s open market operations over the past four weeks in a bid to increase liquidity in the interbank market, according to a report in Shanghai Securities News. This stands in contrast to the PBC’s raising of the reserve requirement ratio (RRR) for banks nine times since last October in order to control the monetary base.

Although the “2011 Q2 Monetary Policy Implementation Report” released by the PBC last Friday confirmed curbing inflation will remain the primary mission for policymakers, the government is releasing signs that tightening measures may not be its only option. A State Council meeting held on August 9 mentioned the need to increase the “flexibility” of the current monetary policy – while generally keeping it stable – due to the increasing uncertainty in the global financial economy.

Another issue that may make policymakers consider more “flexibility” in the monetary policy is the significantly tightening liquidity, which could finally harm the country’s economic growth. In July, the newly increased RMB loan issuance only reached RMB492.6 billion, a decrease of RMB25.2 billion from a year earlier and almost RMB60 billion lower than expected. The plummeting loan issuance size has led to the slow growth of M2 money supply, which only increased by 14.7 percent from a year earlier, marking a record low in the past six years.

The Japan-based Nomura Securities believes China will no longer raise interest rates and the RRR during the rest of this year. The country may even reduce the RRR if the overseas situation deteriorates. Nomura pointed out that the PBC has been encouraging banks to offer loans to affordable housing projects and small enterprises at favorable interest rates, indicating a subtle change in the tightening policies.

However, Lu Zhengwei, chief economist of Industrial Bank (China) has a different opinion and speculates interest rates will still be hiked one or two more times before the end of this year.

Lu believes low bank deposit growth – instead of a decrease in demand  – has likely led to the relatively small size of newly increased loan issuance in July. Therefore, he still remains optimistic about China’s economic growth prospects.

A report by the Bank of Communications predicts China’s monetary policy to remain “prudent.” Naming open market operations and directionally eased loan issuance as prior monetary policy tools, the report says the tools of RRR and interest rates will be used “very cautiously.”

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