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Tuesday, August 10, 2021
Medium to Long-Term Trend of China's Monetary Policy Normalization
ANBOUND

On August 9, the People's Bank of China (PBoC) released the China Monetary Policy Implementation Report for the second quarter of 2021, which analyzed the current macro situation and provided an outlook for the next phase of monetary policy. The policy implications of the report stand out as it comes after the PBoC "unexpectedly" cut the reserve requirement ratio and sparked speculation about a monetary policy change. According to researchers at ANBOUND, the central bank's repeated emphasis on normalizing monetary policy in the report is the basis of policy for a long time to come. Any "precise regulation" that may occur in the future will be within the "reasonable and appropriate" range and will not deviate from this basis.

The PBoC's report not only emphasizes that monetary policy has started to normalize from the stimulus responses to the pandemic, but also emphasizes the need to maintain the stability of monetary policy in the process of cross-cyclical adjustment in the future, and there will be no major shift in the policy. According to the report, the monetary policy in the first half of this year has basically returned to the pre-pandemic normal state, maintaining a leading position in the global macro policy. In the next phase, the central bank will coordinate the macro policies between this year and the next, maintain the stability of monetary policy, and make it more forward-looking and effective. While supporting the real economy, the PBoC will resolutely refrain from massive easing policies. It will maintain moderate monetary growth to support high-quality economic development, support the recovery of small and medium-sized enterprises and industries that are in difficulty, and keep the economy operating within a reasonable range.

As for the basis of monetary policy normalization, the PBoC highlighted the relationship between inflation and currency in a special column in the report. It still adheres to the conventional theory of currency issuance and believes that the current global new quantitative easing policy, which focuses on fiscal monetization, is actually leading to higher global inflation. This is already affecting commodity price, which in turn is affecting China. The PBoC pointed out that the monetary policy normalization has been implemented since the outbreak of COVID-19 last year, and the stability of domestic aggregate supply and demand is conducive to stable price trends. Therefore, there is no basis for long-term inflation or deflation. In particular, the PBoC mentioned in its report that itself and the fiscal department should maintain the overall stability of the price level. This means that it does not approve of the policy of "fiscal monetization" adopted by some countries. What China's central bank wants to emphasize is its independence in implementing monetary policy, its reserve attitude about the "double easing" of fiscal and monetary policy, as well as its policy stance of not adopting "fiscal monetization". From this perspective, there is little chance of large-scale easing policy in the future.

This judgment implies that the PBoC will continue to normalize monetary policy for a long time. In addition, it also implies that it will not use monetary policy as the major measure to promote growth, but rather the emphasis is on the "reasonable and moderate" currency issuance. In addition, it sticks to the idea of matching the growth of monetary and social financing scale with nominal GDP growth. In this regard, the PBoC's monetary policy will stick to the main mode of "aggregate control and structural adjustment" to achieve its targets. Considering all these factors, structural adjustment will be the focus of "precise regulation" in the future.

It is worth noting that, in terms of aggregate, the "matching" of money supply and economic growth needs to be considered from a cross-cycle perspective. ANBOUND has previously mentioned that China's economy needs to be assessed "on a three-year basis" due to the impact of the pandemic. Policy wise, this is said to include not only last year's situation, but also this year and next year. In fact, currency issuance was greatly "over the limit" under the measures to handle Covid-19 last year, which is also the reason for the relatively tight monetary policy in the first half of this year. Understandably, the growth of money supply and social financing scale in this year and next year needs to pay attention to whether it can reach the scale of last year. In general, the growth rate will be controlled by "precise regulation". From this point of view, the sign of easing policy brought by the reserve requirement ratio cut has been greatly reduced. The "surprise reserve requirement ratio cut" in July and some institutions' expectations for future reserve requirement ratio cuts will not deviate from the "aggregate control" policy tone.

As emphasized in the report of the PBoC, with the monetary aggregates under control, monetary policy is expected to achieve the unimpeded "circulation" of financial resource allocation and the reduction of overall credit cost through structural tools and policies. Given the current situation, on the one hand, the financial constraints on the real estate industry and conventional energy-intensive industries are still being strengthened, and more resources will be tilted to emerging industries, green industries, and small and medium-sized enterprises, so as to promote economic restructuring. At the same time, monetary policy will focus on the reform of financial system and mechanism. In its report, the PBoC highlighted the gradual decline in the cost of credit in the market as a result of financial reforms. After the space released by the reform of the interest rate mechanism is gradually absorbed by financial institutions, the results of landmark structural adjustments such as the decline in LPR will still be seen. However, it should be emphasized that even if there is the decline in LPR, it does not indicate an overall "easing", and the PBoC will still restrain and guide the direction of credit through various ways.

In addition, it should be noted that the PBoC has proposed in the report that monetary policy supports coordinated regional development. This column actually implies that monetary policy is playing an increasingly important role in preventing regional credit risks from the perspective of risk prevention. At present, the economic downturn and financial problems in some regions are intertwined, the economic and financial cycles are not smooth, and credit growth is slow. In order to promote coordinated regional development, it is necessary to take targeted measures to increase the credit supply in areas with slow credit growth, so as to smooth the economic and financial cycle. China's central bank attaches great importance to the coordinated regional development, and guides all kinds of financial institutions to increase credit support to regions with slow credit growth on the premise of controlling risks. This change, in fact, can also be understood from the perspective of regional structural adjustment, indicating that the threat of regional credit differentials in the future will constitute increasing pressure on economic stability and growth, thus making it to focus on regional balanced development and financial risk prevention.

As far as China's economic trend is concerned, on the one hand, the sustainable development of the economy is not only facing structural and overall pressure, but also facing the increasing international economic and geopolitical pressure. On the other hand, financial risks are still accumulating in some domestic industries and in some regions. This not only poses a challenge to monetary policy formulation, but also limits the monetary policy room for maneuver. This is the main reason why the PBoC has repeatedly stressed the "normalization" of monetary policy. It is expected that future monetary policy will continue to adopt the "aggregate control and structural adjustment" approach to achieve the goal of stabilizing growth and preventing risks.

Final analysis conclusion:

With the overall economy recovering from the pandemic and facing a transition back to the long-term growth path, the PBoC's new monetary policy implementation report reveals that the policy tone of normalization will be maintained for a long time to come.

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