China only had in 2009 in history

Author: Lian Ping Source: Wall Street News

Today’s meeting of the Political Bureau of the CPC Central Committee pointed out the need to implement a moderately loose monetary policy.

In September, Lian Ping, chief economist of Guangfa Securities Research Institute and chairman of China Chief Economist Forum, released an article titled “Proposal to Adjust the Monetary Policy Stance to “Moderately Loose”.” Lian suggested that the monetary policy stance should be defined more scientifically and reasonably. Adjusting the monetary policy stance to “moderately loose” will create a suitable policy environment for implementing greater reductions in reserve requirements and interest rates.

In the article, Lian Ping reviewed the practice of monetary policy in China over the past 30 years. The Central Bank has only implemented a ‘moderately loose’ monetary policy during the period of 2009-2010.

The following is the full text of the article by Lian Ping:

Since 2011, China has implemented a “prudent” monetary policy stance for 14 years. The current domestic and international economic situation has undergone significant changes, especially domestically facing severe demand insufficiency, deflation, and downward pressure, while the monetary policy of the United States and Europe is shifting towards easing. In this context, should China’s monetary policy continue to maintain a “prudent” stance? Or should it be adjusted timely to send a more positive and clear policy signal to the market, enabling the monetary policy to better play its countercyclical adjustment function? This article will discuss and put forward opinions.

Flexible adjustment of monetary policy should be the norm

Looking back on the past 30 years of monetary policy practice in our country, the general tone of monetary policy can be divided into the intervals of ‘tightening,’ ‘moderately tight,’ ‘prudent,’ ‘moderately loose,’ and ‘loose’ in sequence. The monetary authorities flexibly adjust between ‘tightening’ and ‘loose’ based on the objective situation, with ‘prudent’ as the central axis, in order to achieve the goals of stabilizing the economy and counter-cyclical regulation.

In 1993, China experienced an overheating economy and serious inflation. The central government adopted a moderately tight monetary policy. By the end of 1996, inflation fell sharply after three years. In 1997, China faced weak domestic demand and severe external shocks due to the Asian financial crisis, leading to a situation of deflation. To cope with internal and external pressures, the monetary policy shifted from ‘moderately tight’ to ‘prudent’, maintaining the stability of the RMB exchange rate by appropriately increasing the money supply and using credit leverage to promote domestic demand and export growth. At the end of 2007, to prevent the economy from shifting from rapid growth to overheating, the central economic work conference set the tone for the monetary policy in 2008 as ‘tight’. In September 2008, with the bankruptcy of Lehman Brothers as a symbol, the subprime mortgage crisis in the United States escalated, and China’s economy was also affected by the unprecedented financial crisis. The central government then decided to implement an active fiscal policy and moderately loose monetary policy, which lasted until 2010. Since 2011, in order to prevent inflation, asset price bubbles, hot money fluctuations, and financial risks, China has returned to a ‘prudent’ monetary policy tone. For about 14 years since then, China’s monetary policy tone has not undergone major changes, only showing a tendency of slight looseness or tightness in actual operation. Among them, the ‘prudent’ monetary policy from 2011 to 2013 was generally tight, emphasizing prevention of inflation. The ‘prudent’ monetary policy from 2014 to 2019 returned to a ‘prudent neutrality’, emphasizing neither looseness nor tightness. The ‘prudent’ monetary policy from 2020 to 2024 is essentially loose, highlighting the flexibility, appropriateness, precision, and strength of monetary policy.

Looking back, there are several points worth following in the practice of our country’s monetary policy.

First, when the economy is severely impacted, the monetary policy stance often undergoes directional or significant adjustments. From historical experience, when the economy is overheating or facing inflation threats, the monetary policy stance usually quickly adjusts towards tightening. For example, in 1993, there was a ‘moderate tightening’ and in 2008, there was a ‘tightening’. On the other hand, in the context of contractionary shocks, the monetary policy stance will be adjusted promptly towards easing, which may be a one-step adjustment or a two-step adjustment. For example, in 1997, the monetary policy stance changed from ‘moderate tightening’ to ‘prudent’, and in 2009, it directly skipped ‘moderate tightening’ and ‘prudent’ and moved to ‘moderate easing’.

The second is that the monetary policy stance sometimes appears to be “inconsistent with reality” in actual operation. Among the five policy stances, “tightening”, “moderately tightening”, “prudent”, and “moderately loose” have all appeared at different times, but “loose” is the only one that is missing. However, this does not mean that the “loose” stance is truly absent. During the period from 2009 to 2010, China’s currency and credit rose rapidly, especially from the end of 2009 to the beginning of 2010, with a year-on-year growth rate of M1 reaching 38.96%, M2 growth rate approaching 30%, and the growth rate of various RMB loans exceeding 34% for several consecutive months; matching the rapid rise in credit, local financing platforms emerged like mushrooms after rain, and some regions even established more than ten financing platforms in a short period of time. It can be seen that the monetary policy stance at that time was far from being nominally “moderately loose”, but truly “loose”. Similarly, the true meaning of “prudent” sometimes is “moderately loose” (such as in 1997), and sometimes it is “moderately tightening” (such as from 2011 to 2013). The expression of the policy stance often changes in the opposite direction compared with the previous policy stance, and it needs to be grasped based on the actual situation to understand its relative looseness or tightness changes.

Third, in recent years, the monetary policy has lacked flexibility. Before 2011, the monetary policy would switch between positions such as ‘tightening’, ‘moderately tightening’, ‘prudent’, and ‘moderately loose’ based on the objective situation and regulatory objectives. However, after 2011, despite significant fluctuations in economic performance, the flexibility of the monetary policy has been insufficient, and the ‘prudent’ approach has been used for 14 years. In fact, over the past 14 years, the Chinese economy has experienced a series of fluctuations, such as the economic downturn and capital outflows in 2015-2016, the trade war launched by the United States against China in 2018-2019, and the impact of the COVID-19 pandemic from 2020 to 2022. However, the overall tone of the monetary policy has remained unchanged, which is obviously not conducive to conducting countercyclical adjustments based on the needs of the real economy. Of course, the spillover effects of the monetary policy of the Federal Reserve have imposed certain constraints on our monetary policy, but the monetary policy of the Federal Reserve has undergone several major adjustments over the past 14 years.

Second, it is necessary and conditional to adjust the current monetary policy stance to “moderate loosening”.

First of all, from the perspective of the domestic environment, macroeconomic and financial indicators are relatively weak, and further monetary policy support is urgently needed. In August 2024, China’s manufacturing purchasing managers’ index (PMI) was 49.1%, a decrease of 0.3 percentage points from the previous month, and the manufacturing industry’s business activity continued to decline, remaining below the boom-bust line for the fourth consecutive month. Since the beginning of this year, the manufacturing PMI has only briefly exceeded the boom-bust line in March and April, and has been below 50% for the other six months. In 2023, it was only above the boom-bust line for four months and below 50% for eight months. In other words, for most of the past two years, China’s manufacturing industry has been in a sluggish state. In terms of financial data, the year-on-year growth rate of Broad Money (M2) balance in August was 6.3%, which has been below 8% for five consecutive months, and the year-on-year decrease in Narrow Money (M1) balance was 7.3%. In July, new loans in RMB only increased by 260 billion yuan, and if the 558.6 billion yuan of bill financing is excluded, the actual new loans would be negative. Although new loans in RMB rebounded to 900 billion yuan in August, they still have a significant gap compared to 12,200-13,600 billion yuan in the same period of 2021-2023. From the sub-item data, the scale of short-term and medium-to-long-term loans for residents and enterprises has declined significantly, and the factors causing the decline in credit may exceed seasonal factors. In addition, indicators such as prices, real estate, and consumption are also in a continuous downturn.

Secondly, there is a significant gap between the current ‘prudent’ monetary policy tone and market expectations. Since 2020, even in the face of major external shocks such as the new crown epidemic and insufficient domestic demand, the monetary policy tone has only slightly shifted towards a more relaxed direction from the ‘prudent neutral’ tone to maintaining a prudent monetary policy that is ‘flexibly moderate,’ ‘flexibly precise and reasonably moderate,’ and ‘precisely effective,’ but the overall tone remains ‘prudent.’ Since 2023, the Central Bank has made multiple adjustments to the LPR interest rate, with the 1-year LPR interest rate being lowered by 10 basis points in June 2023, August 2023, and July 2024, and the 5-year LPR interest rate being lowered by 10, 25, and 10 basis points in June 2023, February 2024, and July 2024, respectively. Except for the relatively larger decrease from 4.2% to 3.95% in the 5-year LPR interest rate in February 2024, the rest of the rate cuts were very small. Compared with the continuous rate cuts of 25-50 basis points in European and American countries, or even a single highest decrease of 100 basis points, the symbolic significance is more than the actual impact, leading to a significant gap between expectations and market expectations. Therefore, a slight rate cut is difficult to have a significant impact on the market. From the perspective of strengthening expectation management and effectively guiding market expectations, making a reasonable and appropriate adjustment to the monetary policy tone as soon as possible will help boost market confidence and change the current situation of generally weak market expectations.

Thirdly, from the perspective of policy coordination, in order to enhance the effect of countercyclical adjustment, it is necessary for monetary policy to better cooperate with fiscal policy and implement the “double loose” combination. In the process of countercyclical adjustment, the government usually uses expansionary fiscal policy to stimulate aggregate social demand through measures such as borrowing, deficits, tax cuts, and expanded government spending. However, expansionary fiscal policy itself has the side effect of the “crowding out effect”, that is, when government spending increases, money demand rises correspondingly, and when the money supply is given, the Intrerest Rate rises, resulting in a suppression of private sector investment. At this time, it is often necessary to cooperate with an expansionary monetary policy to suppress the upward movement of the Intrerest Rate by increasing the Money Supply. In recent years, the tone of China’s fiscal policy has clearly determined that it is located in the “active fiscal policy”, and proposed to “increase efficiency” and tilt towards expansion as a whole. The national budget deficit for 2023 was initially set at 3%, but in October 2023, the budget was adjusted, adding 1 trillion yuan of ultra-long-term government bonds, and the final fiscal deficit ratio reached 3.8%. In 2024, China’s budget deficit ratio will continue to be set at 3%, and the quota of local government special bonds will be 3.9 trillion yuan, which will be further higher than last year, and at the same time, it will be decided to issue ultra-long-term special treasury bonds on a large scale for several consecutive years from this year. While the tone of fiscal policy is clearly expanding, monetary policy is bound to actively cooperate, including increasing the supply of liquidity and further droping the Intrerest Rate. At this time, it is necessary to adjust the tone of monetary policy accordingly, from “prudent” to substantial “moderate easing”.

Finally, the external environment changes have provided a time window for the adjustment of our country’s monetary policy tone. On August 23, Fed Chairman Powell officially confirmed the arrival of the “timing for policy adjustment” in his speech at the global Central Bank Governors’ Meeting. The market generally believes that the Fed’s announcement of a rate cut in September is a foregone conclusion. We expect that this round of Fed interest rate cuts may last for as long as 14-16 months, with 6-8 rate cuts and a cumulative reduction of 150-200 basis points. It is undeniable that in recent years, despite the increasing downward pressure on the economy and the persistent deflationary pressure, our country’s monetary policy tone has not been adjusted. A significant reason for this is that the high interest rate policy implemented by the Fed has constrained our country’s economic and financial situation. Currently, the Fed’s new round of rate cuts is imminent. Against this backdrop, our country’s monetary policy tone has obtained a rare adjustment time window, and has the potential to push for a new round of reserve requirement ratio cuts and interest rate cuts.

The ‘moderately loose’ monetary policy tone is between ‘prudent’ and ‘loose’, and it has three positive implications when implemented in the current situation: First, compared to the ‘prudent’ monetary policy tone, it is more proactive, which allows for a greater use of total, price, and structural monetary policy tools, injects sufficient Liquidity into the market, and significantly lowers the actual Intrerest Rate. Second, compared to the ‘loose’ monetary policy tone, it is relatively more cautious. Due to the moderate looseness, it can avoid causing ‘flooding’ and serious inflation. Third, compared to the current monetary policy tone, which is named ‘prudent’ but is actually loose, the greatest positive implication is that it can send a clearer and more explicit policy signal to the market, enabling all parties in the market to better understand the loose intention of the policy and form a consistent positive expectation for subsequent policies, enhancing confidence in the economic recovery. Since the recent frequent adjustments of reserve requirements, interest rates, and structural tools have been leaning towards loosening, and the direction of countercyclical adjustments will not change in the future, why not pragmatically adjust the ‘prudent’ tone to a ‘moderately loose’ tone? Taking all aspects into account, the current conditions for implementing a truly ‘moderately loose’ monetary policy tone are ripe.

3. Policy Recommendations

Suggestion 2: Further strengthen expectation management and transmit clear signals of monetary policy to the market. While establishing a standardized system for the tone of monetary policy, it is recommended that monetary authorities adopt a more rigorous and accurate policy tone that better reflects current needs, allowing all parties in the market to better understand the direction of monetary policy and form positive feedback resonance. As pointed out by the leaders of the Central Bank, ‘When the transparency of monetary policy increases, the comprehensibility and authority of the policy will also be enhanced, and the market will spontaneously form stable expectations for the future direction of monetary policy, optimizing their own decision-making reasonably and achieving twice the result with half the effort in monetary policy regulation’.

Suggestion 3: Adjust the monetary policy stance to “moderately loose” to create a favorable policy environment for implementing more substantial reserve requirement ratio cuts and interest rate reductions. In terms of the possibility of reserve requirement ratio cuts, currently, the weighted average reserve requirement ratio of small banks in China has dropped to around 5.0%, with relatively limited short-term space, but it does not mean that further reductions are not possible; the weighted average reserve requirement ratio of medium-sized banks is 6.5%, and that of large banks is 8.5%. If the monetary authorities implement a new round of reserve requirement ratio cuts, they can consider targeted cuts for state-owned large commercial banks and nationwide joint-stock commercial banks. Considering that these related banking institutions account for about 60% of the deposit share in China’s banking industry, a targeted reduction of 0.5 percentage points is expected to release liquidity of more than 600 billion yuan to the market. Considering that the current actual interest rate in China is still relatively high, it is also necessary to further reduce interest rates. It is recommended to concentrate policy resources and implement a relatively large interest rate cut of about 50 basis points in late this year or early next year. At the same time, considering that the carbon emission reduction support tools, inclusive micro and small loans support tools, and inclusive pension special refinancing loans in the structural monetary policy tools will all expire at the end of this year, new quotas can also be further added to these relevant structural monetary policy tools at the beginning of next year, and the Intrerest Rate for supporting agriculture refinancing loans, supporting small loans refinancing, and rediscount can be reduced by 0.5 percentage points each to facilitate the coordination of green finance, inclusive finance, and pension finance.