China's Monetary Policy Needs to Undergo Trial and Error, Central Bank Counselor Says
Zhou Ailin
/SOURCE : Yicai
China's Monetary Policy Needs to Undergo Trial and Error, Central Bank Counselor Says

(Yicai Global) May 24 -- The implementation of China's 'neutral, tightening' monetary policy needs to undergo continuous trial and error as the nation looks to deleverage, a senior central bank official said in an exclusive interview with Yicai Global.

"With regards to tightening policy, regulation set by the People's Bank of China will not be over the top," said Sheng Songcheng, counselor to the central bank, "but it needs to go through trial and error. The US Federal Reserve is doing the same."

On May 11, the bank made CNY80 billion (USD11.6 billion) in reverse repurchases after a period of net withdrawal from circulation, he said. On May 12, the bank restarted medium-term lending facilities operations, injecting CNY459 billion into the market and on May 15, the institution once again suspended open market operations. This is just a combination of tightening and loosening, Sheng said. It's trial and error, not a shift in monetary policy.

"After the money market interest rates increase, financial bubbles are squeezed out. If the deposit and lending benchmark rates go up, it directly affects the real economy, so the former is still the focus of regulation," he added.

Sheng believes the probability of the bank lowering the reserve requirement ratio is low, although the excess reserve rate is below average now. "There are two major concerns in lowering this ratio. First, it gives the market a strong hint that policy is loosening, which is inconsistent with the current tone of regulation. Second, after the ratio is reduced, it will be hard to make tight again, so the central bank is more willing to regulate liquidity with open market operations."

In recent years, Sheng has said many times the scale of social financing is more suitable as an intermediate target for monetary policy than new loans, as it covers a wider range of financing channels.

"With the expansion of off-balance-sheet business at banks, direct financing has grown rapidly. Businesses are not entirely dependent on bank loans, so the effect of scale of credit will weaken in the monetary transmission mechanism" Sheng said, adding that M2 and social financing data over the past two months has begun to diverge, with M2 showing signs of distortion or failure.

For example, the social financing growth rates in March and April this year were 12.5 percent and 12.8 percent, respectively. Growth rates of M2 were 10.6 percent and 10.5 percent. "If the M2 was not distorted, it shows that monetary policy has been tight, so why should we emphasize 'neutral' tightening?"

M2 refers to the measure of money supply including cash, checking deposits, savings deposits, money market securities, mutual funds and other time deposits.

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Keywords: Central Bank, Monetary Policy, Deleverage, Regulation, Interest Rate