Cash & Liquidity Management

The unusual evolution of China’s monetary policy

Published: May 2017
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May 2017

Historically, monitoring the People’s Bank of China’s (PBoC’s) monetary policy was relatively challenging due to opaque monetary policy meetings and limited communication from policymakers. Fortunately, the central bank’s limited set of interest rate tools meant that interpreting PBoC changes was relatively simple. By using a combination of interest rates (deposit rates, lending rates and reserve retirement ratio) and influence (window guidance and loan targets), the PBoC could determine the cost and quantity of money available to domestic, mainly state-owned enterprises.

However, the proliferation of financial instruments triggered by interest rate liberalisation, combined with the rapid growth of non-bank financial institutions and huge growth in the shadow banking market, has made the task of implementing monetary policy significantly more difficult in recent years. Consequently, interpreting PBoC policy has also become more challenging.

Attempts by the PBoC to balance the government’s requirement for growth and stability with the need to deleverage and mitigate financial risks have led to a trifurcation of PBoC monetary policy across traditional, quasi and regulatory methods. Traditional monetary policy tools remain, but are less significant and little used. Use of quasi monetary policy tools, including the Medium Term Lending Facility (MLF) and Standing Lending Facility (SLF), has expanded rapidly, with the PBoC manipulating multiple programs, tenors and interest rates to fine tune market liquidity. Finally, the central bank’s regulatory monetary policy (exemplified by macro prudential assessment and the new unified regulations) is forcing banks and other financial instructions to adjust their liquidity and interest rate requirements.

While these changes should reduce market risk and complexity, in the short term they have created more volatility and uncertainty for investors. Prudence in selecting investments remains important, as does a focus on security and liquidity.

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