China unlikely to relax monetary policy stance

Source:Global Times Published: 2017/12/27 22:23:40

Illustration: Peter C. Espina/GT

Many major developments have affected global markets recently. These include the US plans to shrink its balance sheet, raise interest rates and overhaul its tax code. It should be closely watched how these moves will influence the US economy as well as the Chinese economy, and what their impact will be on China's monetary policy next year.

First, the US Federal Reserve Board began reducing its balance sheet in October. A central bank's balance sheet is very important, because it determines the money supply of the country.

Due to its quantitative easing policy during and after the global financial crisis, the Fed's balance sheet expanded from less than $900 billion in 2007 to $4.5 trillion in 2014. Although the figure hasn't changed much since then, the Fed still faces growing pressure to address its balance sheet.

But this is not the case for the People's Bank of China (PBC), the country's central bank. The PBC's balance sheet less than doubled in size during the same seven years, meaning that the PBC doesn't face the same pressure to unwind. There is no need for China to follow the US and shrink its balance sheet. Given China's tight money supply these days, it would be more reasonable for the PBC to expand its balance sheet instead of reducing it.

Second, the Fed raised interest rates three times this year, in March, June and December. The purpose of the Fed's rate hikes is to increase the federal funds rate, which in turn guides interest rates in the financial markets.

After the three Fed rate hikes, the PBC slightly increased short- and medium-term interest rates for open market operations in March and December, with no changes in June. It is also important to note that the PBC has kept the benchmark one-year deposit and lending rates unchanged since October 2015. Apparently, China's monetary policy doesn't need to track that of the Fed.

There is no good reason to raise our benchmark interest rates at present. China's market interest rates are already at a relatively high level, with the one-year deposit rate exceeding 5.2 percent at some city commercial banks, a situation that indicates tight capital supply. Moreover, as downward pressure persists on the Chinese economy, increasing benchmark rates will only drive up corporate borrowing costs, and add to pressure on the real economy. To support the development of the real economy and promote capital flows from the virtual economy to the real one, China is unlikely to hike benchmark interest rates in the near term.

Third, US President Donald Trump last week signed the country's largest tax overhaul plan in three decades. Most importantly, the final version slashed the corporate tax rate from 35 percent to 21 percent. The tax cut is expected to draw US companies and capital back home with lower business costs.

There is no denying that China may face short-term pressure from capital outflows due to the US tax reform, but the situation is still manageable. That is because capital outflows from China are subject to strict controls, which have hardly changed over the years. Some may say that four or five years ago, Chinese companies could send capital abroad easily for overseas investments. But at that time, Chinese authorities encouraged capital outflows because of the nation's relatively high foreign exchange reserves. In the past, it might only have taken three months for regulators to approve State-owned enterprises' foreign acquisitions. Now, it may take as long as nine months.

Last but not least, as China's economic restructuring, opening-up, industrial upgrading and new industrialization advance steadily, it is essential for the country to remain cautious in establishing economic and financial policies. According to the annual tone-setting Central Economic Work Conference last week, the economy will shift from rapid growth to high-quality development. Given the nation's large number of traditional industries, the shift to quality is making slow progress. But it is important to provide a steady environment for this transition, which is why the government adheres to the path of stable and peaceful development. It also explains why the conference basically maintained policies unchanged for the coming year.

In conclusion, the US will probably adopt a combination of loose fiscal policy and tight monetary policy in 2018, mainly by means of tax cuts, an increased fiscal deficit and interest rate hikes. Nevertheless, China will stick to the course of proactive fiscal policy and prudent monetary policy, with relatively tight market liquidity expected for some time. A relaxation of monetary policy is highly unlikely.

This article was compiled based on a speech by Sheng Songcheng, counselor to the People's Bank of China and executive deputy director of the CEIBS Lujiazui Institute of International Finance, at the Shanghai University of Finance and Economics on Saturday.


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