EF3461EF3461The Economies of Mainland The Economies of Mainland

China and Hong KongChina and Hong Kong

Tutorial 10Tutorial 10China’s Monetary PolicyChina’s Monetary Policy

City University of Hong KongCity University of Hong Kong

Dr. Isabel YanDr. Isabel Yan

The Monetary Policy in ChinaThe Monetary Policy in China

Reference:Reference: Li, Kui-Wai (1997), “Financing China Trade and Li, Kui-Wai (1997), “Financing China Trade and

Investment”, Westport: Praeger Publishers, Chapter 1 and 2Investment”, Westport: Praeger Publishers, Chapter 1 and 2

Definitions of Money Supply in China and Definitions of Money Supply in China and HKHK In China:In China:

M0 = currency held by the publicM0 = currency held by the publicM1 = M0 + demand deposits of enterprises, rural collectives and M1 = M0 + demand deposits of enterprises, rural collectives and

other institutionsother institutionsM2 = M1 + time deposits of enterprises + deposits of self M2 = M1 + time deposits of enterprises + deposits of self

financed funds of capital construction + housing saving financed funds of capital construction + housing saving deposits + other deposits deposits + other deposits

In HK:In HK:M0 = currency held by the publicM0 = currency held by the publicM1 = M0 + demand deposits with licensed banksM1 = M0 + demand deposits with licensed banksM2 = M1 + saving and time deposits with licensed banks + M2 = M1 + saving and time deposits with licensed banks +

NCDs issued by licensed banks and held by the publicNCDs issued by licensed banks and held by the publicM3 = M2 + deposits with restricted licensed banks and deposit M3 = M2 + deposits with restricted licensed banks and deposit

taking companies + NCDs issued by restricted licensed banks taking companies + NCDs issued by restricted licensed banks and deposit taking companies and held by the publicand deposit taking companies and held by the public

Monetary Policy in China and HKMonetary Policy in China and HKChina:

After the reform, the central bank attempted to exercise an independent monetary policy to achieve four policy targets:

(i) monetary stability

(ii) economic growth

(iii) full employment

(iv) Balance of payment

balance

HK:

Since HK adopts the currency board system which requires all base money to be fully backed by USD, HK does not have independent monetary policy. The money supply is determined passively by the availability of foreign currency.

Instruments of Monetary Policy in ChinaInstruments of Monetary Policy in China1. 1. Credit ceilingCredit ceiling

The PBC set ceilings on the amount of lending that the four The PBC set ceilings on the amount of lending that the four specialized banks can make. First of all, a money supply target is specialized banks can make. First of all, a money supply target is calculated by the central bank according to the needs of economic calculated by the central bank according to the needs of economic growth, price level increase etc. The plan includes the quota for growth, price level increase etc. The plan includes the quota for new loans and targets for deposits for the specialized banks. Then new loans and targets for deposits for the specialized banks. Then the central bank informs the specialized banks of its tentative plan the central bank informs the specialized banks of its tentative plan and allocate the approved credit quotas and required deposit targets and allocate the approved credit quotas and required deposit targets to their provincial and regional branches.to their provincial and regional branches.

Note: The four specialized banks include the Agricultural Bank of Note: The four specialized banks include the Agricultural Bank of China (AOC), Bank of China (BOC), The People’s Construction China (AOC), Bank of China (BOC), The People’s Construction Bank of China (PCBC) and The Industrial and Commercial Bank of Bank of China (PCBC) and The Industrial and Commercial Bank of China (ICBC).China (ICBC).

2. 2. Loan by the Central Bank (PBC) to the Specialized Loan by the Central Bank (PBC) to the Specialized Banks (Reloan):Banks (Reloan):PBOC provides regular and temporary loans to the PBOC provides regular and temporary loans to the specialized banks and commercial banks which specialized banks and commercial banks which increases the bank liquidity.increases the bank liquidity.

3. 3. Interest rate and discount rate:Interest rate and discount rate:The central bank decides the discount rate (the rate of The central bank decides the discount rate (the rate of the central bank’s loans to other banks) and regulates the central bank’s loans to other banks) and regulates almost all lending and deposit rates. Interest rate almost all lending and deposit rates. Interest rate changes affect both the demand for credits and changes affect both the demand for credits and household savings.household savings.

4. 4. Reserve requirementsReserve requirementsRequired reserve:Required reserve:

Bank deposits are subject to a reserve requirement which Bank deposits are subject to a reserve requirement which is set at 13% for domestic currency deposits in 1994. is set at 13% for domestic currency deposits in 1994.

The The reserves have to be submitted to the PBOC. Reserve reserves have to be submitted to the PBOC. Reserve shortfalls are subject to penalty interest rates. The shortfalls are subject to penalty interest rates. The

required reserve changes the money supply through the required reserve changes the money supply through the banking multiplier.banking multiplier.

Excess reserve (standby reserve):Excess reserve (standby reserve):Excess reserves are used to meet cash withdrawals, Excess reserves are used to meet cash withdrawals,

lending lending in the interbank market etc. In 1989, the PBC in the interbank market etc. In 1989, the PBC issued a issued a guideline on the level of excess reserves – 5 to guideline on the level of excess reserves – 5 to 7% 7% of of deposits.deposits.

5. 5. Open Market Operation:Open Market Operation:

The PBC began to issue central bank financing notes in The PBC began to issue central bank financing notes in May 1993 to implement open market operation (to May 1993 to implement open market operation (to influence the base money through the buying and selling influence the base money through the buying and selling of the financial notes).of the financial notes).

Monetary Policies in China for the Period 1985-1998Monetary Policies in China for the Period 1985-1998The monetary policy of China is characterized by the The monetary policy of China is characterized by the “stop-go” cycle“stop-go” cycle: : when the economy overheats, tight monetary policy is used. But when when the economy overheats, tight monetary policy is used. But when output falls, the money supply expands again.output falls, the money supply expands again.

Monetary policy in 1985 (the “stop” phase )Monetary policy in 1985 (the “stop” phase )::

In 1984, the central bankIn 1984, the central bank pumped too much liquidity into the economy pumped too much liquidity into the economy which resulted in economy overhearing. Because of this, the central which resulted in economy overhearing. Because of this, the central bank has to tighten the money supply in 1985. Five measures were bank has to tighten the money supply in 1985. Five measures were adopted:adopted:

(i) specialized banks are allowed to make loans only to the extend of their deposits.(i) specialized banks are allowed to make loans only to the extend of their deposits.

(ii) strict credit control policy was instituted(ii) strict credit control policy was instituted

(iii) the credit funds of People’s Construction Bank of China was incorporated into (iii) the credit funds of People’s Construction Bank of China was incorporated into

the credit management of PBC.the credit management of PBC.

(iv) the Renminbi was devaluated.(iv) the Renminbi was devaluated.

Monetary policy in 1986 (the “go” phase )Monetary policy in 1986 (the “go” phase )::By 1986, economic activities had cooled down considerably and By 1986, economic activities had cooled down considerably and the growth of production fell. Subsequently, three measures were the growth of production fell. Subsequently, three measures were applied to relax the tight monetary policy:applied to relax the tight monetary policy:(i) (i) the PBC increased the amount of reloan by 5 billion Renminbi to clear the PBC increased the amount of reloan by 5 billion Renminbi to clear

up the enterprise debts up the enterprise debts (ii)(ii) it canceled the directory credit plan imposed on the specialized banksit canceled the directory credit plan imposed on the specialized banks(iii)(iii) temporary loans were granted to the specialized bankstemporary loans were granted to the specialized banks

Monetary policy in 1988 (the “stop” phase )Monetary policy in 1988 (the “stop” phase )::In 1987, the economy was overheated. Thus quantity control and In 1987, the economy was overheated. Thus quantity control and structural readjustment was applied again in 1988: structural readjustment was applied again in 1988: (i) (i) credit aggregates were restrictedcredit aggregates were restricted

(ii)(ii) the long-term interest rate was increased and all short-term loans were the long-term interest rate was increased and all short-term loans were recalledrecalled

(iii)(iii) the required reserve was raised to 13% and the reloan rate was the required reserve was raised to 13% and the reloan rate was increased.increased.

Monetary policy in 1990 (the “go” phase )Monetary policy in 1990 (the “go” phase )::From October 1989, the Chinese economy experienced negative From October 1989, the Chinese economy experienced negative growth in income for several months, mainly caused by the growth in income for several months, mainly caused by the triangular-debt problem among different enterprises. In 1990, triangular-debt problem among different enterprises. In 1990, the State Council relaxed the tight monetary policy. Major the State Council relaxed the tight monetary policy. Major measures include:measures include:

(i) a reloan readjustment plan increased credits from 30 billion to 60 billion (i) a reloan readjustment plan increased credits from 30 billion to 60 billion RenminbiRenminbi

(ii) PBC increased its technology reconstruction loans to enterprises and loans (ii) PBC increased its technology reconstruction loans to enterprises and loans were granted to solve the triangular-debt problem.were granted to solve the triangular-debt problem.

(iii) banks’ deposit and loan rates were lowered by an average of 1.26 percent.(iii) banks’ deposit and loan rates were lowered by an average of 1.26 percent.(iv) a favorable interest rate was granted to import and export enterprises(iv) a favorable interest rate was granted to import and export enterprises

Monetary policy in 1991 (the “stop” phase )Monetary policy in 1991 (the “stop” phase )::The economy picked up at the end of 1990 which led the State The economy picked up at the end of 1990 which led the State Council to introduce a tight monetary policy again in 1991.Council to introduce a tight monetary policy again in 1991.

Monetary policy in 1992 (the “go” phase )Monetary policy in 1992 (the “go” phase )::In 1992, Deng Xiaoping toured southern China and called for In 1992, Deng Xiaoping toured southern China and called for further reform. Monetary policy has to be loosen to promote further reform. Monetary policy has to be loosen to promote further reform. Measures taken include:further reform. Measures taken include:

(i) increase the credit aggregate to RMB 350 billion (i) increase the credit aggregate to RMB 350 billion

(ii) the high demand for loans had led to a sharp increase in credits(ii) the high demand for loans had led to a sharp increase in credits

Monetary policy in 1993 (the “stop” phase )Monetary policy in 1993 (the “stop” phase )::

In 1993, the Austerity Plan was introduced to strengthen control In 1993, the Austerity Plan was introduced to strengthen control on the financial sector. Under the Austerity Plan, strict control on the financial sector. Under the Austerity Plan, strict control was imposed on currency issue, all forms of illegal interbank was imposed on currency issue, all forms of illegal interbank borrowing and lending were stopped etc.borrowing and lending were stopped etc.

Monetary policy in 1994 (the “go” phase )Monetary policy in 1994 (the “go” phase )::The tight monetary policy hurt the economy badly. The The tight monetary policy hurt the economy badly. The industrial growth dropped and the real estate market was in deep industrial growth dropped and the real estate market was in deep recession. Under these circumstances, the State Council and recession. Under these circumstances, the State Council and PBS loosened the monetary policy to prevent the economy from PBS loosened the monetary policy to prevent the economy from sliding further.sliding further.

Monetary policy in 1998 (the “go” phase )Monetary policy in 1998 (the “go” phase )::

Since the SOE reform and the opening to the outside world, the Since the SOE reform and the opening to the outside world, the weight of the non-state-owned economy against the whole weight of the non-state-owned economy against the whole national economy kept increasing. Nevertheless, the loans for national economy kept increasing. Nevertheless, the loans for the non-state-owned economy did not reach 3% of the loan the non-state-owned economy did not reach 3% of the loan balance, thus it is necessary to increase money supply to balance, thus it is necessary to increase money supply to stimulate the initiatives of the non-state-owned economy and stimulate the initiatives of the non-state-owned economy and promote the increase of consumption.promote the increase of consumption.