The complex monetary policy of the People’s Bank of China

In retrospect, China has always been popular as not only an investment opportunity, given its remarkable double digit growth figures a couple of years ago and now the relatively high mid-single digit growth. For the avoidance of doubt, China is still the second-largest economy in the world. Lately, markets have been focusing on attempting to analyse China’s policy decisions to understand how vast flows of Chinese funds will react.

In terms of the U.S. economy, investors watch for changes that the Fed makes to its target for the ‘federal funds rate’ but in China such a signal is less clear because the country has multiple tools to control interest rates and money supply within the Chinese economy. Hence, attempting to interpret what China wants to achieve can sometimes be a confusing affair.

In addition to, Chinese policymakers frequently add new tools or retire older ones as they modernise their country’s system into something more aligned with those in developed countries. Keeping track of the said changes can add difficulty to reading the central bank’s signals.

People’s Bank of China (PBOC)

Like in the advanced economies, the PBOC has the dual mandate of maintaining price stability and promoting growth through the management of monetary policies.

Monetary policy refers to the ways central banks manage the supply of money and interest rates in their economies, amongst others. Those policies are adjusted according to the economic conditions that a country is facing.

How China manages its Monetary Policy

The PBOC lists seven tools it uses to make adjustments to its monetary policy.

The first being Open Market Operations (OMO) which mostly involves repurchasing or reverse repurchasing agreements but only allows control over money supply and interest rates for the short-term. The former means removing liquidity from the economy when the PBOC sells short-term bonds to commercial banks and the latter is the opposite i.e. buying those contracts so banks have more cash on hand.

Another is the Reserve Requirement Ratio (RRR) which refers to the amount of money the banks must hold as a proportion of their total deposits. Lowering the requirement will increase money supply and therefore cuts borrowing costs.

The PBOC also controls the one-year benchmark lending and deposit rates which affect the borrowing costs for banks, businesses and individuals. The last time this was adjusted was in October 2015 and now allows commercial banks some flexibility to go below or above to determine the interest rate they charge.

Banks are offered the option to “rediscount” the loans that they extend to customers through the PBOC. This tool involves the central bank buying up the existing loans and giving them extra liquidity. For this, the PBOC charges an interest rate on those funds and hence, influences borrowing costs in the banking system.

In addition to, the PBOC offers lending in other types such as the Standing Lending Facility (SLF) which was introduced in 2013. This includes loans that have a maturity period of one to three months. To receive money through this framework, banks must guarantee assets with high credit ratings as collateral.

An extension to the aforementioned lending facility is the medium-term leading facility (MLF) where Chinese banks get funds for a longer maturity typically three months to a year. In this case, a wider range of collateral is accepted which included government bonds and notes, local government debt and highly rated loans of small companies.

Last but not least is one of the newest monetary policy tools in China – Pledged Supplementary Lending (PSL). This was introduced to guide long-term interest rates and money supply. Selected banks are injected with such funds so that they can provide loans to specific sectors. Till now only three banks have received this facility: China Development Bank, Agricultural Development Bank of China and the Export-Import Bank of China.

Evolution of China’s Monetary Policy

Formerly, the PBOC had mostly focused on managing the quantity of money in its economy and setting quotas on how much banks can lend. This took an absolute turn in 2018 when the central bank stopped setting specific targets.

Instead, China is now seeking to form an interest rate regime like those used by the Fed and European Central Bank. One possibility under consideration is an "interest rate corridor" with the floor and ceiling established by the PBOC, while allowing the market to set rates within that specified band. This is obviously still a work-in-progress for the PBOC.

Ultimately, China’s moves from all fronts will still have high sensitivity on financial markets. The second largest economy was, is and will remain a very important contributor towards global growth. Such reliance will be sustained in the coming years given the increase in domestic demand, primarily supported by demographics.

This article was issued by Maria Fenech, investment management support officer at Calamatta Cuschieri. For more information visit, The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.

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