On May 30th of 2014, the Chinese State Council made a detailed plan for the financial work of the second half of the year. It seems to stress enhancing the capability of financial services for the real economy, but in fact it sets the tone for the central bank’s monetary policy in the second half of the year. It is also innovative in strengthening “directional drop quasi”, lowering the financing cost, and optimizing bank credit.
First, the so-called “directional drop quasi” means a directional reduction of the reserve requirement ratio. In the case of China’s downward economic growth, a periodic adjustment of the real estate market, and an increasing risk of default for Chinese enterprises, “directional drop quasi” means that the Chinese central bank will not likely change the present moderately tight monetary policy but can only fine tune different bank reserve ratios. Thus, the debate over the central bank’s expected reduction of the reserve ratio came to a halt, meaning a lower possibility of an overall reduction of reserve requirement ratios and loan interest rates in the second half of the year.
Meanwhile, “directional drop quasi” also means that in the case of a tight control of credit and social financing scale, a directional easing policy will be adopted to support the development of the real economy, the development of agriculture as well as small and micro businesses in particular. At present, China’s over expanding credit funds failed to flow into these enterprise. These industries and enterprises not only relate to the people’s livelihoods and the most dynamic aspects of the social economy, but also to the industries contributing the most to job opportunities. So, in the second half of the year, a directional easing policy will improve the financing conditions for agriculture as well as small and micro businesses.
Also, “directional drop quasi” is a way to regulate China’s financial market. In the early years, the fast growth of China’s interbank market was very related to the excessive use of the interbank market by quite a few small and medium banks as well as financial institutions. Due to the lack of available loans, caused by excessive expansion, these banks had to go to the interbank market for short borrowing and long lending, thus causing a serious maturity mismatch of their assets. Any trouble in the market will cause turbulence in the interbank market. That was the cause of the “money shortage” in 2013. Adopting a directional easing policy is meant to encourage small and medium banks to make themselves accessible to the real economy and to small and micro businesses.
Of course, “directional drop quasi” is a quantitative policy instrument of a small effect. If the issues exist, such as the lack of further reform of China’s interest rate market, the distortion of financial market price mechanisms, and the lack of a fundamental transformation of the investment-oriented real estate market, “directional drop quasi” will have a limited ability in enhancing the service for the real economy. Now there are a lot of problems in the Chinese financial market and these problems are mainly caused by the central bank’s excessive use of the quantitative policy instrument instead of a flexible use of price instruments. Therefore, if a directional easing policy is set as a usual instrument, it will still have a limited effect.
Second, social financing cost should be comprehensively reduced. It should be done through “deleveraging” and reducing bank service charges respectively. The government has excessively controlled the financial market and misused monetary policy instruments, thus impeding the marketization reform of the interest rate market. In this case, Chinese banks and financial institutions had to break through controls through all kinds of so-called financial innovations. For instance, there are the problems of the prosperity of the interbank market, the spreading of transactions, such as trusts, wealth management, and entrusted loans, and the explosive growth of internet finance. The emergence of these financial markets not only made the entire financial market’s financing chain unlimitedly expand and become complicated, thus increasing the price level of the financial market, but it also increased the potential risk of the entire financial system.
In 2013, the government started to regulate these financial markets. Particularly in 2014, relevant documents were issued and were targeted at the interbank market. They were demanding a regulation of the complicated and ever expanding financing chain, bringing all the non-standard banking businesses under supervision so as to clear away the unnecessary financial “channels” and “bridge” links, shorten the financing chain, and reduce the financing cost and potential risk of the financial system.
However, if the “deleveraging” policy is launched, it will be effective in the short term from the technological perspective, but the market will likely break through these supervisions through new ways in the long term. So the key to the problem of Chinese shadow banks is to accelerate the marketization reform of Chinese interest rates and exchange rates, to change the central bank’s thinking on its policy, and to allow for the decisive role of the effective price mechanism in the financial market operation.
Third, optimizing financing structures concern how to guarantee the flow of bank credit into the real economy and the government-supported industries as well as to control credit to the industries of over capacity. This policy is expected to have quite a big impact on China’s real estate market, which is in the process of periodic adjustment. Faced with the huge risk in China’s real estate market, not only are the commercial banks unwilling to undertake related transactions, but policy restrictions are also more likely to worsen the financing problems of Chinese real estate. So, unless China’s financial system shows systematic risk, the central bank’s monetary policies will not change very often.
These three aspects are innovative and also the focus and trend of the central bank’s monetary policy in the second half of the year.
Yi Xianrong is a researcher at the Financial Institute of the Chinese Academy of Social Sciences.