Monetary Policy Analysis Group of

the People's Bank of China

May 11, 2004

Executive Summary

The global economy witnessed a good start in the first quarter of 2004 with more and more countries joining the economic recovery and growth. China's economy continued to grow rapidly. The GDP in Q1 of 2004 grew by 9.7 percent, household income, corporate profits and fiscal revenues all increased in a large scale, agricultural sector developed healthily and the growth of foreign trade maintained strong momentum.

At end March, the balance of broad money M₂ reached RMB23.2 trillion yuan, up 19.1 percent from a year earlier. New loans issued in Q1 totaled RMB835.1 billion yuan, which is equivalent to 32 percent of this year's projected loan increase of RMB2.6 trillion yuan, year-on-year rise of RMB24.7 billion yuan. Systemic risks inherent in the financial institutions such as "borrow short and lend long" should receive good notice. At end March, the balance of all kinds of deposits in financial institutions was RMB23.3 trillion yuan, up 19.6 percent. The base money of the People's Bank of China (PBC) stood at RMB5.05 trillion yuan, down by RMB178.8 billion yuan from the end of last year. The average excess reserve ratio of the financial institutions was 4.28 percent, 0.84 percentage points lower than that recorded at the end of last March. Official foreign exchange reserve reached USD439.8 billion, up USD36.5 billion over the end of last year, with a stable exchange rate at RMB8.2771 yuan per US dollar.

In Q1 of 2004, guided by the Central Economic Work Conference, the PBC kept strengthening and improving its management over the financial sector by leverage of various monetary means. The Central Bank kept the growth of monetary aggregate in check to ward off inflation pressure. Meanwhile, measures were taken to institutionalize macro financial management. First, open market operations were strengthened to almost fully sterilize the liquidity growth caused by foreign exchange repurchase in the market. Second, required reserve ratios were generally raised by 0.5 percentage points. Third, the positive incentives were introduced to adopt differentiated required reserve ratio system for the financial institutions. Fourth, interest rate of central bank lending was floated to redefine the funding relationship between the Central Bank and its borrowers. Central bank lending rates at every tranche were all raised by 0.63 percentage points with the rediscount rate escalating by 0.27 percentage points. Fifth, window guidance was strengthened to promote credit structure in the commercial banks. Sixth, in order to support economic development in the rural area, reform of the rural credit cooperatives was accelerated. Seventh, the development of money market was promoted and its management and service were upgraded. Finally, the balance of China's payments was promoted while the renminbi exchange rate was maintained basically stable at an equilibrium and adaptive level. 

On the whole, measures of macroeconomic management introduced since 2003 have continued to bear fruit. Despite new achievement in the social and economic development, difficulties and problems have emerged in the economic operation, particularly overinvestment in fixed assets and the resulting fast growth of credit.

The economic growth rate of China in 2004 is projected to reach about 7 percent, and CPI to rise about 3 percent. It should be noted that growth of GDP and CPI will likely remain high in the second quarter and a slowdown is expected in the second half of the year due to two facts. First, with the influence of base period, GDP growth in Q2 of 2004 is likely to reach a relatively high level based on the merely 6.7 percent expansion recorded in the same period of last year as a result of SARS epidemic. CPI is expected to first rise after April and then fall in Q3, affected by seasonal factors. Second, it will take some time for the macro-control policies and measures adopted since 2003 to begin to deliver their effects in the second half of 2004.

In line with principles stipulated by the Central Economic Work Conference and the Government Work Report, the PBC will take a scientific approach to economic development and carry out all plans of the central government. Measures consistent with economic and financial development will be timely applied to appropriately control the growth of credit and improve transmission mechanism of monetary policy. The target of money and credit supply projected early this year is still attainable, i.e. broad money M₂ and narrow money M₁ both grow by 17 percent, and new renminbi loans by all financial institutions reach about RMB2.6 trillion yuan. The stance of sound monetary policy in the coming periods should be for "appropriately tight", aiming at avoiding hard brake on the economy. First, excessive growth of money and credit will be controlled through tightening liquidity in the financial system. Second, close attention will be paid to price movement and steadily promote the market-based interest rate reform. Third, efforts made to economic restructuring will be strengthened to prevent one-size-fits-all solutions. Fourth, initiatives will be taken to promote financial market development and expand direct financing. Fifth, exchange rate will be kept basically stable at adaptive and equilibrium level. Sixth, renminbi pilot reform of rural credit cooperatives will be advanced to transform their operational mechanism.

    

 

 

 

 

 

Part One  MONETARY and Credit Performance

In the first quarter of this year, the Chinese economy maintained its rapid growth momentum. However, overinvestment in fixed assets intensified pressures on inflation, continuous increase of capital inflow and fast growth of money and credit all pose formidable challenges for macro financial management.

I . Rapid growth of money supply

Broad money M₂ grew by 19.1 percent to RMB23.2 trillion yuan at end March, representing an acceleration of 0.6 percentage points over the growth recorded a year earlier or 0.5 percentage points down from end 2003. Narrow money M₁ was RMB8.6 trillion yuan, growing by 20.1 percent on a year-on-year basis, with the growth rate equivalent to that recorded at the same time of last year, or 1.4 percentage points higher over the end of 2003.  Cash in circulation M0 amounted to RMB1.9 trillion yuan, increasing by 12.8 percent. Cumulative net cash withdrawal in Q1 totaled RMB44.9 billion yuan, RMB27.7 billion yuan more than that recorded for the same period of last year.

II . More increase of loans by financial institutions and maturity mismatch poses a concern

In the first quarter of 2004, loans by all financial institutions (including foreign-funded ones) in both renminbi and foreign currencies increased by RMB913.1 billion yuan, representing an added growth of RMB59.6 billion yuan over the same period of last year. The renminbi loans grew by RMB835.1 billion yuan, indicating an added growth of RMB24.7 billion yuan on a year-on-year basis. Loans in foreign exchange rose by USD9.4 billion, representing an acceleration of USD4.2 billion over the same period of last year.

At end March, loans by all financial institutions in both renminbi and foreign currencies amounted to RMB17.9 trillion yuan, growing year-on-year by 20.7 percent, 1.2 percentage points higher over the same time of last year or 0.7 percentage points lower than the growth recorded for 2003. The renminbi loans reached RMB16.7 trillion yuan, indicating a growth of 20.1 percent on a year-on-year basis, which was up by 0.2 percentage points over the same time of last year and down by 1 percentage point from that of 2003. Foreign exchange loans reached USD140.2 billion, representing a growth of 29.9 percent, with the growth rate accelerated by 17.3 percentage points over end-March of last year or by 3.2 percentage points over 2003.

Increased renminbi loans mainly came from short-term agricultural loans and medium or long-term loans for capital construction etc, while discounted commercial paper loans decreased. In Q1 of 2004, agricultural loans increased by RMB120.3 billion yuan with an acceleration of RMB35.2 billion yuan over the growth recorded from the same period of last year. In particular, agricultural loans issued by rural credit cooperatives amounted to RMB115.8 billion yuan, accelerating by RMB33.4 billion yuan. Since the beginning of this year, with the increase of farmers' income and further reform of rural credit cooperatives and post saving system, rural credit cooperatives has witnessed an upturn of both deposit and lending business and strengthened credit support for spring plough and agricultural development. Due to the stimulus effect of rapid growth of investment in fixed asset, the medium or long-term loans such as loans for capital constructions continued to grow. The loans for capital constructions grew by RMB170 billion yuan, RMB33.7 billion yuan more than the growth recorded for the same period of last year. Other medium or long-term loans grew by RMB188.7 billion yuan, representing a year-on-year increase of RMB36.2 billion yuan. Notably, the proportion of medium or long-term loans has continued increasing since 1998.  It reached 40 percent at end March 2004, up 20 percentage points over the end 1997, while the proportion of time deposits in the fund sources of financial institutions continued to fall, posing a maturity mismatch concern.

In terms of institutional distribution, the state-owned commercial banks saw a decrease of new loans in the first quarter while new loans issued by other financial institutions generally increased. On the year-on-year basis, loans issued by rural credit cooperatives grew by RMB173.9 billion yuan, accelerating by RMB51.4 billion yuan; loans issued by joint-stock commercial banks grew by RMB160.2 billion yuan, an acceleration of RMB27.3 billion yuan; loans granted by city commercial banks rose by RMB45 billion yuan, an acceleration of RMB18.9 billion yuan; loans extended by policy banks grew by RMB29.7 billion yuan, accelerating by RMB10.8 billion yuan; while loans issued by state-owned commercial banks increased by RMB399.9 billion yuan, decelerating by RMB98.4 billion yuan.

In terms of regional distribution, in the first quarter of 2004, new loans issued mainly flew to the provinces or municipalities of Jiangsu, Zhejiang, Guangdong, Shanghai and Shandong, involving RMB400 billion yuan which accounted for 47 percent of the total new renminbi loans. The top five provinces or municipalities which witnessed rapidest growth of loans were Tianjin, Zhejiang, Jiangsu, Ningxia and Guizhou.

III . Significant growth of deposits and rapid growth of corporate deposits

In the first quarter of 2004, on the year-on-year basis, deposits of financial institutions both in renminbi and foreign currencies increased by RMB1.23 trillion yuan, representing an acceleration of RMB108.7 billion yuan. In particular, renminbi deposits rose by RMB1.25 trillion yuan, accelerating by RMB112.8 billion yuan; household renminbi deposits surged by RMB824.6 billion yuan, an acceleration of RMB66.4 billion yuan; and corporate deposits went up by RMB200.3 billion yuan, accelerating by RMB28.4 billion yuan.

At end-March, deposits both in renminbi and foreign currencies of financial institutions increased to RMB23.3 trillion yuan, growing year-on-year by 19.6 percent. In particular, household deposits increased to RMB11.87 trillion yuan, expanding by 16.4 percent, and corporate deposits soared 20.7 percent to RMB7.93 trillion yuan.

IV . Net withdrawal of base money and decline of excess reserve ratio of financial institutions

At end-March, the balance of base money of the PBC totaled RMB5.05 trillion yuan, a decrease of RMB178.8 billion yuan from the beginning of this year. The average excess reserve ratio of financial institutions was 4.28 percent, down 0.84 percentage points from a year earlier. In particular, the wholly state-owned commercial banks carried a ratio of 3.75 percent, 1.47 percentage points down from a year earlier; rural credit cooperatives excess reserve ratio averages at 4.75 percent, almost equivalent to that recorded at end-March of last year; the joint-stock commercial banks took a ratio of 6.33 percent, 0.88 percentage points higher over a year earlier.

 

Box 1  Definition and Statistics of Base Money

 

Base money, also called monetary base, is capable of increasing or decreasing money supply in a multiplied manner, therefore, dubbed "high-powered money". According to the definition in Monetary and Financial Statistics Manual (2000) of IMF, base money includes all kinds of liabilities provided by the central bank for broad money and credit expansion, which mainly refers to in-bank money (cash in vault) and out-bank money (cash in circulation) and deposits by both banks and non-bank institutions in the monetary authority.

 

Different definitions and statistics of base money can be found in different countries; even in the same country there can be different definitions varying with its analysis purposes. The definition and statistics in China also evolved gradually.

 

In 1994, China began to compile statistics of base money. Base money for statistics was then defined as base money=cash in vault of financial institutions +cash in circulation +reserve deposits by financial institutions + special deposits by financial institutions + post savings converted deposits + deposits in the PBC by governmental organizations and public institutions. Vault cash of financial institutions includes cash held by commercial banks, policy banks, urban and rural credit cooperatives and finance companies. Special deposit by financial institutions was a special account setting up to withdraw excessive liquidity of rural credit cooperatives. The balance is usually small and inactive.

 

In January 2002, the PBC restructured the Balance Sheet of the Monetary Authority and the concept of reserve money was first introduced. It includes money issued by the PBC, reserve deposits in the PBC by all financial institutions, post savings deposits and deposits of governmental organizations and public institutions, and thus is equivalent to base money in theory. The inclusion of all post savings deposits in the reserve money statistics was consistent with the function of post savings institutions as special institutions on behalf of the PBC to withdraw money from households and enterprises because they had neither access nor ability to operate the absorbed funds.

 

In August 2003, with the reform of fund management system for post savings deposit, came the way for post savings deposit institutions to invest on their own and to entrust their assets management, resulting in an increasing gap between total deposits of their liabilities and converted deposits in the PBC by their financers. It is therefore more appropriate to introduce converted post savings deposits in the PBC in place of the deposits of post savings institutions in the statistics of reserve money. After January 2004, when a modification was made correspondingly, the figures in the statistics of base money have been identical with those in the statistics of reserve money issued in the PBC's Quarterly Statistics Report .

V . Stable market interest rate

After the interest rate cut on February 21, 2002, the interest rate for 1-year time deposit has remained at 1.98 percent, the lowest in more than two decades of reform and opening. The interest rate for the 1-year loan stands at 5.31 percent, and for required reserve at 1.89 percent. From 25 March, floating interest rate for central bank lending was introduced by the PBC to raise slightly the interest rate charged for liquidity support to financial institutions. In particular, the interest rate for 20-day central bank lending stood at 3.33 percent, up 0.63 percentage points, and 3.24 percent for rediscount, representing a growth of 0.27 percentage points. In the first quarter of 2004, the interest rates of negotiated deposits in commercial banks (over RMB30 million yuan per deposit) rose slightly, with the interest rate for 61-month deposits ranging from 3.6 percent to 3.8 percent, indicating an increase of 0.2 percentage points over the beginning of this year, and the rate paid for 37-month deposits ranging from 3.6 percent to 3.7 percent, a growth of 0.5 percentage points over the beginning of this year.

 

Influenced by international markets, the interest rates for loans in foreign currencies dropped slightly. In March, the weighted average interest rate for one-year large-amount US dollar deposit (with amount above USD3 million) in commercial banks was 1.39 percent, increasing by 0.4 percentage points over the beginning of the year. The weighted average fixed interest rate of one-year US dollar loan and the weighted average floating interest rate were 2.44 percent and 2.17 percent respectively, declining by 0.11 and 0.03 percentage points over the beginning of the year. At the beginning of the year, inter-bank market rates in Hongkong saw persistent fall, pushing commercial banks in the mainland to cut interest rate for small-amount Hongkong dollar deposit on January 19th, with interest rate for one-year time deposit sliding from 0.5 percent to 0.1 percent, down 0.4 percentage points.

VI . Stable exchange rate

At end March, official foreign exchange reserves reached USD439.8 billion, USD36.5 billion more than 2003. The renminbi exchange rate remained stable, being at RMB8.2771 yuan per US dollar.

 

 

 

 

 

 

 

 

 

Part TWO  Monetary Policy Conduct

In line with principles stipulated by the Central Economic Work Conference and the Government Work Report, the PBC, in Q1, 2004, strengthened and improved financial management by adjusting money and credit aggregates and structure with various monetary policy instruments, and attached great importance to preventing inflation while accelerating the establishment of institutional framework for macro financial management.

I . Intensifying open market operations and fully sterilizing liquidity increase caused by foreign exchange purchase

In Q1 of 2004, the PBC released base money of RMB291.6 billion yuan through open market operations and withdrew base money of RMB281 billion yuan through open market operations in securities transactions, a net release of base money reaching RMB10.6 billion yuan, almost with fully sterilizing the base money increase as a result of foreign exchange purchase. Meanwhile the money market interest rates were maintained stable. In the first quarter of 2004, the PBC offered RMB435.2 billion yuan in 28 issues of central bank bills, among which, RMB131.27 billion yuan was 3-month bills, RMB143.97 billion yuan was 6-month bills and RMB159.96 billion yuan was 1-year bills, with the outstanding reaching RMB615.45 billion yuan at end March.

 

Open market operations saw two phases in Q1. The first one ran from the New Year to the Spring Festival, in which defensive operations were conducted to meet the seasonal liquidity demand of the commercial banks and ease the pressure on short-term liquidity of commercial banks. Along with the proper issues of central bank bills, the PBC provided short-term funds to commercial banks through 14-day reverse repurchase operations. During this period, the PBC released RMB127.3 billion yuan of base money through open market operations. The second phase ran from the Spring Festival to the end of March. In face of persistent growth of base money as a result of foreign exchange increase, acceleration of cash withdrawal and an overall excess liquidity of the commercial banks, the PBC launched aggressive operations by increasing central bank bills issuance and extending the bills' maturity dates to withdraw excess liquidity. During this period, the PBC withdrew RMB408.3 billion yuan of base money through open market operations.

 

Based on the market transactions volume, asset size, management and liquidity of financial institutions in Q1, the PBC approved two securities companies, four insurance companies, two rural credit cooperatives and one city commercial banks as primary dealers in open market operations and established an annual evaluation system for those dealers, to broaden and deepen the influences of open market operations and to further improve their effectiveness.

II . Raising required reserve ratio by 0.5 percentage points to prevent overgrowth of money and credit

In view of the limitations of open market operations as a regular, short-term and flexible tool in sterilizing the persistent growth of money resulted from foreign exchange purchase, the PBC, with the consent of the State Council, decided to raise required reserve ratio by 0.5 percentage points from 7 percent to 7.5 percent effective on April 25, 2004. This action was taken to maintain a stable, rapid and healthy development of national economy and ward off excessive growth of money and credit. The increase of required reserve ratio will freeze liquidity of financial institutions by about RMB110 billion yuan. At present, the balance of required reserves and excess reserves of financial institutions in the PBC is more than RMB2 trillion yuan, in addition to RMB3 trillion yuan of highly liquid assets such as treasury bonds, financial bonds and central bank bills. After the increase of required reserve ratio, commercial banks still maintain their payment capability and are able to increase loans steadily.

III . Introducing positive incentives to apply differentiated required reserve ratio system

With the consent of the State Council, the PBC decided to adopt differentiated required reserve ratio system, effective from April 25, 2004, under which required reserve ratio of financial institutions should correlate with such indices as capital adequacy ratio and asset quality, etc. The lower asset adequacy ratio and the higher proportion of bad loans will result in higher required reserve ratio, and vice versa. Differentiated required reserve ratio and capital adequacy ratio are complementary and can improve the transmission mechanism of monetary policy, which constitutes a particular financial system in China.

 

Box 2  System of Differentiated Required Reserve Ratio

   

The system of differentiated required reserve ratios is a policy arrangement in line with China's actual financial developments, and embodies the following 4 aspects. First, the determinants for differentiated required reserve ratios. They include such factors as the capital adequacy ratio, NPL ratio, the status of internal control, major violations of regulations and occurrence of severe risks, obvious worsening of the ability to pay and the risks that are likely to damage the safety of the payment system of financial institutions. Second, financial institutions subject to differentiated required reserve ratios. The arrangement of differentiated required reserve ratios adopts a uniform framework design and standard classification. All depository financial institutions are subject to this arrangement. Given