China’s monetary policy adjustment and challenge

China’s Monetary policy Adjustment and Challenge

(By Jorge Nascimento Rodrigues，Contributor to Expresso weekly newspaper, Lisbon. Editor of Janelanaweb.com. Co-author of Business Minds and Pioneers of Globalization; By Xu Hongcai, Professor, and Deputy Director-General of Information Department of China Center for International Economic Exchanges)

CCIEE’s Xu Hongcai talks on the reasons of the PBOC’s recent decision of loosing monetary policy while lowering banks’ reserve ratio by half a point. That is part of a “wave of ease” on an international scale to support the real economy.

Speculation on a new Chinese monetary policy easing has been dominating the media for quite some time. Now, materialized. This week, the central bank – the People’s Bank of China – went a step further. It lowered the reserve ratio for large banks in more than half a percentage point to 20.5%. “This adjustment is a clear policy signal of expanding money supply to prevent a fall in China’s economic growth in actual complicated domestic and international context”, points Xu Hongcai, professor at the Tsinghua University and deputy director of information department of the think tank China Center for International Economic Exchanges.

In late November last year, the central bank had already taken this path, breaking the tight monetary policy that had been following since 2009, seeking to counteract inflation, particularly in food and in the real estate “bubble”. In 2011, the central bank increased six times the banks’ reserve ratio and moved three times the interest on deposits and loans. At the time, POBC lowered the reserve ratio of large banks from 21.5% to 21% and 19% for small banks.

International Wave

It is estimated that the central bank’s decision would expand the financing capacity of the economy between 41.7 to 47.8 billion Euros. Some analysts see further declines in the next six months. The move of the Chinese central bank joins a wave of “quantitative easing” that is taking place with different shapes.

The U.S. Federal Reserve holds “Operation Twist” and gave signs that will keep interest rates near 0% well into 2014. The Bank of England recently announced an extension by a further 50 billion pounds (59 billion Euros) of its “quantitative easing” program. The European Central Bank, while repudiating the “quantitative easing” strategies, launched the LTRO, an additional program to provide liquidity to banks in the Euro area for three years

This international wave pretends to avoid the return of a global recession or prevent the deterioration of conditions of economic recession or stagnation. In China’s case, the headache is the growth rate. There is a sacred 8% threshold, below which the annual growth cannot come down, otherwise it would endanger the whole economic strategy of the country since the capitalist revolution of Deng Xiaoping in late 1970′s。

The trend has been downward: “China’s economy grew 9.2 percent in 2011 down from 10.3 percent in 2010; while 8.9 percent fourth quarter economic growth in 2011, the slowest in 10 quarters. An even lower 8.5 per cent is the forecast for 2012. Recently, the small and medium sized enterprises (SMEs) has widely faced the financing difficulties that reflected the situation of insufficient funds. China’s trade and capital flows have encountered the shock from outside factors. The debt crisis in the Euro zone and high unemployment in the United States have hurt consumer confidence and dented demand for Chinese goods. The bilateral trade between China and the European Union fell more than 7% in January.” outlined Xu Hongcai.

China’s Four Challenges

Slower growth reflected the huge difficulty to move China’s growth away from the export-oriented economic mode. This year, China’s economy still needs to face four challenges as follows.

1: driving a sustainable growth from enhancing domestic demand

The first challenge for China in this year is whether it could succeed in driving a sustainable growth from enhancing domestic demand, especially consumption demand. The average level of income per capita has increased rapidly in China, but income inequality is becoming a more serious problem that may threaten social stability and the sustainability of economic development. In fact, China’s goal of spurring household consumption still remains elusive.

2: achieve a balanced growth and tackle the negative impact of European debt crisis and American protectionism

The second challenge is to achieve a more balanced growth and to tackle the negative impact of European debt crisis and American protectionism. So far China’s economy is still reliant on exports and government-led fixed asset investment. Official figures showed a sharp decline in foreign direct investment (FDI) and a sharp narrowness in China’s current account surplus. Unfortunately, this trend will be maintained in 2012.

3: enhance competitive ability of financial institutions and deal with local government debt legacy

The third challenge is to enhance competitive ability of financial institutions and to deal with the local government debt, a legacy of a $586 billion stimulus plan to invest in major infrastructure projects that probably leads to the commercial bank’s bad loans. In China, government has excessively protected the interest of banking sector that has damaged the interest of households and enterprises to a certain extent. And thus, this policy has distorted China’s economic structure.

4: enhance competitive or innovational ability of enterprises

The fourth challenge is to enhance competitive or innovational ability of enterprises, especially private companies and SMEs. Recently, so many enterprises such as Foxxconn, have hiked in worker wages. As a result, the cost increase of enterprises has been aggravated at China’s manufacturing. At the same time, it is part of a large force that we continue to underscore: The cumulative combination of inflation, RMB appreciation, and wages cost is impacting on the competitive edge of China’s economy.