Figure 3 Monthly RMB Payments and Receipts under the Current Account
Source: People’s Bank of China
Part 2 Monetary Policy Operations
During the first half of 2017, the upward momentum in the Chinese economy was sustained, with a strengthening of stabilization, improvements in the economy, a further recovery of external demand, a closing of the divergence in price trends, a dropping of the growth rate of the leverage ratio, and stabilization of the real estate market. In accordance with the overall arrangements of the Central Committee of the Communist Party of China (CPC) and the State Council, the PBC maintained a prudent and neutral monetary policy and properly managed the cash supply to ensure the stability of liquidity, building favorable monetary and financial environments for efforts to stabilize growth, restructure the economy, advance the reforms, improve the people’s livelihood, contain bubbles, and prevent risks.
I. Open Market Operations were Conducted in a Flexible Manner
As required by the prudent and neutral monetary policy and to strike a balance between deleveraging and the need to maintain liquidity stability, the PBC improved the forward-guidance nature, flexibility, and precision of Open Market Operations, enhanced preemptive fine-tuning and management of expectations, properly arranged the combinations of Open Market Operations tools, and reasonably adjusted the intensity and pace of operations and mitigated liquidity volatility by addressing excesses and shortages. As a result, the money market and bond market both functioned well, and progress was also made in lowering the leverage ratio of internal funding within the financial system.
During the first quarter, liquidity in the banking system remained at a stable, neutral, and appropriate level, with interest rates in the money market generally stabilizing and volatilities at specific spots were soon mitigated under the market mechanism. In April, financial regulations were tightened against potential risks in the financial system and market expectations also changed. The PBC, CBRC, CSRC, CIRC, and SAFE enhanced financial regulatory coordination under the Ministerial Inter-Agency Meeting for Financial Regulatory Coordination, worked closely in terms of time and pace when launching supervisory policies, stabilized market expectations through preemptive fine-tunings, and refrained from excessive interventions to allow market forces to play a corrective role. On the one hand, in late May the PBC Open Market Operations Office sent out operations signals and on June 6 it conducted MLF operations totaling RMB 498 billion to offset beforehand the MLF maturity that totaled RMB 431.3 billion in June and to provide a reasonable amount of incremental liquidity. On June 7, the PBC restarted the 28-day repos, with maturities spanning to the end of the first half of 2017 and thereafter it continuously conducted repo operations to offset the impact of taxes and the required deposit reserves of financial institutions as well the maturities of PBC liquidity tools, and to address liquidity shortages in a neutral and moderate manner. On the other hand, considering that fiscal expenditures at the end of each month injected a great amount of liquidity into the system, in order to contain total liquidity at a neutral and reasonable level, the PBC's Open Market Operations Office suspended operations for 12 consecutive working days beginning on June 23 and it used the PBC's maturing repo operations to address the excesses of total liquidity. Meanwhile, the PBC issued statements to explain the adjustments and suspensions of operations to enhance communications with the market and to improve transparency. In general, market expectations have been stable since the second quarter, and financial institutions have deepened their understandings of the PBC's measures to address liquidity excesses and shortages to maintain a neutral and reasonable stance. As a result, there have been fewer market misinterpretations. The 7-day repo rate (DR007) - the most representative inter-bank market rate—was generally moving within a range between 2.75 and 3.0 percent, pointing to a slightly downward trend, and the bond market was recovering.
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Along with increasing scale of the total economy, the growing size of the financial system’s balance sheet, and the enhancement of the correlations of cross-market funds and institutions, the impact of liquidity has been amplified due to factors such as fiscal revenue and expenditures, payments and refunds of the required deposit reserves of financial institutions, cash injections and recycling, and market expectations, and these impacts easily overlapped. For example, the middle of each month is usually the time when the tightening effect of multiple factors overlap, therefore open market operations to address liquidity shortages are intensified. In contrast, at the end of each month fiscal expenditures inject liquidity, so open market operations are mainly conducted to address liquidity excesses and to maintain flexibility to reflect the pace and scale of fiscal expenditures. To avoid market misinterpretations of the prudent and neutral monetary policy stance due to a sustained tightening or loosening of liquidity during a certain period of time, the Open Market Operations enhance the flexibility of cash injections or recycling, enrich the maturities of PBC repo products, improve the stability of liquidity, and guide financial institutions to improve the maturity structures of their balance sheets so as to maintain liquidity in the banking system at a stable and neutral level.
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