Stable money policy, prudent easing are key

Ever since the US Federal Reserve began to tighten its monetary policy in March, the external environment has drastically changed, posing bigger challenges to China's monetary policy. The market has been highly attentive as to how China's monetary policy will roll out in the coming months.

The complexity piling up regarding China's monetary policy has been rarely seen in the past. The downward pressure on economic growth cannot be overlooked, although recovery is in progress. COVID-19 resurgences have affected consumption and private sector investment grew only 2.3 percent year-on-year in August, approaching a 20-year low.

China's GDP growth stood at only 0.4 percent in the second quarter. The property sector slowdown is the chief culprit, as it accounts for nearly 30 percent of the country's GDP.

From the perspective of domestic demand, relatively relaxed monetary policy, together with various policy tools and measures, seem to be necessary to support the real economy.

The Fed has adopted an extremely aggressive monetary tightening by raising interest rates by 375 basis points with six continuous hikes so far this year.

Such significant tightening within a short period is sure to impact the global economy. Nearly 70 of the world's major economies have had to follow suit by raising their interest rates. Large amounts of global capital have jumped to US dollar assets, pushing the US dollar index to a 20-year high. Major currencies such as the euro and the Japanese yen have depreciated significantly, resulting in higher volatility in the international capital market.

Under such circumstances, following the steps of other economies to tighten their monetary policy may be an option for China in theory. But given China's downward economic pressure, monetary tightening is definitely infeasible at present.

The soaring inflation in the US will not reach a tipping point in the near term. The Fed may implement another two to three interest rate hikes before the end of the year to tame inflation. Monetary tightening on a global scale can thus be expected in the fourth quarter.

In this sense, domestic and international markets will present opposing challenges as to where China's monetary policy should trend. Decisions should be made prudently to come up with precise policies.

It can be expected that China's interest rates will not be elevated, which will result in the further expansion in the widening interest rate differential between China and the US. China will continue to face capital outflow pressure given the high US dollar index.

Global policy tightening might ease till the first half of 2023. Difficulties confronting Chinese monetary policymakers may not fundamentally change over the next quarter or two.

One major challenge that monetary policymakers face now is renminbi depreciation pressure. Although China's economic resilience is stronger at present, and the financial risks that affected markets between 2015 and 2016 do not concurrently exist, the Chinese currency's recent depreciation and capital outflow pressure cannot be overlooked.

For open economies, asset prices are closely related to exchange rates. Renminbi depreciation will exert negative impact on financial accounts, and special attention should be paid to the successive risks to be exerted in the financial sector. Considering the Fed's continued interest rate hikes and Europe's recession, prevention and control of related risks in the financial sector should be the top priority for China's monetary policymakers.

Against such a backdrop, China's monetary policies should be firmly based on the country's current situation, the core of which is to stabilize economic growth. Countercyclical and cross-cyclical adjustments should be carried out.

Related policy tools, including structural tools, should be better utilized to support the real economy. But pricing tools cannot merely be adopted in a relaxed manner to avoid further renminbi depreciation.

In general, China's monetary policy should be implemented to keep market liquidity reasonably ample. Short-term interest rates should be kept relatively low.

The reserve requirement ratio can be further lowered. The current weighted RRR in China's banking system is around 8.1 percent, while the historic low was around 6 percent.

Over the past three years, RRR cuts were mainly adopted when the loan-deposit ratio rose quickly. The market responded quickly to RRR cuts under such circumstances. But this year's situation is a little different. The ratio between additional loans and deposits has dropped 4 percentage points so far, while that for existing loans and deposits has also been declining. This is in contrast to the significantly expanding loans and deposits over the past few years.

It indicates adequate liquidity in the banking system this year. Insufficient demand from the real economy has also been reflected. If there is a major difficulty in achieving economic growth, we are still likely to see further interest rate cuts to inject more liquidity. But in general, the overall money supply will not undergo substantial adjustments in the short term.

The People's Bank of China — the central bank — has rolled out several relending or rediscount structural tools over the past two years to address the country's key development areas or major strategies, including relending tools to nurture scientific research or equipment upgrades. From the end of this year to next year, such structural tools can be provided to sectors undergoing difficulties, including agriculture and transportation. The tools can be also used to stimulate consumption and boost demand.

There is still the possibility of further interest rate cuts, but the room is very limited. China's consumer price index is still rising and it may exceed the normally 3 percent policy target next year. Imported inflation is also affecting China.

In light of the complicated global economy and worldwide economic recession that may take place in 2023, China's monetary policymakers should be prepared to bring about further relaxations, especially over the short term, to secure the stability of policies and economic growth.

I do not agree that more flexibility should be allowed for the renminbi exchange rate. The foreign exchange rate should only be reasonably elastic. Significant depreciation will not only have a negative impact on financial markets, capital and financial accounts, and may result in related risks in other financial variables.

Excessively high elasticity of the foreign exchange rate may jeopardize the stability of market expectations and lead to unnecessary panic — and further depreciation. So-called adequate elasticity may grow into laissez-faire policies and bring harm to the normal operation of the macroeconomy.

As monetary policies tighten worldwide, marginal positive results from China's monetary relaxation will be very limited. Rational market expectations can hardly be built on such relaxation.

In this sense, a stable monetary policy is of utmost importance to China over the short term, which is especially true for the fourth quarter this year and the beginning of 2023. Even though there is demand for relaxation, it should be conducted very prudently.

The writer is chief economist at Zhixin Investment, and honorary director of the Faculty of Economics and Management at East China Normal University.

The views do not necessarily reflect those of China Daily.