Strengthen the Role of Monetary Policy

Dai Xianglong

Governor of the People's Bank of China

The envisaged macroeconomic targets for 1999 were achieved as the People's Bank of China strived to strengthen the role of monetary policy by using instruments such as the adjustments of interest rates, reserve requirement and central bank lending to appropriately increase money supply. 

The sharp reduction of deposit and loan interest rates on June 10 has shown desired effect. First, the marked alleviation of interest burden has significantly contributed to the improvement of SOEs' balance sheets. The interest rate cuts on seven occasions since 1996 has resulted in 260 billion yuan reduction in corporate interest burden. During 1997-1999, loans to the 1000 enterprises under the PBC survey increased by 350 billion yuan while their interest payment decreased by 3 billion. Second, the interest rate cut helped invigorate the capital market. In 1999, the daily stock trading volume in China reached 13.1 billion yuan, up 50% over 1998. Third, this measure also stimulated household consumption, as evidenced by the acceleration of the growth of household consumption in the second half of the year. 

The reduction of required reserve ratio from 8% to 6% on November 21 resulted in 200 billion yuan increase in liquidity of commercial banks. The PBC also conducted open market operations frequently during the year and its purchase of bonds amounted to 63.3 billion yuan. Liquidity injection through open market operations totaled 191.9 billion yuan, up 120 billion over 1998.  

The central bank increased loans to commercial banks and credit cooperatives in the year to enable them to increase credit. At end-1999, the outstanding central bank loans to financial institutions amounted to 1370 billion yuan, up 122.1 billion over a year earlier, 320 billion yuan more than the growth of the previous year.  

The central bank also timely introduced a number of credit policies to adjust the direction of loans and to stimulate consumption. The maximum maturity of housing loans was extended from 15 years to 20, and a six-month preferential rate is applied. By the end of November 1999, housing loans extended to households by the state commercial banks had grown by 61 billion (or 124%) to 110 billion yuan.  

The central bank has achieved its policy goals envisaged at the beginning of 1999 and has created a favorable macroeconomic environment for expanding domestic demand, promoting SOE reform and sustaining economic growth. At the end of 1999, the broad money supply M2 was about 12 trillion yuan, representing an increase of 14.7%, close to the 15% target. M1 was around 4.6 trillion, up 17.7%, about six percentage points higher than the year before and three percentage points above the target. While the loans extended by financial institutions grew by 1085 billion yuan and the growth slowed by 64 billion, the direct financing expanded, and enterprises' financial position improved significantly. At the end of 1999, total deposits of financial institutions reached 3.72 trillion yuan, representing an increase of 470 billion and 82.5 billion growth acceleration. The foreign exchange reserves grew by USD9.7 billion to USD154.7 billion and the RMB exchange rate remained stable.  

I. The main cause for price decline was not inadequate money supply. Monetary policy should not only accommodate the expansion of domestic demand, but also prevent excessive money supply.  

In the second half of 1997, some signs of deflation began to surface, mainly reflected in the continuous significant decrease in prices. The trend was mainly attributable to the correction of price hikes during 1992-1994, excessive supply of industrial as well as agricultural products, rather than inadequate money supply. Given the high increase of money supply and the economic growth, it is inappropriate to describe the problems in China's economy as those that characterize deflation. While the decrease of prices is conducive to the structural adjustment, it will be harmful if significant price drops continue for too long. Hence, China adopted aggressive fiscal policy and achieved great progress. Solution to deflation normally involves expansionary fiscal and monetary policies. However, for a long time, production and construction were mainly financed by bank loans and this has resulted in heavy burden both on SOEs and banks. The current price decrease has mainly resulted from the irrational economic structure rather than inadequate money supply. Under such circumstances, monetary policy should not only facilitate expansion of domestic demand, but also prevent excessive expansion of money supply.  

II. In 2000 the PBC will reinforce the role of monetary policy in the following five aspects

First, the PBC will timely adjust the money supply so that it will grow at the rate of the previous year. It will encourage commercial banks to purchase government debt and other financial debt instruments. With the 1.3 trillion bonds held by financial institutions, the central bank will expand open market operations. M2 and M1 are expected to grow by 14-15% and 15-17% respectively, and the loans of financial institutions to increase by 1 trillion yuan.

Second, the central bank will introduce credit policies and improve credit structure. Financial institutions will be required to improve their management and to clarify responsibilities of loan officers. They will be encouraged to extend fixed-asset loans to support the infrastructure projects financed by government debt as well as working loans to enterprises with marketable products, good earnings and creditworthiness. The central bank will also encourage financial institutions to expand housing loans, student loans and credit to support the development of small-sized enterprises in hi-tech and service sectors and to resolve financing difficulties facing the peasants.

Third, China will strengthen credit discipline to encourage enterprises to improve management, and promote structural adjustment of the economy. For the duplicate construction projects, enterprises with heavy stockpiles, small-sized mines and factories which need to be closed, enterprises trying to evade repayment obligations and industries with excess capacity, no new loans will be extended; and the matured loans will be recalled. Loans to those enterprises trying to evade repayment obligations will be recovered with legal enforcement.

Fourth, the central bank will take measures to support the development of capital market and expand direct financing. The short-term finance to securities firms can be expanded in line with relevant conditions. Commercial banks can extend collateralised loans to securities firms. Industrial funds and venture funds will be developed, and joint-venture enterprise investment funds will be encouraged.

Fifth, we will accelerate the financial system reform and strengthen internal management so as to further strengthen the role of monetary policy.  

To implement the policies promulgated by the State Council concerning economic management in 2000, the PBC will, on the one hand, strengthen its internal management, and on the other, improve self-discipline, financial supervision, credit culture and efficiency of resource allocation through enhancing banks' credit discipline on the corporate borrowers.