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Economic Downward Pressure Calls for Easy Monetary Policy


By Fan Jianjun, Department of Macroeconomic Research, DRC

2017-10-30 17:45

In the 3rd quarter of 2017, GDP increased by 6.8% year on year (YOY), down by 0.1 percentage point from the 2nd quarter, indicating a slight economic slowdown.

Viewing from the disaggregated data, the growth rate of industrial added value above designated size fell from 6.9% in Q2 to 6.7% in Q3. The growth rate of investment in fixed assets fell from 8.6% in Q2 to 7.5% in Q3, among which the growth rate of investment in manufacturing industry dropped from 5.5% in Q2 to 4.2% in Q3, and that of private investment in fixed assets from 7.2% in Q2 to 6.0% in Q3. The growth rate of total amount of import and export (in USD) declined from 12.7% in Q2 to 11.7% in Q3, among which the growth rate of export dropped from 8.1% in Q2 to 7.5% in Q3, while that of import from 18.9% in Q2 to 17.3% in Q3. Owing to the unexpected growth of the disposable income of urban and rural residents, the current growth rate of consumption has generally remained stable and the growth rate of total retail sales of social consumer goods in Q2 and Q3 was respectively 10.4%.

The above-mentioned macroeconomic data show that domestic economy is still facing downward pressure and the economy is likely to go down in Q4.

The author believes that the main reason to promote this round of economic stabilization lies in the remarkable improvement of demand-side nominal aggregate demand. As the central bank lowered the statutory deposit reserve ratio (RRR) for five times in a row from the beginning of 2015 to the beginning of 2016, the growth rate of “true currency” (cash plus current deposit) supply representing the total nominal domestic demand gradually increased from the lowest 2.7% in April 2015 to 22.1% in June 2016 and maintained its high growth rate of around 20% by the end of 2016.

Continued improvement of nominal aggregate demand has led to a rapid rebound in average utilization of economic capacity, which is particularly evident in the industrial sector. PPI of industrial products improved from a YOY decline of 6.0% in 2015 to a YOY increase of 5.5% in the end of 2016. The utilization recovery of domestic economy’s average capacity has driven GDP growth to get stabilized and rally up since Q4 of 2016.

However, since January 2017, the growth of “cash plus current deposit” representing the growth of nominal aggregate domestic demand has fallen rapidly and to a relatively low rate of 12.5% by September 2017. At present, it remains the trend of continued decline. Taking into account the lagged effect of monetary policy, the decline of the aggregate domestic demand growth since the beginning of the year has led to signs of GDP slowdown in Q3.

The main reason causing the rapid growth of domestic “cash plus current deposit” during the year was the continued tightening of monetary policy. The weighted average interest rate on inter-bank bond pledged repurchase representing the “benchmark interest rate” of domestic monetary policy has climbed from the lowest of 1.30% in May 2015 to a higher level of over 3.0% in August and September 2017. Under the current downward pressure of the economy and the relatively low prices, the inter-bank market interest rate of over 3.0% is obviously too high. High benchmark interest rates of monetary policy will inevitably suppress issuance of bonds and credit growth, which will lead to a steady decline in the growth of domestic nominal aggregate demand (the growth of “cash plus current deposit”).

By the end of September in 2017, the outstanding balance of central bank’s reverse repo and medium-term lending facility (MLF) amounted to 4.83 trillion yuan (of which 480 billion yuan for reverse repo and 4.35 trillion yuan for MLF). The central bank has adequate room for policy adjustment by using a series of gradual and flexible reserve requirement ratio (RRR) cut measures to hedge against the huge expiration volume of reverse repo and MLF. On the one hand, it can effectively reduce the intensity and frequency of the central bank’s daily open market operation; and more crucially, it can effectively curb the monthly rise of inter-bank benchmark interest rate and the monthly decline of nominal demand, reduce the capital cost of bank lending, and stabilize the market’s expectation of benchmark interest rate (monetary policy). The implementation of flexible RRR cut policy does not contradict the target of neutral and steady monetary policy set by the central bank.

At the end of September, the central bank announced that it will implement a targeted RRR cut policy for inclusive finance from 2018. The implementation of this policy will help stabilize the momentum of rising domestic interest rate of the interbank market, and improve the tight liquidity situation in the interbank market and the real economy. However, at the moment when liquidity is tightening, macro economy is facing downward pressure and the price level is still at a low level, the author suggests that the central bank should promptly adopt a monetary policy with gradual, flexible and all-round RRR cut measures in order to ease the downward pressure of economy as monetary policy is usually featured by lagged effect.