China: Changing money growth model – Standard Chartered

Analysts at Standard Chartered explain that China’s money growth model has been changing and money creation is likely to rely more on RRR cuts than PBoC lending in the next few years

Key Quotes

“FX purchases by the People’s Bank of China (PBoC) were the main source of growth in reserve money (or the monetary base) until 2013. Since 2014, the central bank’s foreign assets have been declining as capital account outflows have more than offset the current account surplus. In response, the PBoC has increased lending to commercial banks to expand its balance sheet. With the April cut in the reserve requirement ratio (RRR), we expect RRR cuts to play a more important role in driving M2 growth going forward.”

“The PBoC’s balance sheet is likely to shrink together with reserve money in the next couple of years. In April, reserve money declined due to the early retirement of the PBoC’s Medium-term Lending Facility (MLF), but the money multiplier increased due to the RRR cut. As a result, M2 (the product of reserve money and the multiplier) continued to grow at over 8%.”

“We expect the PBoC to cut the RRR further and retire more MLF lending to offer banks longer-term liquidity at lower cost. Unlike for the US Fed, the expected reduction in the PBoC’s balance sheet does not reflect a change in its neutral policy stance, in our view.”

“We expect the PBoC to cut the RRR by another 3ppt by end-2019 to keep M2 growth in high single digits. We assume the central bank will cut MLF lending outstanding by half, and our calculation suggests that every 1ppt RRR cut would increase the money multiplier by roughly 0.3. The next RRR cut may take place as early as July to compensate for the liquidity drain from tax payments.”