End of loose monetary policy

By Yi Xianrong (China Daily)
Updated: 2010-12-07 13:27
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Prudent proactive fiscal measures will increase the flexibility of macroeconomic regulations and aid sustainable growth

China will be "prudent", and tighten its "moderately loose" monetary policy, a recent conference of the Political Bureau of the Communist Party of China (CPC) Central Committee indicates. The meeting, held on Friday, was expected to set the tone for the annual Central Economic Work Conference, which convened over the weekend and which will lay out economic policies for next year.

The politburo meeting said the country will adopt a proactive fiscal policy in an effort to increase the flexibility and efficacy of macroeconomic regulations. It indicated the country's resolve to return to a normal monetary state and an end to the moderately loose - essentially ultra-loose - monetary policy adopted since the outbreak of the global financial crisis.

Following the start of the global financial crisis in late 2008, China launched a 4 trillion yuan-worth ($586 billion) stimulus package in a bid to contain any economic slowdown and introduced credit relaxation and several interest rate cuts. As a result, the country's credit volumes increased by 11 trillion yuan in the 14 months from November 2008 to December 2009, which, combined with the newly increased lending of 6.9 trillion during the first 10 months of this year, means that the lending in the past two years amounted to more than 18 trillion yuan, approaching the 20.80 trillion yuan of lending between 1998 to 2007.

Under the loose monetary policy, China's M1 supply in 2009 had a year-on-year growth rate of 27.7 percent and the M2 year-on-year growth rate was 32.4 percent. That momentum did not slow substantially in the first 10 months of this year.

The country's monetary policy remained basically the same from 1998 to 2007, the longest period for a monetary policy since 1984 when the People's Bank of China began to exercise the central bank functions. During this period, the annual newly increased bank lending was about 2 trillion yuan on average, less than a quarter that of 2009 to 2010.

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Despite its significant role in bolstering the country's economic growth at a time of crisis, monetary over-supply over the past two years has pushed up prices, as indicated by the rising consumer price index (CPI) over the past months. The soaring prices of consumer goods have not only seriously affected ordinary people's living conditions, they have also added systematic risks to the country's financial market.

A shift to a "prudent" monetary policy heralds the adoption of necessary measures to restrict excess liquidity next year and an attempt to keep the proportion of circulating money volumes to a moderate level. The move will help drive national economic growth and rein in inflation and the rapid rises in property prices.

Two years after the global financial crisis, China has managed to pull out of the global economic slowdown and achieved an economic recovery. However, the rapid rise in property prices and growing inflation are two major concerns for the country's economy.

The expanding bubble in the real estate market has led to a distorted distribution of market resources and national incomes, and the formation of complicated and intermingled economic interests among different social groups. The unreasonably high property prices have also added risks to the country's financial institutions, aggravated imbalances in the country's economic development and worsened people's living conditions. Correcting all these outstanding problems depends on whether the country can push forward a reasonable monetary policy to squeeze the real estate bubble and tame inflation.

In the absence of fundamental changes to the country's loose monetary policy, the momentum of credit over-expansion by profit-pursuing commercial banks will not be contained. According to estimates, this year's banking credit will be no less than that of 2009. From another perspective this may also explain the country's failure up to now to tame the rising prices and inflation.

A shift to a prudent monetary policy means the end of the monetary policy adopted at an abnormal time. It shows the country's determination to better manage liquidity and maintain a reasonable credit growth rate to promote the much-needed transformation of the national growth model and economic restructuring. It will aid effective liquidity management and reduce financial risks as well as maintain financial stability and reduce prices to a normal level.

The author is a researcher with the Institute of Finance and Banking under the Chinese Academy o Social Sciences.