China Has No Choice

China’s central bank was given more independence to conduct monetary policies in late 2003. It had been operating under Order No. 46 of the President of the People’s Republic of China issued in March 1995, which led the 3rd Session of the Eighth National People’s Congress (China’s de facto legislature) to create and adopt the Law of the People’s Republic of China on the People’s Bank of China. This was amended in December 2003 by the 6th Meeting of the Standing Committee of the Tenth National People’s Congress.

Already by then, the PBOC had begun using more of its monetary toolkit. It had experimented in 2002 with Open Market Operations or OMO’s. The central bank would issue “bills” to Chinese banks, selling them in order to “soak up” excess liquidity under its definitions.

These were supplemented beginning in September 2003 by the first increase in the RRR, the reserve requirement ratio. This bank lever had been around since the eighties though rarely was it ever used. During China’s rough experience with the Asian flu in the late nineties, the RRR had been deeply reduced to help cushion the economic impact of massive eurodollar irregularities sweeping across its front.

This was an economic response in terms of a debt policy, not a monetary decision.

The RRR told banks how much they needed to keep in liquid reserves (a ledger entry, satisfied via cash holdings or on account with the central bank). If it was reduced, theoretically banks would be able to increase lending because they would be increasingly freed from the reserve constraint. This would include lending in China’s nascent wholesale money markets.

By 2003, the winds of eurodollar influence were blowing heavily in China’s favor again. That meant an excess of monetary resources for the banking sector, only some of which was scooped up by the PBOC as a consequence of pegging CNY’s exchange value to the dollar. To head off harmful inflation, the central bank required the more flexible mandate which was finally sanctioned at the Tenth Congress.

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Disclosure: This material has been distributed for informational purposes only. It is the opinion of the author and should not be considered as investment advice or a recommendation of any ...

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