China's monetary policy to feature more prudence

BEIJING - Given the changes to its economy and financial market, China's monetary policy will maintain a certain degree of looseness in the coming months, but "prudence" will feature more prominently than last year.

Positive signs are converging, boosting sentiment that the slowdown in the Chinese economy may be bottoming out.

In March, exports logged a sharp recovery, the official index tracking factory activity returned to growth for the first time since July 2015, and foreign exchange reserves posted their first monthly increase since November. For the first quarter (Q1), the economy also saw better-than-expected growth in retail sales, industrial output and fixed asset investment.

The accommodative policies have played a crucial role in achieving such an encouraging performance and created room for structural reforms.

The central bank has lowered interest rates six times since November 2014 and slashed the reserve requirement ratio (RRR) for banks.

China will continue to implement a prudent monetary policy this year, and, in the context of the economic slowdown, top officials have described the prudent policy as one "with a slight easing bias."

As the economy is yet to fully restore its strength, China will not shy away from using the ample tools at its disposal to bolster the economy. But it will be more careful to prevent the easing from going too far.

Signs of pickup in inflation would limit room for easing, after the consumer price index (CPI) in February rose at its fastest pace in more than a year. Even unchanged in March, CPI is likely to see a modest rise.

To stop real interest rates from stepping into negative territory, the central bank is faced with less room for rate cuts.

As the renminbi exchange rate has stabilized recently and expectations for a US Fed rate hike have reduced, capital outflow has abated, thereby, reducing the pressure for further RRR cuts.

From a longer perspective, it is necessary for the central bank to unleash liquidity, against a backdrop of a shrinking foreign exchange reserves, to provide a neutral monetary environment.

However, China's overall financial market this year will mean the People's Bank of China, which has pumped enormous sums of cash into the market since the end of 2014, more prudent in loosening its policy.

Take bank loans for example. New loans extended by banks jumped to 4.61 trillion yuan ($711 billion) in Q1, nearly one trillion yuan more than the same period last year. In addition, some of the cash, instead of supporting the real economy, ended up in the stock and bond markets, raising the risks of bubbles in the capital market, and leading some to reflect on the limitations of the easing policy and the drawbacks of aggressive loosening.

Under pressure to prop up the economy, monetary policy should be used to inject life into the real economy. However, excessive liquidity can bring risks. This is why "flexibility" and "appropriateness" have become the more salient features of monetary policy this year.

China should be flexible when implementing the appropriate monetary policy and maintain reasonably ample liquidity, central bank governor Zhou Xiaochuan said at a meeting in Washington over the weekend.

Highlighting "prudence," the authorities will be more cautious when cutting interest rates or RRR, and turn to more low-profile monetary tools, such as the medium-term lending facility (MLF), to steer the economy.

As the marginal effect of monetary policies are diminishing, fiscal policies will become more proactive and play an increasing role in promoting growth and supply-side structural reforms.

China is equipped to do so, as the country's government debt, local debt included, accounted for about 50 percent of its gross domestic product, a very safe level according to international standards.

China is taking steps to implement more forceful fiscal policies including increasing its deficit and reducing taxes, Finance Minister Lou Jiwei said at a G20 meeting over the weekend.