By Fan Jianjun, DRC

2017-2-22

Over the past year, with the excessive issuance of government bonds and corporate credit bonds, demand deposits have witnessed a profound increase, which has significantly widened the gap between the growth rate of M1 and that of M2. This is the root cause for the further widening of "scissors gap" between M1 and M2. On the other hand, the continued decrease of RMB loans and the negative growth of funds outstanding for foreign exchange plus a massive release of interbank deposits, also account for the falling of M2 growth rate in recent months.

In the past few months, there has been a significant drop of the growth rate of the issuance of government bonds and corporate bonds, as well as that of the custody balance. Since 2016, the growth of bank loans has undergone monthly decline. In the months beyond, M1 growth is expected to fluctuate over 25%, but its upward trend will be sharply weakened. Therefore, the possibility of a slow down after some time is not ruled out. Unless a substantial turnaround occurs in the credit growth, M2 growth will be in a unilateral downward channel for quite a long period of time in the future.

Subject to the overestimation of the data on broad money supply (M2) stock, the central bank is rather prudent in implementing the monetary policy. To achieve thorough stabilization and picking up of the domestic economy, the monetary policy needs to provide further support for economic performance. On the one hand, the central bank needs to lower the required reserve ratio, enhance the regular open market operations, further increase the supply of monetary base in the interbank market and strive to pull the current weighted average interbank lending rate of 2.3% down to around 2.0% or even lower. On the other hand, the central bank needs to use the reserve requirement ratio reduction tools in the first place, rather than adopting the “quasi-relending” tools such as medium-term lending facility (MLF) or pledged supplementary lending (PSL), to supplement the monetary base in the interbank market.