Preface

[based on Geiger, 2006: 4-5, 49-51; and Geiger, 2008: 1-4]

This analysis argues that the monetary policy in China in the last decade was not only conducted and influenced by the People’s Bank of China (PBC), the Chinese central bank, but also by other authorities, mainly the central government. The PBC is neither goal, nor instrument independent, i.e. the PBC can neither set its final targets, nor its instruments without approval of the state council. Moreover, non-central bank policy instruments are in place, which are not controlled by the central bank, but have a direct influence on the final targets of monetary policy. Thus the description of the instruments of monetary policy in China incorporates both the instruments of the central bank and other non-central bank instruments. The instruments of the central bank are divided into two parts: Price-based and quantity-based monetary policy instruments. While the major Chinese particularities of the price-based instruments are shortly described, in this paper the main focus is on the quantity-based and non-central bank policy instruments.

The subsequent analysis of the effectiveness of the monetary policy in China is dedicated to the explanation of the interdependency and the interaction between the three types of instruments:

1. Central bank’s price-based instruments,

2. Central bank’s quantity-based instruments, and

3. Non-central bank and non-monetary instruments.

This distinction pays tribute to the fact that China’s economy and financial system is under transition from a planned towards a market- and price-based system. Having chosen a gradual approach of transformation it is in the very nature that during the period of transition price- and quantity-based measurements are in place simultaneously. Moreover, there are certain non-central bank instruments that particularly helped to reach price stability throughout the decade within the context of an uncompetitive and unsound banking environment.

China has a very specific economic environment. Thus, for an analysis of the instruments of monetary policy in China it is important to recall some of these specific factors ( 1 ): First, there is a huge amount of non-performing loans (NPL) within the Chinese financial system. Officially the central bank speaks of a NPL ratio of 20.36 per cent of all assets held by the four state-owned commercial banks (SOCBs), which amounted to around 230 billion USD in 2004 ( 2 ). While there was progress in lowering NPL ratios for the “Big Four” commercial banks (Agricultural Bank of China, Bank of China, China Construction Bank, Industrial and Commercial Bank of China) between 2004 and 2006 ( 3 ), for the banking system as a whole the problem remains unsolved. Worse, in addition to the NPL problem that developed in the 1990s, there is evidence that the recent explosion in lending (triggered by the government’s economy-boosting measures) has resulted in a new NPL pile-up” (EIU, 2005a: 13). Technically, the Chinese banking system is on the edge of bankruptcy. Independent estimates of the cost for a total bank restructuring are between 30 and 50 per cent of GDP (cf. Schlotthauer, 2003: 230; and EIU, 2005a: 36f). Second, most of the commercial banks lack capital adequacy. PBC officials speak about substantial deviations of the actual ratios and the eight per cent capital adequacy ratio stated in the Basel Accord. Third, the four state-owned commercial banks have a quasi monopoly in China’s financial market. They possess more than 80 per cent of the whole banking sector’s assets and liabilities and they account for around 80 per cent of the lending and 70 per cent of the deposit business. Furthermore, the “Big Four” still do not compete in all business and geographic areas with each other. The original tasks assigned to each of them, which also expand into the banks’ names, still segregate parts. Fourth, interest rates are still subject to the control of the authorities. Despite great steps towards interest rate liberalization there is still not sufficient competition and not enough room for credit-risk related credit decision-making ( 4 ).

The situation of an unsound banking system with high NPL ratios, insufficient capital adequacy, a de facto monopoly of the SOCB and high political influence within the financial system have major impacts on the financial transmission process of the economy. First, there is a distorted behavior of the SOCB in terms of their risk assessment recognizable since the monopolizing SOCBs tend to be risk adverse. Through the strong position in the system their restrictive behavior can influence the overall impact of the central bank’s policy. For instance, one might think of a situation where the central bank wants to pursue a neutral stance of monetary policy. Due to the SOCBs obligation to meet capital adequacy requirements ( 5 ) the central bank induced neutral stance might actually turn into a de facto restrictive stance against the central bank’s will ( 6 ). Second, the state-owned commercial banks are not profit-driven ( 7 ). Resulting in long time lags for the implementation of interest changes, Xie Ping argues that “the weak motive of making profit of the four state-owned commercial banks makes monetary policy ineffective” (Xie, 2004b: 4). Third, a desired expansionary policy of the central bank can be absorbed via an increase of excess reserves of the SOCBs ( 8 ). Fourth, through monopolized open market operations, where the four SOCBs’ represent half of the total size of the Chinese operations, the SOCBs can manipulate the money market interest rates. Fifth, a strong lobby of state-owned commercial banks can undermine the central bank’s policies. Since the PBC functions under the influence of the government, the SOCBs can lobby the government to influence financial and banking related decisions that affect their own business operations. Additionally, the commercial banks are represented in the Monetary Policy Committee of the PBC. Indeed, the committee has no decision-making authority, but it is consulting the PBC in various financial and monetary policy related issues ( 9 ).

Finally, the central bank has insufficient instrument independence. The PBC cannot decide independently about the level of the interest rates. Moreover, according to Xie Ping, the PBC has to take into consideration an additional and purely political target, which is the reallocation of national income. This makes the instrument of the interest rate partially ineffective since interest rate adjustments are not necessarily consistent with the predominant monetary policy stance. “We can say that each adjustment was decided through bargaining of concerned parties, and the complicated process and long time lag of decision making greatly decrease the effectiveness of interest rate, and even probably produce opposite effect to monetary policy goal” (Xie, 2004b: 5).

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Footnotes

( 1 ) This section is mainly based on a comment of Xie Ping (Xie, 2004b), the then Director of the Financial Stability Department of the PBC and the subsequent discussions during the Joint China-IMF Training Program, High Level Seminar on China’s Monetary Policy Transmission Mechanism, April 12-13, 2004, Beijing.

( 2 ) This figure might even be too small. E.g. Ernst & Young (Non-performing loan report: Asia 2002) estimate the NPLs in China to amount to USD 500 billion (RMB 4,139 billion) at the end of 2002; and a decrease of 50 per cent in 2 years seems infeasible.

( 3 ) The improvements in the capital adequacy and non-performing loan ratios of BOC, CCB and ICBC in 2004 did not come as a surprise. Their timing was determined by the government’s wish of listing state-owned commercial banks on international stock exchanges to prepare them for the opening up of the financial system. This was scheduled for the end of 2006 along China’s commitments of the WTO entry. Accordingly, CCB went public in Hong Kong in October 2005 followed by BOC in June and the ICBC at the end of 2006.

( 4 ) The market for bank deposits is yet completely controlled, while the ceilings on the lending market have been abolished for all institutions but the rural credit cooperatives since October 2004.

( 5 ) Capital adequacy is subject to ever-tighter surveillance via the newly established China Banking Regulatory Commission (CBRC).

( 6 ) While such a situation was observable during the deflationary phase of the late 1990s, the recent past showed the contrary. In 2003, bank lending increased with higher ratios than the PBC was willing to accept. 60 per cent of the granted loans have been granted by the four SOCBs. As a reaction, the PBC enforced its window guidance policy.

( 7 ) Other scholars, like Dai (2002) are of the opinion that the desire for profit as early as in 2002 already played a prominent role in commercial banks’ business operations.

( 8 ) This is true for the deflationary phase of 1998 to 2002 with an excess reserves ratio of 7.61 per cent in 2001. Having realized this problem the PBC decreased the interest rate on excess reserves to 1.62 per cent, lower that the interest on the excess reserves that stands at 1.89 per cent currently.

( 9 ) The Monetary Policy Commitee meets quarterly and briefings of the meetings are available at www.pbc.gov.cn/english/xinwen/.