By Jin Yan

In 2003, as the Chinese economy started a new round of growth, credit and monetary growth hit the fast lane, with blind investment and low-quality capacity expansion in certain sectors and regions becoming obvious problems and increasing potential financial risks.

In light of these trends, the People's Bank of China took a series of monetary policy actions to adjust the overall scale and structure of credits, bringing rapid monetary growth under effective control in the second half of the year and managing to further optimize the lending structure.

In the latest round of economic growth, monetary policy, in keeping with changes in the economic and financial situation, has taken on new characteristics. It became more forward-looking and more focused on making adjustments with the proper strength. Reforms of the interest rate regime and exchange rate-forming mechanism were promoted at a stable pace, which contributed to maintaining the continued and rapid growth of the national economy.

Firstly, the focus of monetary policy was promptly adjusted in accordance with the changing economic situation and key problems in economic and financial developments.

Following the Asian financial crisis in 1997, China's economic growth slid continuously and prices witnessed a negative impact. In an effort to prevent deflation, the People's Bank of China has maintained a prudent monetary policy in the ensuing years, and has been striving to promote economic growth while staving off financial risks.

Although temporary shifts in monetary policy in response to changes in the economic situation were not absent, generally speaking, monetary policy has in recent years been tilted towards increasing money supply moderately to promote growth and price recovery.

In 2003, as the economic situation has changed, fundamental changes have occurred in monetary conditions. On the one hand, the demand for credits has prospered the surge in investment demand has decisively reversed a situation featuring inadequate demand and stimulated borrowing needs. Investment impulses at local governments, after the new administration took office, have further amplified the demand for loans.

On the other hand, the inherent expansiveness of monetary growth has strengthened further.

From the central bank's perspective, the huge increases in foreign exchange reserves have led to massive rises in base money supply by way of foreign exchange purchases. On the part of commercial banks, the abundance of funds has pushed them from being "lending-reluctant" to becoming aggressive in extending loans.

The combined effects of both demand and supply resulted in rapid monetary growth and accelerating prices. And the upward trend is inclined to keep going while lending risks have shown some early signs in certain areas. Under such circumstances, the People's Bank of China became more keen about prudence over monetary policy issues, and focused its attention on preventing loans from accelerating excessively.

The rapid credit and monetary growth in 2003 was both a result of spontaneous needs generated by economic growth, but influenced by systematic factors like being pushed by regional governments and desire on the part of commercial banks to inflate their loan bases so as to bring down non-performing loan ratios.

Lurking in the Chinese economy are not only the risk of an aggregate imbalance, but the problems of overheating in some areas and considerable lending risks in others.

Therefore, the central bank, on the one hand, needs to meet the reasonable needs of economic growth and protect the strong momentum in economic development. On the other hand, it must prevent excessively rapid credit and monetary growth, a buildup in inflationary pressures and heightened system-wide financial risks.

Noting such a situation, monetary policy in 2003 was not tightened abruptly, but fine-tuned in terms of total money supply with attention being devoted to dissolving the protrusive lending risks in certain sectors.

Secondly, at the level of specific monetary policy actions, a sharper focus on the proper strength of adjustments and using market-oriented methods is another key feature of monetary policy operations at the moment. The major content of recent monetary policy actions included the following aspects:

(1) Multiple monetary policy instruments were used to adjust the total amount of loans and money supply to ensure stable growth. This included broadening the archery of open market operations by issuing central bank bills to convert some fiscal overdrafts and borrowings into standardized Treasury bonds.

The bonds are usable in open market operations.

As well, upscaling the strength of open market operations to sterilize excessive liquidity and fine-tune base money in a flexible manner were also key policy moves.

Mandatory reserve requirements were raised to 7 percent from 6 percent, and window guidance on financial institutions was enhanced.

(2) In light of the problem of regional overheating in the real estate industry, the central bank issued instructional guidelines on real estate development loans, working capital loans to the construction industry, consumer loans to multiply the number of home-owners and loans to luxury housing buyers so as to promote the healthy development of the real estate sector.

(3) The market-oriented reform of the interest rate regime was promoted steadily. The floating range of financial institutions' lending rates was broadened; the interest rate on the excess reserves of financial institutions was reduced to 1.62 percent from 1.89 percent; the reform of deposits transformed from postal savings was pushed actively; and efforts were made to co-ordinate interest rate policies for local and foreign currencies.

(4) Reform of the foreign exchange regulatory system was deepened, and the basic stability of the yuan's exchange rate was maintained to promote balanced international payments.

(5) The central bank took measures to support the reform of rural credit co-operatives and improve financial services in rural areas.

(6) The central bank encouraged education loans to students, and took steps to perfect the small-amount secured loans designed for laid-off workers as well as the administration of lending related to export rebate accounts.

These measures helped maintain stable growth in lending, and also promoted the optimization of credit structure while helping propel the market-oriented reform of monetary policy instruments.

Thirdly, monetary policy operations were conducted with a more forward-looking approach. Monetary policy operations in 2003 were adjusted when signs of overheating in parts of the economy were just beginning to emerge, and policy actions were taken accordingly. The forward-looking approach was enhanced considerably, and the characteristics of "preventive adjustments" and "fine-tuning adjustments" were demonstrated well.

Since China embarked on its reform and opening up policy, its economy has experienced three periods of overheating - namely 1983-84, 1987-88 and 1992-93. All were serious situations, and the State implemented macro policies with considerable strength.

In the current round of economic growth, the People's Bank of China, taking note of the relatively fast credit growth, took adjustment measures promptly, with significant attention concentrated on dissolving potential financial risks in overheating in areas like real estate, so as to prevent major disturbances to the economy.

Since adjustments were implemented early, the central bank found it unnecessary to resort to "heavy dosages" like those used in the previous three serious periods, but conducted "fine-tuning adjustments" through economic tools.

Although adjusting the bank reserve ratio is theoretically a "heavy dosage," a 1 percentage point hike in reserve requirements which froze some 150 billion yuan (US$18 billion) in the excess reserves of commercial banks was a moderate move, given the relative ampleness of overall liquidity in the financial system.

Furthermore, the central bank announced the measure with a one-month notice, which provided enough time for the market to make preparatory adjustments. Although the immediate market reaction turned out to be fairly strong due to factors like the listing of the Huaxia Bank, the central bank provided short-term funding support through its open market operations and prevented an abrupt contraction in credit and monetary growth.

As for the subsequent financial performance, credit and monetary growth slid along a smooth curve after September. The excessively rapid growth of lending was curbed. The new characteristics of monetary policy operations at present reflect the central bank's positive changes in the areas of strengthening and improving macro-control, as well as pushing a forward-looking approach and improving the effectiveness of financial management.

With the continued improvement of monetary policy instruments and gradual progress in the central bank's financial management skills, monetary policy will play a more important role in macroeconomic adjustments.

Jin Yan: senior expert at the Research Bureau of the People's Bank of China

(China Daily March 22, 2004)