Soon after China’s central bank’s sudden interest rate cut in November of 2014, the market strongly called for a quantitative easing policy. Especially when Japan and Europe upgraded their quantitative easing policy and when China’s economic growth pressure increased rather than decreased with domestic CPI down to “1” in December, the market was even more insistent that China’s central bank would enter a period of interest rate cuts. Interest rate cuts and quasi-drops are policy tools that China’s central bank uses most frequently. Thus, the market has expected the central bank’s interest rate cut and a quasi-drop for more than one month. However, judging from China’s central bank work conference of 2015, China’s central bank is less likely to implement an easing monetary policy. China’s central bank will continue with its neutral monetary policy in 2015.

China’s central bank’s monetary policy focused on two aspects in 2014. One aspect was deepening the reform of interest rate marketization and the reform of marketizing RMB exchange rate formation mechanism. The important measure to marketize interest rates is to increase the ceiling of RMB deposit rates from the benchmark 1.1 fold to 1.2 fold. Although this policy enhances the ability of the commercial banks’ space and ability to “name your own price,” it also severely reduces the profit of the commercial banks. To a certain extent, it will change banks’ behavior and management, and thus China’s interest rate market will take another important step.

The main measure used to marketize the RMB exchange rate formation mechanism is to raise the RMB trading price against the dollar from 1% to 2% in the spot foreign exchange market. A higher flexibility of RMB exchange rate is not only a big step towards marketizing the RMB exchange rate formation mechanism, but also will weaken the central bank’s normal foreign exchange rate intervention. In 2014, the RMB exchange rate against the dollar basically fluctuated within the RMB exchange rate flexibility range. But it does not mean that China’s central bank has basically withdrawn from its normal foreign exchange rate intervention. It just means that its intervention is weaker than before.

The other change was stronger financial support for the real economy. This support was provided by ensuring adequate bank liquidity and lowering fund raising costs in the entire financial market, so as to allow the financial resources to serve “San Nong” (agriculture, rural areas and farmers) and micro enterprises, and to make financial institutions give more support to the key industries and newly emerging industries, etc.

All this shows that the central bank’s monetary policy of 2014 was more directional and had more initiative. The central bank continued to supplement and improve the composition of its monetary policy tools, such as a directional quasi-drop and the establishment of various loaning facilities, instead of taking a comprehensive easing monetary policy to stimulate economic growth.

China’s central bank work conference shows that China central bank’s monetary policy of 2015 will not change much compared with 2014. The two aspects emphasized above will still be the focus of its 2015 monetary policy. Under normal conditions, a stable monetary policy will not change and the central bank will ensure adequate bank liquidity through various tools, especially through various directional regulating tools. That is to say, China’s central bank will neither “flood the economy with money” or ease the monetary policy, nor tighten the monetary policy above the market limit. So, China is less likely to enter a period of interest rate cuts and quasi-drops in 2015, as the market expects.

In 2015, the RMB fluctuating trading price against the dollar will probably expand from the existing 2% to 3%, further increasing the flexibility of the RMB exchange rate. But the central bank will face the dilemma of whether to extend the fluctuating trading price range of the RMB against the dollar to other non-dollar currencies. If dollar still remains strong while the RMB only fluctuates after the dollar exchange rate in 2015, the RMB will possibly become a strong currency only after the dollar. It will not only go against China’s economic reality in 2015 but also will cause a comprehensive appreciation of the RMB against other non-dollar currencies. Possibly, it will both hit China’s exports to countries of non-dollar currencies, and also further push up China’s asset prices. This is the dilemma faced by China’s central bank in 2015.

Besides, China’s 2015 monetary policy has a different focus from that of 2014, which is to take comprehensive measures to guard against regional and systematic financial risks. China’s financial system could face three main risks in 2015. The first one is the impact from the international market. The international market volatility will be intensified by such issues as the US Federal Reserve’s higher interest rates, a stronger dollar, a continuous slump of oil prices, a severe differentiation from the monetary policies of major developed countries’ central banks and intensified geopolitics, etc. This market volatility can hit the Chinese financial system at any time. China’s central bank will maintain vigilance . The second risk comes from China’s stock market which rose 53% in 2014, running like a “mad bull.” If the market maintains this momentum in 2015, China’s stock market will face a huge risk. Considering this important factor, China’s central bank will not stimulate the stock market so as to avoid another “mad bull.” The third risk is whether the debt risk of the real estate enterprises will lead to a real estate bubble burst and affect the banking and financial system, thus causing regional and systematic risk. Although the central bank’s new housing loan policy bailed out the market and mitigated this risk in 2014, it is uncertain whether there has been enough time for the policy to be effective before the risk arises. The real estate market in China still faces a huge risk of a burst bubble. This is key to the fact that China’s central bank’s monetary policy will go back to a neutral stance.

The author a researcher at the Financial Institute of the Chinese Academy of Social Sciences.

This article was first published at chinausfocus.com. To see the original version please visit http://www.chinausfocus.com/finance-economy/monetary-policy-will-stay-neutral-in-2015/

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