China’s economic policy diverging from US while ‘putting own needs first’, central bank says

Head of monetary policy says China’s economic focus is primarily on maintaining stability in its own financial markets
But diverging policies with the US may result in different interest rates and currency exchange rates that would be likely to cause unintended hot capital flows

China economy

Orange Wang

Published: 12:00am, 14 Jul 2021

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China has shrugged off the monetary policy shift by the US Federal Reserve and says maintaining stability in its own domestic financial markets is the main priority at this stage in its post-pandemic economic recovery, which is further along than that of the United States.

The position was relayed on Tuesday by the head of the central bank’s monetary policy department, Sun Guofeng. He acknowledged that the People’s Bank of China (PBOC) has taken notice of recent market discussions over a potential tightening by the Fed, but stressed that China’s financial markets are operating smoothly.

“Due to the time difference in terms of pandemic control and economic recovery, the difference in monetary policies of the US and China is very normal,” Sun said at a press conference while also noting that the two economies interact with each other closely due to the effects of globalisation.

China’s short-term priority lies in sustaining growth, while the United States is focused on reining in inflation. These diverging policies may result in different interest rates and currency exchange rates that could, for example, cause unintended speculative capital flows.

Sun said that China – the first major economy to return to growth since the coronavirus shock – will maintain its normal monetary policy and monetary autonomy while enacting policies that are based on the domestic economic situation and price movements in the year’s second half.

“We will also closely follow changes in the international economic and financial situation [and] carry out international macro policy coordination while putting our own needs first,” he said, adding that China will do its part to help support a “stable recovery of the global economy”.

Earlier this year, policymakers in Beijing warned of mounting external financial threats and their potential impact on the Chinese economy. They cautioned that developed countries should pay more attention to the impact that proactive fiscal policies and extremely loose monetary policies were having on the rest of the world.

While the US is expected to tighten its policy stance, China surprised the market on Friday by confirming that it will cut the reserve requirement ratio (RRR) by 0.5 percentage points and release 1 trillion yuan ($154.67 billion) worth of liquidity into the interbank system this Thursday. The move is intended to help underpin China’s post-coronavirus recovery that is starting to lose momentum.

The PBOC last cut the RRR in April 2020, when the Chinese economy was still badly affected by the coronavirus crisis. But small firms are now bearing the brunt of a recent surge in raw material prices while being unable to pass on the higher costs to consumers.

Higher raw material prices gave rise in May to 13-year-high factory-gate price inflation, which dipped only slightly last month. Sun said they were likely to hover at that elevated level in the third quarter, before falling back in the fourth quarter and next year.

The situation, he reassured, is only temporary – due to a low base comparison from last year – and is more a reflection of the imported effects of global inflation.

Some analysts have argued that the unexpected RRR cut increases the risk that China will see increased capital outflows and depreciation in its yuan during the second half of this year.

Sun said the RRR cut is mainly aimed at improving the capital structure of financial institutions to let them better serve the real economy.

“China’s economy is maintaining good momentum in steady growth at present, the price trend is generally under control … there is no change in the prudent monetary policy stance,” he said.

Ruan Jianhong, head of the PBOC’s statistics department, also stressed that the central bank’s strategy is about maintaining a prudent and stable monetary policy.

“From the perspective of economic recovery and debt growth in the second quarter, we expect that the macro leverage ratio remained stable in the second quarter,” Ruan said.