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UPDATED: April 1, 2013 NO. 14 APRIL 4, 2013
The supply of renminbi should be determined by the demands of the economy
By Lan Xinzhen

Moreover, since China is experiencing the process of economic monetization, its money demand has become higher. Developed countries—after a long process of development—have been at high and steady levels of monetization.

In China, since the reform and opening up, various factors of production are allocated by the market. Assets such as land and houses, which were never or seldom priced, are traded on the market and have had their values monetized, hence increasing currency demand. Since China's monetization process has begun later than in developed countries, it needs to advance monetization much more intensively than developed countries had done within more than a century, accelerating the speed of M2 growth.

Niu Wenxin, chief commentator of China Central Television's securities channel, thinks it is misleading to the public to say China over-issues its currency. Nominal GDP should be used to compare M2 and GDP, he says. However, the GDP figures China releases are price-deducted ones. Moreover, factors taken into consideration should include demand for the currency brought by price hikes and asset monetization, its cross-border flows as well as renminbi in the hands of foreigners.

Niu says China's central bank has been deciding the M2 growth by adding 2-3 percentage points to the sum of the country's GDP and CPI growth rates. This is a reasonable method. For example, the Chinese Government expects that the GDP will grow by 7.5 percent this year and CPI by 3.5 percent, therefore the central bank should decide that a growth rate of 13 percent for M2 is suitable for the economy. A small money supply will slow down economic growth, but a large one will push CPI growth too high and intensify inflation.

Niu adds that in fact China's money supply is linked up with the U.S. dollar. Since the United States has been easing its monetary policy, China and other countries have to print more bank notes. Global money growth starts in the United States, and the main reason for global price hikes is the U.S. quantitative easing.

Serving the economy

However argued, China's monetary policy will only change to suit the demands of its economy, because the monetary policy has four targets: maintaining low inflation, promoting economic growth, increasing employment and maintaining the balance of international payments.

According to Zhou, CPI figures are the top consideration for China's monetary policy. "The 13-percent growth of M2 in 2013 indicates a sound or a neutral monetary policy. Compared with 2012 or 2011, 13-percent growth has been obviously tightened, and this is to maintain price levels," he said.

In fact, the central bank has been practicing such a principle. The National Bureau of Statistics released February CPI figures on March 9. CPI grew by 3.2 percent in February compared with the same period last year, which was 1.2 percentage points higher than in January. This indicated signs of inflation. On the same day, the central bank intensified efforts in reducing money supply. By March 21 it had withdrawn 1.01 trillion yuan ($161.08 billion) of cash from the market.

Mei Xingbao, a consultant with China Orient Asset Management Corp., says this year's economic growth target requires a prudent monetary policy. After CPI grew higher than expected in February, the government has heightened vigilance against inflation. Since high inflation remains a possibility and economic recovery continues, the liquidity of renminbi will be weaker in the second quarter than in the first.

According to Yang, moderate inflation brought on by labor price hikes may be acceptable in an open economy and will be conducive to facilitating sustainable economic growth. Therefore the central bank, when paying close attention to inflation pressure, should analyze the reason for inflation so as to decide a new standard for "modest inflation" instead of merely taking the 3.5-percent CPI growth as the standard to adjust money supply.

"We have all seen that every year the central bank issues its money supply target for the next year, but in the end the real supply is all quite different from the set targets," said Yang.

He thinks China should urgently improve the transparency of its monetary policy in order to reduce controversy over whether China is over-issuing money.

"A transparent monetary policy has become a trend practiced by the central banks of various countries, for it can satisfy the public demand for policy disclosure," Yang said. "In addition, the central bank itself can affect expectations of market participants by improving access to information."

Email us at: lanxinzhen@bjreview.com

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