It raises the question: what the heck happened? Was this financial suffocation actually intended, or was it just tolerated as it emerged? Or did it happen by accident, perhaps the result of some miscommunication between the various arms of government, the actions of which each make an impact on financial conditions?
Since it's important, it's worth taking a short tour around the recent data, as a sort of financial battle-field trip. The crucial thing to understand is that the PBOC's open market operations, although closely watched, are not necessarily the largest factor determining monthly shifts in market liquidity. That honour quite often belongs to movements in the government's deposits in PBOC. These deposits currently stand at 3.914tr yuan, and whilst over the last year to August, they have risen by a relatively negligible 17bn yuan per month, they have huge volatility, with a standard deviation of 551bn yuan in their monthly movement. Obviously, if these deposits are rising, that reflects not merely a net fiscal tightening (a fiscal surplus) but is also, ceteris paribus, something that will tighten monetary conditions.
In July, the monthly fiscal surplus was nothing exceptional: 240.6bn yuan, vs 249bn in July 2013 (with revenues up 6.9% yoy and spending up 9.6%). But this probably understates the impact of government activity on private sector cashflows, because govt deposits in PBOC rose by 566bn yuan in July, up from 446bn in July 2013, and 1.2SDs higher than normal seasonal trends. In other words, the fiscal tightening in July was greater than advertised.
Moreover, this reversed significant de facto fiscal stimuluses:
- in June, when government deposits fell 275bn yuan during a month when historically they tend to be near-unchanged, and
- in May, when the 105bn yuan rise in deposits was less than a third of the c350bn yuan rise normally expected.
What is more, this de facto fiscal tightening was not offset by PBOC market operations, which added on average only 74bn yuan per week, down from 204bn yuan in June and from 96bn yuan in July 2013.
At this point, it is tempting to believe that July's tightening had an accidental component, in which the monetary impact of Ministry of Finance's determination to retrieve a fiscal situation which had threatened to deteriorate beyond expectations was not fully appreciated by PBOC.
Moving to August, there are signs of a modest reversal: government revenues are still weak, rising 6.1% yoy on a monthly movement slightly below trend, whilst government spending also slowed to 6.2% yoy, which although below trend, represents a slightly recovery from July's stringency. The monthly deficit of 109.5bn yuan is virtually unchanged since August 2013. More importantly, the marginal 20bn yuan rise in government deposits is 0.3SDs below the 84bn yuan normally expected in August and is slightly lower than in August 2013.
Meanwhile, there is no sign of relaxed accommodation from PBOC, with open market operations averaging an expansion of just 50bn yuan per week in August, falling to approximately zero in September.
Conclusions time: There is no sign that PBOC has significantly loosened policy in response to July's distress-signal. But both the overt and de facto fiscal squeeze which bit in July was not repeated in August - rather fiscal conditions were normalized. My interpretation is that the July's financial squeeze was exacerbated, though not solely caused, by the unexpected diligence of the finance ministry in retrieving a deteriorating fiscal position.