China Post-Dollar Policy - Coordination or Frustration?

With faultless timing, the BIS’s Financial Stability Board published its once-every-five-years peer review of China, assessing the authorities’ administrative ability to foresee, recognize and react in a timely manner to financial instability. Its message? That whilst great strides had been made, there are still a plethora of regulatory agencies with mandates sufficiently loosely drawn that their efforts sometime overlap and nullify each other.

Or, as they put it: ‘Enhancing inter-agency coordination and developing an integrated risk assessment framework will promote a common understanding of objectives and risks, which will in turn facilitate joint policy actions and public communication.’

Whilst the FSB was focussing on the agencies with a claim to oversee various parts of China’s proliferating financial sector, they could have extended their review to highlight the way the different agendas of the Ministry of Finance and PBOC have hampered effective monetary policy development in the run-up to the stockmarket collapse and subsequent yuan devaluation.

The tension between the two arises because government has 3.6tr yuan deposits with the central bank, amounting to 11% of its total assets, or, excluding fx reserves,  about a third of the implied domestic assets of PBOC. By raising or lowering those deposits, the Finance Ministry can affect private sector liquidity: when it lowers its deposits, it pumps money into the private sector; when it raises deposits, it takes money out of the private sector.

Over the last year, the average monthly movement of these deposits (addition or subtraction) has come to 373bn yuan.

During the same time period, the average monthly addition/subtraction to liquidity made by PBOC has been 85bn yuan. But open market activities are not the sum total of PBOC’s interactions with the domestic economy. We can estimate those by looking at the change in PBOC’s total assets, minus the change in the fx reserves kept on that balance sheet.  Currently, these implied domestic assets amount to 11.28tr yuan, and they increased by 2.71tr yuan, or by 32%, in the year to July, with the average monthly addition/subtraction coming to 418bn yuan.

As we can see, the Finance Ministry has a swing factor averaging 373bn yuan a month, and PBOC has a total swing factor of 418bn yuan.  Those are big numbers, and if deployed in a consistent and coherent way, they could have a serious impact on domestic liquidity.  But they are also so similar in size that they each separately could frustrate and cancel out each other’s policy intentions.

So what’s actually happening?  The following chart shows the 6m momentum change vs in government deposits and PBOC’s implied domestic assets, expressed in SDs vs historic seasonal trends.

And what it captures is that the default position over the last year has been for PBOC and Ministry of Finance actions to pretty much cancel each other out.  During the second half of 2014, as the dollar began to rise and China’s foreign exchange reserves began to fall, PBOC responded by rapidly expanding their domestic assets. This was a reasonable response to the tightening of conditions implied by the forced-march rise of the Rmb. But the impact was negated by the rise in government deposits made by the Finance Ministry - what PBOC put in, the Finance Ministry took out. 

Early this year, when it was clear that the economy was in worse shape than anticipated, the Finance Ministry abruptly changed its tactics, running down its deposits in PBOC, with the effect of pumping liquidity into the domestic economy.  Unfortunately, just at that time PBOC also changed its policy, cutting back sharply on the growth of domestic assets: 72% of the rise in domestic assets made in the year to July was made during between July 2014 and Jan 2015.  Result? Both policy initiatives were cancelled out once again. 

The hope is that, with monetary policy no longer constrained by the need to shadow the dollar, both PBOC and Finance Ministry can agree on coordinating a mutual approach to fiscal and monetary policy which can be sufficiently accommodating to make a positive impact on the economy. The data for July - the latest available - hints that something like this may yet emerge.