PBOC Seeks to Assuage Concerns Over Shrinking Balance Sheet

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An insider from the Chinese central bank has sought to calm concerns about Q1 balance sheet contractions and the attendant liquidity impacts by airing his views on the  matter in one of the country’s most influential financial publications.

Market observers have expressed trepidation about the effect of an ongoing deleveraging drive by Chinese financial regulators, in particular the potential impact on liquidity of the People’s Bank of China’s considerable shrinking of its balance sheet during the first quarter.

The “Monetary Authority Balance Sheet” released by PBOC at the end of March indicated that the central bank’s assets shrank by 1.1 trillion yuan over the preceding two month period, for a decline of 3.1%.

Caixin has since cited the opinions of an”authoritative figure” from within the central bank who claims that market concerns over PBOC’s dwindling balance sheet are overblown.

According to the PBOC insider recent attention given to the central bank balance sheet is far greater than the extent of actual change, and prevailing concerns over tightening of monetary policy are excessive.

PBOC previously sought to dampen worries about its shrinking assets earlier this month with the release of the “2017 Q1 China Monetary Implementation Policy Report” on 12 May, which sent the message that a contracting central bank balance sheet didn’t necessarily mean that the money supply would tighten.

According to the report the contraction in PBOC’s balance sheet during the first quarter was primarily due to short-term seasonal factors such as fiscal expenditures, as well as changes in foreign reserves and adjustments to open market tools.

The latest data published by PBOC indicates that in April its balance sheet reversed the previous two month decline, with a modest rise of 394.317 billion to 34.13 trillion in total by the month’s end.

Chinese analysts note, however, that PBOC has continued to send mixed messages to market. While it’s stated officially that balance sheet contractions do not entail tightening of the money supply, a 30 basis point rise in the bidding rate for 3-month fixed deposits of commercial banks for central treasury cash management to 4.5% on 19 May was interpreted by many analysts as a sign of further tightening.

PBOC strives to balance deleveraging with maintenance of adequate liquidity

The general consensus of Chinese market observers on PBOC’s mixed policy signals is that the central bank is striving to avoid the risk that simultaneous deleveraging of the financial sector and tightening of the money supply could create.

According to Yu Yongding from the Chinese Academy of Social Sciences, China’s monetary authorities have become extremely cautious in their policy manoeuvres ever since putting the kibosh on comparatively loose monetary policy in 2014.

“While financial rectification is necessary, when rectification itself has already created strong monetary contraction effects, monetary contraction should be appropriately delayed, in order to avoid the collapse of asset bubbles caused by tightening of monetary policy as has occurred repeatedly in other countries, dragging them into financial crisis,” said Yu to Caixin. 

Yu notes that while PBOC has previously avowed that shrinking of its balance sheet won’t necessarily entail reductions in the money supply, for other central banks such as the US Federal Reserve shrinking of the balance sheet refers precisely to base money contraction.

He further points out that shrinking of the balance sheet isn’t an accurate way to describe China’s current monetary policy, and that PBOC policy isn’t significant of a reduction in government deposits as much as reluctant to expand base money.

According to Morgan Shidan Lihuaxin Securities chief economist Zhang Jun, China is currently implementing a Chinese-style “balance sheet contraction,” which does not involve a reduction in central bank assets as much as the balance sheets of excessively leveraged financial institutions such as commercial banks.

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