Chinese Central Bank’s Balance Sheet Contracts by over $100B in First Half, Money Multiplier Hits Record High

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The People’s Bank of China (PBOC) has reported a sizeable contraction in the scale of its balance sheet in the first half of 2020.

The latest data from PBOC indicates that as of the end of June 2020 its balance sheet totalled 36.4 trillion yuan (approx. USD$5.21 trillion), for a contraction of around 720 billion yuan (approx. $103.01 billion) compared to the end of last year.

The chief factor behind PBOC balance sheet contraction in the first half was a drop in “claims on other depository companies,” which declined by 613 billion yuan, primarily due to fewer medium-term lending facilities (MLF) and targeted MLF’s.

Funds outstanding for foreign exchange (外汇占款) declined 57.5 billion yuan in the first half to 21.2 trillion yuan by the end of June, accounting for around 60% of all central bank assets.

Funds outstanding for foreign exchange have declined by 6 trillion yuan since their peak in 2014, primarily due to China’s flagging trade surplus.

Following this decline PBOC has made increasingly frequent use of open market operations such as reverse repos and MLF’s to release base money, and “claims on other depository companies” has seen a rapid expansion to comprise around 30% of assets at present.

On the liabilities side of PBOC’s balance sheet the base money supply declined 1.58 trillion yuan, following repeated cuts to the reserve requirement in the first half.

PBOC has previously said that its multiple cuts to the reserve requirement for commercial banks would lead to a contraction in its balance sheet, but that this would not result in a tightening of the money supply, and instead strengthen expansion effects.

According to PBOC this differs from the balance sheet contractions of the Fed and other central banks in developed economies, which are achieved via reductions in bond holdings and lead to tightening of the money supply.

The chief reason for this is that reductions in the reserve requirement means increases the money creation capabilities of commercial banks.

PBOC data indicates that as of the end of June the base money balance was 30.8 trillion yuan, for a decline of 1.58 trillion yuan compared to the end of last year. Base money remains the largest item on the liabilities side of PBOC’s balance sheet, with a 85% share.

The M2 money supply balance was 213.49 trillion yuan, however for a YoY increase of 11.1%, and an acceleration of 2.6 percentage points compared to the same period last year.

As of the end of June China’s money multiplier – defined as the M2 money supply balance divided by the base money supply, hit a historic high of 6.92, as Beijing loosened credit policies to help deal with the impacts of COVID-19.

The Chinese central bank’s balance sheet contraction stands in sharp contrast to the expansion pursued by the US Federal Reserve in 2020 via the purchase of Treasury bonds and mortgage-backed securities (MBS).

Data from Wind indicates that as of the end of June the Fed’s balance sheet reached $7.31 trillion, for an expansion of 70% compared to the end of last year.

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