China's Monetary Policy Dilemma

By Sun Jianfang, Zhao Yuxin
Published: 2009-07-31

News, page 6
Translated by Liu Peng
Original article:

China's central bank has found itself stuck in a dilemma as to what to do in regard to current monetary policy.

Last week, Caijing, a well-known financial magazine, reported that the People's Bank of China (PBoC) would soon switch to making preventing inflation and controlling the rise of domestic asset prices its top priority, while, at the same time, continuing to carry out a moderately loose monetary policy.

As of press time, the central bank had yet to respond to the Caijing report. However, a source from the central bank revealed to the Economic Observer that the bank's policy approach over the next half year was unlikely to reflect that outlined in the the financial magazine's report.

In fact, the prevailing market expectation is that over the next half year, the central bank will pay attention to the rise in domestic asset prices and inflation expectation, and it has already released several signals that it plans to fine tune its monetary policy.

These signals include a recent article by Zhang Xiaohui, director of the PBoC's monetary policy department, in which he advised that current monetary policy should focus on controlling the price fluctuations of assets and primary commodities.

In addition, the central bank has also begun to absorb excessive liquidity through open market operations, another sign that it is beginning to adjust or at least fine tune monetary policy.

The central bank is facing a dilemma. On the one hand, it's worried that it will miss the chance to adjust monetary policy and therefore that inflation could rise, which would no doubt leave them open to criticism. On the other hand, it's also concerned that a mild adjustment in monetary policy could be misinterpreted as being in conflict with the central government's policy stance and that they would be held responsible for any economic slide that might occur in the future.

In addition, the friction between the central bank's desire to lower inflation and the interests of other ministries also raisies diffiuclties for the country's monetary policy.

In order to ease inflation, the central bank would need to withdraw money from circulation and raise the cost of financing, but such moves would cause the cost of any treasury bonds issued by the Ministry of Finance to increase.

If that's the case, these T-bonds would likely fail to be sold at auction and thus impact the ministry's bond issuance plan over the next half year, which would further cause problems for financing the economic stimulus package.

Although loose monetary policy has allowed excessive liquidity to flood the market and has been accompanied by a sharp rise in asset prices and an increased expectation of inflation, last week, Chinese Premier Wen Jiabao pledged that the government would stick to its proactive fiscal policy and moderately loose monetary policy for sustained growth.

China's central bank released an announcement on Wednesday evening, pledging it would continue to stick to a "moderately loose" monetary policy. Concerns about future inflation and bubbles in the stock market and real estate sector? have led to reports that the central bank may soon start to adjust monetary policy, this is the third time in the past six days, that the central bank has assured the public that, aside from some "fine tuning", it has no intention of altering monetary policy.