MONETARY POLICY IN CHINA
By Miriam (Penny) Milsom
January 13, 2003
Executive Summary
Introduction
Monetary Policy in the United States
Monetary Policy in China
The History of the People’s Bank of China (PBC)
The Risks of Investing in China
Staples and Investing in China
Summary
References
Executive Summary
The term "monetary policy" refers to the measures taken by a central bank to influence the availability and cost of money and credit. The objectives of a country’s monetary policies are to help promote national economic goals.
In the United States, the monetary policy is established by the Federal Reserve. The Federal Reserve, by making changes in the open market operations, the discount rate, and the reserve requirements, can influence such events as the interest rate, money supply, unemployment, and ultimately, the costs of goods and services. Monetary policies impact trade within the United States and affect both imports and exports.
In China, the monetary policy is established by the People’s Bank of China (PBC). The PBC, similar to the U. S. Federal Reserve, implements policies that will promote economic growth and ensure the stability of the Chinese financial industry. By maintaining a secure financial environment, companies will be encouraged to expand to China, thus increasing imports, creating jobs, and increasing national wealth.
As Staples considers an expansion into China, corporate analysts must study the monetary policies in the United States and in China to see how those policies might impact the success of opening Staples stores in China.
Introduction
Monetary policy is regarded as a major tool to ease cyclical and
external impacts. Central banks attempt to control money supply through
the adjustment of base money (cash plus reserve money) and other monetary
tools. Although the goal is stability, recently, on a worldwide basis,
many central banks have not produced this desired economic constancy. The
United States and the People’s Republic of China have central banks that
are similarly designed yet operate in different manners.
Monetary Policy in the United States
In the United States, The Federal Reserve Act of 1913 gave the Federal Reserve the responsibility for setting monetary policy. The Federal Reserve uses three tools of monetary policy to influence the demand for, and supply of, money. These three tools are the open market operations, the discount rate, and the reserve requirements. Controlling the supply of money influences interest rates which “triggers a chain of events that affects other short-term interest rates, foreign exchange rates, long-term interest rates, the amount of money and credit, and, ultimately, a range of economic variables, including employment, output, and prices of goods and services” (http://federalreserve.gov/fomc/. 2002. Par 3).
Open Market Operations are the primary means for implementing the United States monetary policy. Open market operations are the sale and purchase of U.S. Treasury and federal securities. The short-term goals for open market operations is specified by the Federal Open Market Committee (FOMC). These goals are often to achieve a certain amount of currency reserves or a certain interest rate. The specific goals of the Federal Open Market Committee have varied over the years. During the 1980s and 1990s, the focus was to reach a specified or explicit level for the federal funds rate. In 2000, the FOMC stated that its long-term objectives were price stability and sustainable economic growth.
The Discount Rate is established by the Federal Reserve Bank. Federal Reserve Banks offer fully secured loans to depository institutions. The Federal Reserve Bank establishes a particular rate of interest, called the discount rate, on money loaned to these commercial banks and other depository institutions. Some loans, such as adjustment credit loans, are usually overnight or weekend loans which meet temporary needs for funds. Other loans, such as seasonal credit, are extended to institutions that have recurring fluctuations in funding needs, such as banks in agricultural or seasonal resort communities. Finally, extended credit may be provided to institutions experiencing exceptional liquidity needs.
The reserve requirement is the quantity of money that a commercial bank is required to hold in reserve against its deposit liabilities. Depository institutions must hold these reserves in the form of vault cash or deposits with Federal Reserve Banks. The Federal Reserve can change the reserve requirements, thus changing the supply of money available to commercial banks.
Monetary Policy in China
In China, the People’s Bank of China (PBC) formulates and implements monetary policies. Much like the U.S. Federal Reserve goal, the goal of the PBC’s monetary policies is to maintain the stability of the value of currency and thereby promote economic growth. In addition, financial supervision is another important function of the PBC. The PBC approves, supervises, and administers financial institutions and financial markets and publicizes financial and business laws and rules. The goal of the PBC‘s financial supervision is to maintain a stable and sound financial industry.
“The PBC's main functions include: formulating and implementing monetary policy; issuing and administering the circulation of the currency; licensing and supervising financial institutions; regulating financial markets; managing official foreign exchange and gold reserves; acting as fiscal agent; maintaining a payment and settlement system; collecting and analyzing financial statistical data; participating in international financial activities at the capacity of the central bank; and overseeing the State Administration of Foreign Exchange” (http://www.pbc.gov.cn/english/about. 2002. Par 1) The Monetary Policy Department of the PBC is responsible for research, design and implementation of monetary policy, drafting and implementing monetary policy proposals, maintaining currency stability, and proposing and implementing credit policies aimed at the balanced development of national and regional economy.
The History of
the People’s Bank of China (PBC)
The People's Bank of China (PBC)
began in December 1948, just before the beginning of the People's Republic
of China. The
PBC was the only
financial institution in China and was part of the fiscal allocation
system. Branches in cities, counties, and provinces took deposits and
transferred the income to the central bank.
PBC branches
disbursed money by making loans according to the national planned economy.
The central government set fiscal and monetary policies. In the 1980s, the
Chinese economy grew and the household income (and savings) also grew.
Unfortunately, as investment increased rapidly, so did inflation.
In 1986, the
PBC moved from
making government-guided financial infusions into the marketplace to
making more traditional bank loans. Bank lending soon overpowered the
process and became the main fundraising activity. In an effort control
lending practices, the
PBC introduced a
credit policy, which more directly based credit and lending policies on
the government's overall macroeconomic planning. Thus, Chinese lending
practices were driven by, and entwined throughout, the central Chinese
government’s political goals and objectives.
Unfortunately, the multiple
PBC roles of
national bank, government entity, and local bank branches conflicted.
Although the central bank was controlled by the national government, local
braches were controlled by local governments.
"The local branches of the PBC had the authority to allocate the credit quota but they were under the strong influence of local governments as the PBC branches were also a part of the local government organization. Despite their status as branches of PBC, the local governments could exercise greater influenced on them as they could appoint the top personnel of the branches. Due to this structure, local interest was placed higher than the macroeconomic policy of the central government, expanding the money supply beyond control" (Ikeya, Makoto. January 22, 2002. Pg 3).
This
unsuccessful system increased instability in China. "High inflation had
cut people's income and subsequent radical tightening by the government
expanded the chaos, creating the background of the Tiananmen incident" (Ikeya,
Makoto. January 22, 2002. pg 3). Increased investments, which fueled
increased bank lending, soon caused double-digit inflation.
By 1995, the People's Bank of China Act re-defined the main role of
the
PBC to 1) maintaining the value of currency and 2)
supporting economic growth. This gave the
PBC the authority
to make and implement monetary policy. "PBC
is equipped with a monetary policy framework called 'credit policy' which
is a system that directly controls bank credit. The current version of the
policy framework was established in January 1998. It directs banks...to
achieve a set target of loan growth" (Ikeya, Makoto. January 22, 2002. pg
2).
Much like the Federal Reserve Bank in the U.S., the functional roles
of the
PBC include
issuing notes, acting as a bank for other banks, and acting as the bank
for the central government. In addition, however, the
PBC
also provides management guidance to the local banks to assure they comply
with the fiscal policy. This management guidance, called 'window
guidance', is more than simple help and direction. In fact, "There has not
been a case in which a bank has refused the guidance" (Ikeya, Makoto.
January 22, 2002. pg 2). The
PBC meets monthly
with officers from each bank to assure that the bank's operation is in
line with the economic plans, and gives additional guidance, as needed.
This guidance system enables the
PBC to control
credit creation by China's banks, limit international capital investments,
and limit the size of the capital market.
Although the 1995 changes were modeled after the Federal Reserve Bank
in the U.S., its objective was to eliminate the influence of the local
governments on bank practices while strengthening the central government's
control. "The
PBC has
unparalleled power to influence the Chinese economy, but in fact its
credit policy must be based on the overall macroeconomic policies set by
the Communist Party and the government" (Ikeya, Makoto. January 22, 2002.
pg 2). This combination of Western bank design, lending practices, and
central government control appears to be an effective monetary tool. The
People's Bank of China has been uniquely successful in achieving economic
stability and in achieving its money supply target. "Dai Xianglong,
governor of China's central bank, (stated that) the stable monetary policy
that China has pursued since late 1998 has proved to be successful" (People's
Daily. March 17, 2002. Par 6). Based on
PBC
data, goals for GDP, inflation, and money supply growth have all been
achieved since mid 1990. In the late 1990s, when other countries were
experiencing a 'boom and bust', the Chinese central bank was successful in
reducing the CPI increases while maintaining high growth. "While the rest
of the world is struggling to come out of stagnation, only China looks set
to maintain relatively high growth momentum" (Ikeya, Makoto. January 22,
2002. Pg 1).
In addition, the
PBC is also an
important part of the government's
industrial policy. The
PBC, the State
Development Planning Commission (SDPC), and the Ministry of Foreign Trade
and Economic Cooperation (MOFTEC) controls which industry receives what
amount of credit. Thus the
PBC can assure
that banks loan money toward creating the central government’s desired
industry mix.
The Risks of Investing in China
The existing monetary and credit structure that the
PBC
provides to China appears to be very successful. However, there are some
identifiable risks. Although the 1990s saw many reform efforts, mechanisms
to control risk have not yet been created since the central bank's 'window
guidance' continues to be the major reason behind lending institutions'
decisions. There continues to be political pressure from the
PBC
to expand loans during stagnant economic conditions. These growth-oriented
lending practices create poor performing loans. "Reducing non-performing
loans from their high level would be a key to the sustainability of the
current monetary framework. Just as supporting the economy through fiscal
expansion cannot be maintained in the long term, inefficient credit
expansion is also unsustainable" (Ikeya, Makoto. January 22, 2002. pg 4).
Another negative aspect of the Chinese monetary system is that strong
government control of the
PBC and resulting
fiscal and credit policies make it difficult for the financial systems to
mature. Banks and businesses will be concerned less about the costs and
risks if the central bank robustly controls credit policies. "Moreover,
under the structure in which priority is given to the accomplishment of
the plan, indirect monetary tools such as interest rates and base money do
not have a major effect, making it more difficult to abandon the credit
control" (Ikeya, Makoto. January 22, 2002. pg 5).
According to China.org, a third issue that the PBC has not been able to conquer is the uneven money distribution. “A central bank's survey in May has exposed that 80 percent of money out of the State-owned commercial banks eventually flows to only a small handful of so-called "excellent" customers, usually big-name firms with reliable credit record, while the majority of medium- and small-sized firms hardly find way to quench their money thirst. ‘These problems indicate that there might lie some structural illnesses in the existing monetary system, to which monetary policy-designers usually feel at their wits end,’” (China.org. 12/26/02. Par 6)
Finally, the
current
PBC credit
policies, successful or not, may not be able to maintain their strong
control in the long run. Private and foreign companies are becoming an
increasingly major force in the Chinese economy. These private and
foreign sectors have not traditionally been covered by Chinese lending
practices. "Future liberalization of cross-border capital movement,
development of the domestic capital market, and expansion of foreign banks
may all serve as a challenge to the system. If the indirect monetary tools
remain weak under the future economic environment, monetary policy may not
be effective in maintaining economic stability" (Ikeya, Makoto. January
22, 2002. pg 5).
Staples and Investing in China
China and its recent growth offers an optimum environment
for Staples
to expand. There is a huge labor pool supplied by the world's largest
population. There is a high-level of capital input energized by sufficient
household savings and foreign direct investment. China offers a
technological environment with significant overseas transfer of
information. In addition, significant structural reform efforts have been
seen.
However, China may not be able to sustain this growth. A decline in
growth may negatively impact stability. This may damage asset quality and
weaken cash flow. China's monetary policies are in a fragile equilibrium.
Government control of the
PBC may not be
able to sustain the recent success in the long term.
Staples
successful entry into the Chinese market may depend on weather China can
successfully create a flexible economic structure that has the ability to
absorb economic volatility.
Fortunately, China may still have time before the economy weakens and
the current direct control system loses effectiveness. Many recent changes
have had positive impacts on banking policies. The
PBC
has a target to lower the non-performing loans and to strengthen its bank
supervision. Dai Xianglong stated that this year China will focus on
accelerating the reform of state-owned enterprises to lift their credit
rating and on improving the running of state-owned banks. Xianglong also
stated that "China will continue its modest monetary policy for the next
five years, so as to fend off financial risks and maintain economic growth
at around seven percent annually" (People's
Daily. March 17, 2002. Par 7 and 8). Xianglong "ruled out
devaluation of the RMB yuan as a policy option by saying that the interim
goal of the central bank's monetary policy is to maintain the value of the
currency, and, on this basis, secure the stable growth of the economy (People's
Daily. March 17, 2002. Par 9).
In March 2002, Robert Mundell, the Columbian University economist
known as "the father of the euro" stated that China's monetary policy is
excellent. Mr. Mundell praised China's policy of keeping its currency
exchange rate stable. "He said that China is lucky to have received a
great deal of foreign investment, adding that China's foreign exchange
reserve is growing rapidly. He said that China is now in a very strong
position, and should maintain that position. 'Despite the global economic
slowdown, I think china will maintain its goal (of growth)'" (People's
Daily, March 17, 2002. Par 4 and 5).
Summary
Monetary policy of both the U.S and China will have a critical impact on the success of opening a Staples store in China. When comparing the two countries’ central banks, the organization of both the U.S. and Chinese central bank is similar. Goals for both the U.S. Federal Reserve and the PBC are the same. Those goals are to achieve financial stability and to sustain economic growth. China, it appears, has been more successful than the United States in surviving the recent turbulent financial crises while maintaining a level growth. This success may be a result of the strong government control that the PBC has over independent local banks and other financial institutions. Under this central control, the Chinese government directs banks to lend to specific industries according to a national plan. Oppositely, the U. S. must rely on a free market and federal incentives to guide specific industry development and investment and other economic changes.
Although the future is unknown, it appears that many economists predict a positive future for the Chinese economy. Staples should be able to successfully open a series of branches in China.
References
Board of Governors of the Federal Reserve System. Retrieved online
12.20.02 from
http://federalreserve.gov.
Central Bank Official Assures Little Change of Monetary Policy. Retrieved online 12.25.02 from http://www.china.org.cn/english/government/37107.htm.
The Discount Rate. Retrieved online 12.24.02 from http://federalreserve.gov/monetarypolicy/discountrate.htm.
Ikeya, Makoto.
January 22, 2002. China - Unique Strengths and
Weaknesses of Monetary Policy Diehard socialism behind 'window guidance'.
Monetary Policy Making. Retrieved online 12.19.02 from
http://federalreserve.gov/fomc/.
Open Market Operations. Retrieved online 12.19.02 from http://federalreserve.gov/fomc/fundsrate.htm.
People's Daily.
March 17, 2002, Nobel Laureate: China's Monetary
Policy Excellent. Retrieved online 12.15.02 from
http://english.peopledaily.com.cn/200203/17/eng20020317_92259.shtml.
Reserve Requirements. Retrieved online 12.24.02 from http://federalreserve.gov/monetarypolicy/reservereq.htm.
Staples, Inc. Retrieved online 12.19.02 from http://www.staples.com.