Monetary policy fine-tunes to market

On May 30, the State Council made a detailed plan for the financial work during the second half of the year. The plan seems to stress enhancing the capability of financial services for the real economy, but in fact it sets the tone for the central bank's monetary policy in the second half of the year. It is also innovative in strengthening "directional drop quasi", lowering the financing cost, and optimizing bank credit.

First, the so-called directional drop quasi means a directional reduction of the reserve requirement ratio. In the case of China's downward economic growth, adjustment of the real estate market, and the increasing risk of default by Chinese enterprises, directional drop quasi means that the Chinese central bank is unlikely to change the present moderately tight monetary policy and will only fine tune different bank reserve ratios. Thus, the debate over the central bank's expected reduction of the reserve ratio has come to a halt, meaning a lower possibility of an overall reduction of reserve requirement ratios and loan interest rates in the second half of the year.

Meanwhile, directional drop quasi also means that in the case of a tight control of credit and social financing scale, a directional easing policy will be adopted to support the development of the real economy, the development of agriculture as well as small and micro businesses in particular.

Also, directional drop quasi is a way to regulate China's financial market. In the early years, the fast growth of China's interbank market was related to the excessive use of the interbank market by quite a few small and medium banks as well as financial institutions. Due to the lack of available loans, caused by excessive expansion, these banks had to go to the interbank market for short borrowing and long lending, thus causing a serious maturity mismatch of their assets. Any trouble in the market will cause turbulence in the interbank market. That was the cause of the "money shortage" in 2013. Adopting a directional easing policy is meant to encourage small and medium-sized banks to make themselves accessible to the real economy and to small and micro businesses.

Of course, directional drop quasi is a quantitative policy instrument, but of small effect. If issues such as the lack of further reform of China's interest rate market, the distortion of financial market price mechanisms, and the lack of a fundamental transformation of the investment-oriented real estate market exist, directional drop quasi will have a limited ability in enhancing the service for the real economy. Problems in the Chinese financial market now are mainly caused by the central bank's excessive use of the quantitative policy instrument instead of a flexible use of price instruments. Therefore, if a directional easing policy is set as a usual instrument, it will still have a limited effect.

Second, social financing costs should be comprehensively reduced. It should be done through deleveraging and reducing bank service charges respectively. Chinese banks and financial institutions had to break through controls and through all kinds of so-called financial innovations. For instance, there are the problems of the prosperity of the interbank market, the spreading of transactions such as trusts, wealth management, and entrusted loans, and the explosive growth of Internet finance. The emergence of these financial markets has not only made the entire chain of the financial market expand without limits and become more complicated, thus increasing the price level of the financial market, it has also increased the potential risks within the entire financial system.

In 2013, the government started to regulate these financial markets. Particularly in 2014, relevant documents were issued targeted at the interbank market. They demanded regulation of the complicated and ever-expanding financing chain, bringing all the non-standard banking businesses under supervision so as to clear away the unnecessary financial "channels" and "bridge" links, shorten the financing chain, and reduce the costs of financing and potential risks in the financial system.

Third, optimizing financing structures involves how to guarantee the flow of bank credit into the real economy and government-supported industries as well as controlling the flow of credit to the industries with overcapacity. This policy is expected to have quite a big impact on China's real estate market, which is in the process of adjustment.

These three aspects will be the focus and trend of the central bank's monetary policy in the second half of the year.

The author Yi Xianrong is a researcher at the Financial Institute of the Chinese Academy of Social Sciences.