China’s Central Bank & China’s Central Bank & Monetary PolicyMonetary PolicyImplications for the Global EconomyImplications for the Global Economy

Presented by Louisa Chu

IntroductionIntroduction

Why is the Chinese economy Why is the Chinese economy important?important? 22ndnd largest economy largest economy Rapid economic growth rateRapid economic growth rate Affects many other national Affects many other national

economieseconomies

Overview of Central BankOverview of Central Bank

People’s Bank of ChinaPeople’s Bank of China Created in 1948Created in 1948 Responsible for both Central and Responsible for both Central and

Commercial banking activitiesCommercial banking activities 1983 (economic reform) split off 1983 (economic reform) split off

commercial banking and was commercial banking and was legally proclaimed as the legally proclaimed as the country’s central bankcountry’s central bank

Important FunctionsImportant Functions

Formulate & implement Monetary Formulate & implement Monetary PolicyPolicy

Issue currency & maintain stable Issue currency & maintain stable exchange rateexchange rate

Regulate financial marketsRegulate financial markets Manage state treasuryManage state treasury Conduct economic research & Conduct economic research &

analysisanalysis Protect state foreign exchange & Protect state foreign exchange &

gold reservesgold reserves Utilizes various instruments to Utilizes various instruments to

stabilize the financial systemstabilize the financial system

Objective of Monetary PolicyObjective of Monetary Policy

““Maintain the stability of the value of Maintain the stability of the value of the currency and thereby promote the currency and thereby promote economic growth”economic growth”

Done through various policy Done through various policy instruments:instruments: Reserve requirement ratioReserve requirement ratio Base interest rateBase interest rate Rediscounting of loansRediscounting of loans Rules for central bank lendingRules for central bank lending Open market operationsOpen market operations

Comparison with the FedComparison with the Fed

SimilaritiesSimilarities Create monetary Create monetary

policypolicy Similar MP Similar MP

instrumentsinstruments Regulate financial Regulate financial

institutions institutions Advisory committeeAdvisory committee Perform economic Perform economic

researchresearch Must report to State Must report to State

Council through Council through Quarterly reportsQuarterly reports

DifferencesDifferences Independence of Independence of

treasury from banktreasury from bank Is completely state-Is completely state-

ownedowned PBC not completely PBC not completely

independent from independent from government for government for important functionsimportant functions

China operates China operates bank-based systembank-based system

Interest RatesInterest Rates

Bank lending industry is growing Bank lending industry is growing rapidlyrapidly

Too much credit growth could Too much credit growth could lead to non-performing loanslead to non-performing loans

Contradictory to efforts to Contradictory to efforts to increase consumptionincrease consumption

Recently raised lending interest Recently raised lending interest ratesrates

Interest RatesInterest Rates

ImplicationsImplications Increased savingsIncreased savings Decrease in property developmentDecrease in property development Decreased investment in financial Decreased investment in financial

securities, thus slowing maturity of securities, thus slowing maturity of global financial marketsglobal financial markets

Negative effect on investors’ Negative effect on investors’ sentiments about future ratessentiments about future rates

Appreciation of currencyAppreciation of currency

OMO & ReservesOMO & Reserves

Further tighten money supplyFurther tighten money supply This year, issued over 600billion This year, issued over 600billion

Yuan in bank bills & repurchase Yuan in bank bills & repurchase agreementsagreements

Effective July, reserve ratio Effective July, reserve ratio raised to 8% raised to 8%

150billion Yuan out of circulation150billion Yuan out of circulation Exchange rate policy Exchange rate policy

contradictory to these market contradictory to these market actionsactions

Exchange RateExchange Rate

““artificial”artificial” undervaluedundervalued Pegged to dollar until recentlyPegged to dollar until recently Not controlled by market but Not controlled by market but

through volatility of other through volatility of other currenciescurrencies

Import/export prices are not fairImport/export prices are not fair China’s mounting surplusChina’s mounting surplus

Exchange RateExchange Rate

China’s reasoning: stabilityChina’s reasoning: stability Devaluation since economic Devaluation since economic

reform in the 1980sreform in the 1980s Do not care about other Do not care about other

countries’ opinions or pressurescountries’ opinions or pressures Central bank’s objectives are Central bank’s objectives are

not in line with the state’snot in line with the state’s

Historical Exchange RatesHistorical Exchange RatesYear Rate Year Rate

1970 2.46 1987 3.72

1971 2.267 1988 3.72

1973 2.04 1989 4.72

1974 1.84 1990 5.22

1975 1.97 1991 5.263

1976 1.88 1992 5.42

1977 1.73 1993 5.75

1978 1.58 1994 8.446

1979 1.5 1995 8.318

1980 1.53 2000 8.178

1981 1.75 2001 8.277

1982 1.93 2002 8.277

1983 2.8 2003 8.277

1985 3.2 2004 8.276

1986 3.72 2005 8.199

2006 8.037

Rate stated in terms of Yuan per US Dollar

Historical Exchange RatesHistorical Exchange Rates

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

0.000

1.000

2.000

3.000

4.000

5.000

6.000

7.000

8.000

9.000

Rate

Year (1970 - 2006)

Annual Exchange Rate (Yuan/Dollar)

Rate

Future PredictionsFuture Predictions

Central bank and government Central bank and government relaxing on exchange rate policyrelaxing on exchange rate policy

““Gradually retreat from active Gradually retreat from active role in onshore currency markets role in onshore currency markets to give market forces more say in to give market forces more say in setting Yuan’s price”setting Yuan’s price”

Economy passing stage of Economy passing stage of “industrializing” to become “industrializing” to become industrialized and a world powerindustrialized and a world power

Future ImplicationsFuture Implications

““fairer” world marketfairer” world market True valuation of YuanTrue valuation of Yuan Access to China’s markets by Access to China’s markets by

outside investorsoutside investors Economic freedom for businesses Economic freedom for businesses

and individualsand individuals Increased consumption & access Increased consumption & access

to foreign goodsto foreign goods

Any Questions?Any Questions?

Thank youThank you