The People’s Bank of China (PBC)Shawn GrewalTing SituIan DuHerman LuGary Vartanian

Introduction

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History/Why was it Established?The People’s Bank of China (PBC) was established on December 1, 1948 It was created in order to take over the role of the Central Bank of the Republic of China which

operated as China’s central bank from 1927 – 1949 This central bank, however, moved to Taiwan with the Taiwanese government following the

Chinese Civil War The PBC was based on the consolidation of the Huabei Bank, the Beihai Bank, and the Xibei Farmer

Bank It was initially headquartered in Shijiazhuang, Hebei, but then moved to Beijing in 1949

PBC

Huabei Bank

Beihai

Bank

Xibei Farmer

Bank

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History (cont.)The PBC was originally the only bank in the People’s Republic of China All other banks within the mainland (such as the Bank of China) operated as either subdivisions under

it or as agencies that didn’t hold deposits Furthermore, it was responsible for both central banking as well as commercial banking

However, in the late 1970s and early 1980s, widespread economic reform swept China As part of this reform, the PBC’s commercial banking operation was divided into 4 independent, state-

owned banks Consequently, this allowed it to function solely as a central bank by 1983

This central bank status was legally confirmed in 1995 by the 3rd Plenum of the 8th National People’s Congress

However, it still had supervisory responsibilities over the financial sector

In 1998, the PBC went through a major restructuring All local and provincial branches were abolished and it opened 9 regional branches

These regional branches’ boundaries did not correspond to local administrative boundaries

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History (cont.)Finally, in 2003, an amendment was passed that granted the PBC a much more prominent role in China’s macroeconomic management The Standing Committee of the 10th National People’s Congress approved an amendment to create the

China Banking Regulatory Commission This agency took over the PBC’s supervisory responsibly such as overseeing reform and

regulation of the banking sector This allowed the PBC to focus exclusively on making and implementing monetary policy

1948PBC established

1983Commercial banking

operation divided among 4 state-owned banks; PBC allowed to

function solely as a central bank

1995Legal status as a

central bank confirmed

1998Major restructuring; local and provincial

branches abolished; 9 regional branches

formed

2003China Banking

Regulatory Commission formed to

supervise financial sector; PBC now able

to focus exclusively on monetary policy

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OrganizationHow is the PBC organized? It has 9 regional branches, 2 operations offices, 303 municipal sub-branches, and 1,809 county-level

sub-branches In addition, the PBC has 18 functional departments (think of them as bureaus), all of which are

outlined belowGeneral Administration DepartmentLegal Affairs DepartmentMonetary Policy DepartmentFinancial Market DepartmentFinancial Stability BureauFinancial Survey and Statistics DepartmentAccounting and Treasury DepartmentPayment System DepartmentTechnology DepartmentCurrency, Gold and Silver BureauState Treasury BureauInternational DepartmentInternal Auditing DepartmentPersonnel DepartmentResearch BureauCredit Information System BureauAnti-Money Laundering Bureau (Security Bureau)Education Department of the CPC PBC Committee

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Monetary Policy DecisionsWho makes the monetary policy? Monetary policy and macroeconomic management

is carried out by the Monetary Policy Committee of the PBC This committee is composed of about 13

members including the governor and 2 deputy governors of the PBC

The committee plays an advisory role on the basis of comprehensive research on the macroeconomic environment and the macro targets set by the government

It operates under the guidance of and must report to the State Council

How often does the committee make monetary policy decisions? The PBC meets every quarter to analyze the

domestic and foreign macroeconomic situation and make or adjust policy to maintain financial stability

However, it may schedule an ad-hoc meeting given extraordinary and unexpected circumstances if proposed by the governor or endorsed by more than 1/3 of the members of the committee

PBC's Governor

2 Deputy Governors

Deputy Secretary-General of the State Council

Vice Minister of the State Development and Reform Commission

Vice Finance Minister

Administrator of the State Administration of Foreign Exchange

Chairman of the China Banking Regulatory Commission

Chairman of the China Securities Regulatory Commission

Chairman of the China Insurance Regulatory Commission

Commissioner of the National Bureau of Statistics

President of the China Association of Banks

Expert from the academia

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LeadershipPBC’s management structure The top management of the PBC is currently composed of a governor and 9 deputy governors The governor is appointed into or removed from office by the President of China

The candidate for governor is nominated by the Premier of the State Council and is approved by the National People’s Congress

The deputy governors are appointed into or removed from office by the Premier of the State Council

What are their duties/roles? The governor supervises the overall work of the PBC The deputy governors provide any necessary support to assist the governor fulfill his responsibilities

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Leadership (cont.)

Zhou Xiaochua

Yi Gang Wang Huaqing Chen Yulu Pan Gongsheng

Fan Yifei Guo Qingping Zhang Xiaohui Yang Ziqiang Yin Yong

Monetary Policy

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Economic Background

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Economic Background (cont.)China’s exports / imports China’s exports and imports are about 22.6% of its GDP In 2015, the average price of imported goods decreased 10.9%, dragging down import growth Total import value: ￥ 10.4 trillion Total export value: ￥ 14.1 trillion In 2015, China had a trade surplus of ￥ 3.7 trillion

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Economic Background (cont.)Who are China’s main trading partners? China’s main trading partners are the United States, Hong Kong, Taiwan, Europe, Japan, Australia,

Germany, South Korea, Brazil, Russia, and ASEAN countries (Indonesia, Malaysia, Philippines, Singapore, Thailand, Vietnam, Laos, Myanmar, and Cambodia)

Exports to the US and ASEAN grew rapidly this past year, while exports to Europe and Japan declined

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Economic Background (cont.)

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Economic Background (cont.)China’s interest rates The average interest rate in China between the years of 1996 – 2015 is 6.35% In 2015, the PBC lowered the interest rate to 4.35%

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Economic Background (cont.)Unemployment in China China has an average unemployment rate of 4.0% In 2015, the unemployment rate was the lowest since the 2008 financial crisis Urban register unemployment rate is 4.05% In recent years, there has been a gradual decrease in the demand for labor

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ObjectiveWhat is the PBC’s objective? The formal objective of the PBC’s monetary policy is “to maintain the stability of the value of the

currency and thereby promote economic growth” Inflation is the primary target of the PBC, facilitating the achievement of the other objectives

(employment, growth, balance in payments) China has a 4% goal for inflation

What instruments does it use to achieve this objective? The PBC uses a mixed set of monetary policy instruments

Direct, quantitative controls Indirect, market-oriented instruments

Direct, quantitativ

e

Indirect, market-based

Monetary policy

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Instruments

Reserve Requirement

RatioLending and

Deposit Rates

Window Guidance

Open Market Operations

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Instruments (cont.)Reserve requirement ratio Top-down, direct monetary policy instrument Requires banks to hold a proportion of deposits in reserve Most actively used “standard” instrument Keys:

Widely used because China’s banking sector plays a huge role in the Chinese financial system An important advantage of using this ratio as a policy tool is that it can be used to effectively

freeze funds until the bank decides on the ratio again

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Instruments (cont.)Reserve requirement ratio (cont.) Ratios vary between 3 types of banks:

Small & Medium Depository Institutions: 17.5% Large depository institutions: 19.5% Rural credit cooperatives and small financial institutions: 16%

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Instruments (cont.)Lending and deposit rates Market-oriented monetary policy instrument The PBC sets a benchmark 1 year lending and deposit rates (rates at which banks charge their

borrowers or pay their depositors) 2nd most actively used instrument Keys:

Pre-1990, this was treated as a secondary instrument Post-1990, this gained popularity due to a series of interest rate liberalization steps initiated by

the bank Most of the money market and bond interest rates are determined by the market, but the PBOC

still controls the benchmark deposit and lending rates

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Instruments (cont.)Lending and deposit rates (cont.) Benchmark rates were cut four times in seven months between November 2014 and June 2015 in an

attempt to improve credit growth

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Instruments (cont.)Window guidance Administrative monetary policy instrument Executive meetings with reps of selected financial institutions, usually from the Big Four state-own

banks Purpose of these meetings is to exercise administrative pressure on financial institutions to act in line

with official prescriptions Keys:

Window guidance has been crucial in preventing events of excessive credit expansion in the early 2000’s

Since problems arose in industry specific sectors as opposed to economy wide, window guidance was aimed to precisely target these problematic sectors rather than distort the entire economy

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Instruments (cont.)Open market operations Market-oriented policy instrument Used sparsely pre-1990 just like interest rates due to limited knowledge and experience in

implementing it Only more recently, with the progressive development of foreign exchange and treasury bond

markets, this instrument has become increasingly important in China The PBC’s holding of government treasury bonds rose from 283 billion yuan in the 2nd quarter of 2007

to 1.6 trillion yuan in the 4th quarter of 2007

Monetary Policy Statement

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Global OutlookGlobal growth is slow Global GPD growth is now projected at 2.5%, which is 0.3% lower than the November outlook China’s financial uncertainty, decrease in commodity prices, and the slow growth of the US

economy

Global trade Appreciation of the US Dollar has contributed to the fall in exports Chinese capital outflows at an alarming rate Chinese economy is shifting from a manufacturing economy to a services-based economy

Global investment Decline in energy prices have been so large that markets have considered higher default risks for

banks Uncertainty regarding the global economic outlook, and capital outflow from China Unstable capital flows and high debt risks in emerging economies

Appreciation of the US Dollar External liabilities in EME’s

Rising borrowing costs

Global commodity prices Supply > Demand Lower commodity prices should help consumers but has actually slowed investment

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Global Outlook (cont.)Global economic environment US: GDP and job growth has been disappointing

Should remain stable, sustained by domestic demand Europe: economic environment has improved

Should continue growing, driven by domestic demand Asia: growth is unlikely to improve Other emerging countries: slow and uncertain growth

Decrease in oil and commodity prices Unstable capital flows and high debt risks Borrowing costs are rising, hurting EME’s with a lot of external liabilities

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Domestic OutlookHow does China’s economy look? The world’s second largest economy has been performing poorly Growth rate: 6.9%

Short of the 7.3% growth rate in 2014 Slowest pace since 1990 Projected to decline to 6.2% by 2017 (OECD)

Chinese exports fell by 11.2% in January year over year 7th straight month of decline

China’s Northeast is already in a deep recession Negative growth after factoring in deflation

Imports fell by 18.8% 15th straight month of decline

Capital outflows at an alarming rate Estimated $1 trillion in 2015

Growth is slowing and rebalancing from manufacturing to service

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Domestic Outlook (cont.)

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Domestic Outlook (cont.)How does China’s economy look? (cont.) Currency depreciation

Inflation rate of 1.8% in January 2016 Unemployment remained stable at around 4.05% Growth in consumer spending and income did not fall as much

Central government support Credit support from banks

Declining reserves Dropped by around $500 billion Lowers confidence in the central bank’s ability to defend the currency

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Balance of RiskWhat does China expect going forward? To “maintain the stability of the value of the currency and

thereby promote economic growth” Inflation projections:

Target: 4% inflation Q1 inflation: 1.8% Expected yearly: 2.2-2.5% Much lower than expected :(

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Balance of Risk (cont.)

Projected decrease in

output

Projected decrease in

current account

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What’s Going On?What’s going on with China? Between the stock market volatility, decreased

expectations, and capital outflow…

China has a problem!!!

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Impossible Trinity

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Cost?Current downward pressure on currency Result → currency goes to maintenance From $3.438 trillion to $3.330 trillion

Lost $108 billion Not much, but want to stop from accelerating What happens when out of reserves?

Mexico Peso Crisis Asian Financial Crisis

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Why the Sticky Situation? IMF - Special Drawing Rights (SDR) China Policy – want stable currency Don’t want wild fluctuations, panic, suddenness, or uncertainty

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Which one not to Have? Loose Exchange Rate

Wild fluctuation and devaluation in currency Sudden change leads to panic, crisis, and probably

recession. Capital Controls

Builds mistrust Usually associated with poor governance Most cases: did not support financial stability

Lose Independent Monetary Policy Leads to loss in reserve Only have so much reserve

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Transition

Fixed Exchange Rate

Looser Exchange Rate

Floating Exchange Rate

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Policy RecommendationConventional policies Lower Interest Rate Lower Reserve Requirement More flexibility with exchange rate (over

course)

Unconventional policies Chinese Quantitative Easing (QE)

Rather than bankroll projects directly → PBC is pumping funds into state lenders known as policy banks to finance government-backed programs

Instead of buying shares to prop up a faltering stock market → it’s aiding a government fund that’s seeking to stabilize prices

Instead of purchasing municipal bonds in the market → it’s accepting such notes as collateral and encouraging banks to buy the debt

“The first thing policymakers have to understand is that current outflows are driven by fear. The constant swerving in policy that has marked the past year has done little to build credibility with investors, whether foreign or domestic. If instead China demonstrated a clear, unambiguous commitment to financial reform, that would reestablish trust and ease at least some investor anxieties.” -Bloomberg

Lower interest rate

Lower reserve requirement

More flexible exchange rate

Quantitative easing

Healthy economy

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What it’s Done Dropped RR by 0.5%

RR 17% (still one of the highest ratio)  

Injected 685 Billion Yuan ($105 billion)

Reversal in the central bank’s stance from two months ago

BAD TIMING (credit) Just assured group of 20

finance chiefs it wouldn’t weaken yuan

Went ahead and weakened the yuan

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Policy Recommendation (cont.)Expanding currency leash (looser peg) Wiggle Room to use monetary policy Enough control to stop any wild fluctuations Gradual step to floating exchange rate Reduce the reserve loss rate Boost exports, spur inflation

More credibility Try making the Central Bank independent Have clear non-conflicting available data Clarity and availability Don’t go back on word

Cooperating with Third Party Cooperation with IMF or World Bank would increase credibility Make plan for next couple of years visible and stick with it

Economists said with the yuan's inclusion in the IMF basket as a reserve currency now looking like a formality, China should step up efforts to build trust between global investors and its policy makers.-Bloomberg

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Questions

Q: What are the 4 instruments China uses to affect monetary policy?

A: Reserve requirement ratio, lending and deposit rates, window guidance, and open market operations

Q: What 3 items compose the impossible trinity?

A: Free capital flow, a fixed exchange rate, and independent monetary policy