Can China meet its 2009 money supply target?

TheChinaPost: China said it wants to increase money supply by 17 percent in 2009 as part of new measures to keep the world’s fourth-largest economy ticking over in the face of the global slowdown.

The government has taken a number of measures to boost domestic demand and cope with the downturn, including repeated interest-rate cuts and a four trillion yuan (US$586 billion) stimulus package announced last month.

In the latest steps, posted on government Web sites late on Saturday, China said it would aim to expand the broad M2 measure of money supply by 17 percent.

It said liquidity for banks would be addressed with shorter term bills, and that more rate cuts and foreign exchange flexibility would be considered. “In order to face the attacks of the global financial crisis... we must expand the scope of financial supports,” the State Council or Cabinet said.

The new measures are “aimed at expanding domestic demand,” it said. China’s M2 money supply growth target for 2008 was 16 percent.

Among other proposals, the Cabinet urged the completion of the Growth Enterprise Board, a Nasdaq-style trading entity aimed at helping small start-ups gain better access to capital markets.

After years of blistering double-digit growth that has turned once agrarian China into a world economic powerhouse, the economy grew at only nine percent in the third quarter, and fourth-quarter numbers are set to be even worse.

China fears that growth at less than eight percent will fail to keep unemployment in check and provide jobs for the vast numbers of people entering the workforce each year in the world’s most populous nation.

“If China’s GDP growth rate falls to six or seven percent, the quality of development would be seriously impacted,” Liu Mingkang, chairman of the China Banking Regulatory Commission, was quoted as saying Saturday.

“China’s economic and financial outlook is not optimistic and Chinese banks will face stern challenges in 2009,” Liu said.

MyTake: The previous vigorous monetary tightening policy to stem the overheating economy, high inflation and hot inflows of money into China has so far created the following effect:

monetary tightening--> interest rate goes up-->economic growth slows-->m2 supply reduces--> credit growth slows-->inflation reduces

However, the tonic proves too strong as the economic numbers are weakening faster than expected. Egs economic growth faltering fast, unemployment on the rise, m2 supply rapidly declining, inflation fast becoming disinflation and probably going into deflation, credit expansion becomes credit contraction.

What China is doing right now is directly the opposite it did earlier(plus fiscal stimulus). The monetary loosening policy stance now amongst others include reducing interest rate, increasing investment and the supply of m2.

I would like to briefly elaborate on the M2 supply in China and it significance. The proposed growth rate of 17% is not considered much different from its target 2008 growth rate of 16% but it is of great hope that such figure can be achieved in view of the weak economic picture. It is important to note that a slowing M2 supply is one of the main ingredients for deflation. By printing money may create liquidity but if banks are reluctant to lend the money will not be circulated. Although the government has stepped in to spur lending, credit conditions still show a lack of liquidity in loans between banks and to consumers. However, I do agree that some progress is seen lately and hopefully improving further. In order for bankers to overcome fear of default and consumers confident to spend, counterparty risk (risk of default) must be reduced – a rather difficult proposition in a weak economy.

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