The 2024 NetEase Economist Annual Conference & Summer Forum, co-hosted by the China Enterprise Reform and Development Research Association, NetEase Finance, and NetEase Finance Think Tank, was held in Shanghai in July. The theme of this year's forum was "Intelligent Manufacturing Gathers Strength, Quality Renews Life."

Professor Sheng Songcheng, a professor of Economics and Finance at China Europe International Business School, delivered a speech titled "Monetary Policy is Effective but Limited, Strengthening Policy Coordination is Needed." The speech covered four aspects: First, the foundation of the current economic recovery still needs to be consolidated; Second, monetary policy is effective but limited; Third, fiscal policy needs to be more proactive, with monetary policy support; Fourth, central bank transactions in government bonds will gradually become one of the tools of China's monetary policy.

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In the first aspect, the foundation of China's economic recovery still needs to be strengthened. Sheng Songcheng stated that the foundation of the current economic recovery still needs to be consolidated, with the overall trend moving in a positive direction, but the progress is relatively slow. As a forward-looking indicator of the economy, financial data has significantly declined since April this year. Financial data also reflects the operation of the economy. With monetary policy maintaining a supportive stance, the main reason for the weakening financial data is the insufficient effective demand, and the internal growth momentum of the economy still needs to be enhanced.

At the end of May, the balance of narrow money (M1) was 64.68 trillion yuan, a year-on-year decrease of 4.2%, the lowest value since the data was available. The decline in M1 is mainly due to the reduction of demand deposits of enterprises and institutions, especially the reduction of corporate demand deposits, while cash changes are not significant. There are mainly three reasons for the reduction of corporate demand deposits:

(1) Corporate deposits become term deposits. Corporate term deposits are not included in M1 but are included in M2. Why do enterprises choose term deposits instead of demand deposits? If enterprises want to invest, they need to buy raw materials, pay wages, etc., and need to write checks, which can only be done with demand deposits, not term deposits. Therefore, if enterprises invest in the short term, they will place their funds in demand deposits. Now that the willingness of enterprises to invest has decreased, demand deposits have reduced, and funds have been moved to term deposits, which also offer higher interest rates than demand deposits.

(2) The real estate market is declining. Since the beginning of this year, the real estate market has seen a decline of almost more than 20% in both sales and scale compared to the same period last year. The sales proceeds of real estate companies are usually placed in demand deposits because real estate companies may need to use them at any time. Now that the real estate market is declining, the demand deposits of real estate companies have also decreased.

(3) Resident consumption demand is still weak. If consumption demand increases and flows to enterprises, it becomes corporate demand deposits. Currently, weak consumption demand suppresses the transformation of resident deposits into corporate deposits.

In the second aspect, monetary policy is effective but limited. Sheng Songcheng stated that unlike fiscal policy, which can directly intervene in economic activities, monetary policy generally plays an indirect role and requires the cooperation of financial institutions, enterprises, and residents. The effectiveness of its implementation is largely influenced by market feedback.

Currently, the excess reserve rate of financial institutions in China is relatively low, and liquidity can be directly adjusted through reserve requirement ratio cuts. In the past two decades, the excess reserve ratio in China has been as high as 7.9%, but as of the end of the first quarter of this year, it was only 1.5%.

The effectiveness of monetary policy implementation also largely depends on the overall economic cooperation. Another prominent example is the use of structural monetary policy tools. In supporting weak links in the economy, agricultural and small business re-lending have played a significant role; and the use of quotas related to high-quality economic development, such as carbon emission reduction support tools and special re-lending for equipment updates and renovations, has also been quite sufficient.The third aspect is that fiscal policy needs to be more proactive, with monetary policy providing support. Sheng Songcheng pointed out that currently, the growth rate of investment has slightly declined. From January to May, fixed asset investment increased by 4.0% year-on-year, with the growth rate falling by 0.2 percentage points compared to January to April. Among them, infrastructure investment increased by 5.7% year-on-year, with the growth rate falling by 0.3 percentage points compared to January to April; manufacturing investment increased by 9.6% year-on-year, with the growth rate falling by 0.1 percentage points compared to January to April; real estate development investment decreased by 10.1% year-on-year, with the decline expanding by 0.3 percentage points compared to January to April. To achieve this year's economic growth target of around 5%, there is still a gap in investment, hence fiscal policy needs to be more proactive.

At the end of May this year, the stock of social financing increased by 8.4% year-on-year, with the growth rate increasing by 0.1 percentage points compared to the end of April. In May, social financing increased by 2.06 trillion yuan, of which net financing of government bonds reached 1.2 trillion yuan (accounting for 59.2% of the increase in social financing in May). Net financing of government bonds in May accounted for nearly half of the net financing from January to May, indicating that the issuance of government bonds has significantly accelerated, and fiscal policy has been strengthened and improved.

How should monetary policy cooperate? Reducing the reserve requirement ratio is the main means for China's monetary policy to cooperate with fiscal policy, which is different from Western countries. This is because most of China's national and local government bonds are purchased by commercial banks. Currently, about 70% of Chinese national bonds and about 82% of local government bonds are held by commercial banks. If the reserve requirement ratio is reduced, it will increase the funds that commercial banks can freely use, thereby better supporting the issuance of national and local government bonds.

Since 2016, China's statutory reserve requirement ratio has been adjusted 21 times, all downward adjustments (reducing the reserve requirement ratio). Currently, the weighted statutory reserve requirement ratio for financial institutions is 7.0%. In contrast, China's policy interest rates have only been adjusted 12 times.

Currently, the Loan Prime Rate (LPR) has reached a new low since the reform in 2019. By the end of 2023, the net interest margin, an important indicator for commercial banks, fell to 1.69%, breaking through the 1.7% threshold for the first time. By the end of the first quarter of this year, the net interest margin of commercial banks further decreased to 1.54%.

The fourth aspect is that the central bank's buying and selling of government bonds will gradually become one of the tools of China's monetary policy. Sheng Songcheng said that the Central Financial Work Conference held last year proposed to "enrich the monetary policy toolkit and gradually increase the buying and selling of government bonds in the central bank's open market operations." Currently, China's government bond market has become the third largest in the world, with liquidity significantly improved, and the conditions for the central bank to issue base money by buying and selling government bonds in the secondary market are gradually ripening.

He believes that gradually including the buying and selling of government bonds in the secondary market into the monetary policy toolkit is a gradual process and cannot be achieved overnight.

Firstly, the issuance pace, term, and coupon rate of government bonds all involve monetary policy operations, thus putting higher demands on government bond issuance. China has a relatively small proportion of short-term government bonds, accounting for about 18%, while the United States accounts for 34%, which is almost double that of China. If buying and selling government bonds are included in the monetary policy toolkit, more short-term government bonds are needed.

Secondly, the central bank's buying and selling of government bonds becoming a routine operation also puts new demands on monetary policy, such as the frequency and scale of operations, the remaining maturity of government bonds held by the central bank, and more importantly, the impact of changes in government bond pricing on the prices of other market assets is significant, because government bonds are risk-free assets, and government bond yields are the basis for financial market pricing.

The current new situation is that financial institutions are buying a large amount of long-term government bonds, leading to a decline in government bond yields. The central bank, out of consideration for maintaining financial stability, will borrow government bonds and sell them in a timely manner. Currently, the total assets of China's central bank are about 43 trillion yuan, of which government bonds account for only 3.5%, while the total assets of the Federal Reserve are about 7.2 trillion US dollars, with government bonds accounting for 61.6%. Therefore, at this stage, China is still difficult to carry out routine operations of buying and selling government bonds like the Federal Reserve.