Abstract

After 2018, local government bonds and national debt in China were successively included in the social financing scale statistical indicators. This move aligns with the definition and original intent of the social financing scale statistics. The revised social financing scale not only comprehensively reflects the transmission of monetary policy but also embodies the coordination between monetary and fiscal policies from multiple dimensions, and more perfectly delineates the relationship between finance and the economy. The revision of statistical standards is a routine international operation aimed at enhancing the precision of macroeconomic regulation. Under the coordination of proactive fiscal policy and prudent monetary policy, the social financing scale that includes government bonds has become a leading indicator of the economic recovery and improvement in China.

Keywords

Social Financing Scale, Government Bonds, Monetary Policy, Fiscal Policy

The social financing scale indicator, introduced 13 years ago, has become well-known and highly regarded by governments at all levels, market participants, and the academic community. By definition, the increase in social financing scale refers to the amount of funds that the real economy obtains from the financial system within a certain period (monthly, quarterly, or annually). The financial system here is a holistic concept: from an institutional perspective, it includes banks, securities, insurance, and other financial institutions; from a market perspective, it encompasses credit markets, bond markets, stock markets, insurance markets, and intermediary service markets. The statistical scope of the social financing scale includes two dimensions: on the one hand, it is the assets of financial institutions, mainly reflected in the support of funds for the real economy through new loans; on the other hand, it is through the issuers in the financial markets, where the real economy obtains funds through direct financing, mainly manifested in stocks, bonds, etc.

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The social financing scale is theoretically supported by the credit view of the monetary policy transmission mechanism. The introduction of this statistical indicator is in line with China's economic and financial environment, characterized by continuous innovation in financial markets and products, rapid development of direct financing, the strengthening role of non-bank financial institutions, and significant changes in the social financing structure.

Including government bonds in the social financing scale statistics is in accordance with the definition and scope of the social financing scale statistics and is consistent with the original intent of the social financing scale design. On the one hand, as a sector of the real economy, the government can directly engage in economic activities such as investment and purchases after obtaining funds through financial markets, promoting the development of the real economy. Therefore, government bonds reflect the funds obtained by the real economy from the financial system. On the other hand, at the beginning of the social financing scale indicator design, the scale of government bonds was small and thus not included in the statistics. Starting from September 2018, the People's Bank of China included "local government special bonds" in the social financing scale statistics because since August 2018, the issuance of local government special bonds has accelerated, showing a clear substitution effect on bank loans and corporate bonds, and its scale and impact on the financing of the real economy can no longer be ignored. Furthermore, to better reflect the macro and sectoral leverage ratios, and to facilitate the coordination of fiscal and monetary policies, in December 2019, the People's Bank of China included "national debt" and "local government general bonds" in the social financing scale statistics, merging with the existing "local government special bonds" into the "government bonds" indicator.

In recent years, the role of the Chinese government in promoting high-quality economic development, exerting counter-cyclical adjustments, and preventing and resolving financial risks has been increasingly strengthened, and the scale of government bonds has risen accordingly. It can be seen that the inclusion of government bonds in the social financing scale statistics, which began five years ago, was a timely and progressive measure.

The social financing scale that includes government bonds more comprehensively reflects the transmission of monetary policy.Since the Central Economic Work Conference first proposed in December 2010 the need to "maintain a reasonable scale of social financing," the indicator of social financing scale has been continuously included in the documents of the Central Economic Work Conference and the "Government Work Report." The Central Economic Work Conference held in December 2023 put forward that "the scale of social financing and the money supply should be matched with the expected targets of economic growth and price levels." It can be seen that the scale of social financing and the money supply constitute the "two intermediate targets" of China's monetary policy regulation.

After calculation, including government bonds, the average annual growth rate of the stock of social financing from 2015 to 2023 increased by 1.5 percentage points, while from 2003 to 2014, the average annual growth rate decreased by 0.2 percentage points, reflecting the increasing proportion of government bonds in the social financing scale. As of the end of December 2023, the proportion of government bonds in the stock of social financing was 18.5%, while before 2015, this proportion was basically below 10%.

After including government bonds, the relationship between the scale of social financing and the broad money supply (M2) has changed. When the government issues bonds, it raises funds by absorbing bank deposits from other sectors (individuals, enterprises, and non-deposit financial institutions, etc.) or by promoting commercial banks to adjust their asset structure (such as using liquid assets to purchase bonds, with liquid assets mainly being excess reserves), thereby forming fiscal deposits, which are not included in M2. In the following period, fiscal deposits will be reformed into deposits of other sectors through expenditure and investment, so the scale of social financing will change to some extent before M2. According to calculations, from 2002 to 2023, after including government bonds, the correlation coefficient between the monthly increase in the scale of social financing and the monthly increase in M2 decreased by 3.3%, but the correlation coefficients with the increases in M2 lagged by one month, two months, and three months increased by 1.7%, 1.9%, and 5.4%, respectively. This confirms the conclusion stated earlier that the scale of social financing changes before M2.

After including government bonds, the relationship between the scale of social financing and economic growth has become closer. According to calculations, from 2002 to 2023, after including government bonds, the correlation coefficient between the annual growth rate of the quarterly stock of social financing and the annual growth rate of nominal Gross Domestic Product (GDP) for the quarter increased by 2 percentage points, and the correlation coefficient with the annual growth rate of nominal GDP lagged by one quarter increased by 0.6 percentage points, but the correlation coefficient with the annual growth rate of nominal GDP lagged by two quarters decreased by 1.1 percentage points. This means that the scale of social financing including government bonds can more timely reflect the changes in economic growth.

Monetary policy can effectively affect the scale of social financing, and the scale of social financing also has a significant impact on the economy, prices, and investment, which is the transmission process of monetary policy intermediate targets to ultimate targets. It can be seen that with the increase in the scale of government bonds, only by including government bonds can the scale of social financing more comprehensively and timely reflect the transmission of monetary policy, especially the role of monetary policy in promoting economic growth.

The scale of social financing including government bonds reflects the coordination and cooperation between monetary policy and fiscal policy. As the two most important macroeconomic policies, monetary policy and fiscal policy need to be coordinated, among which the most concerned and core content of cooperation is how the monetary system supports the issuance and trading of government bonds. The holder structure of government bonds, especially Treasury bonds, can roughly show the way monetary policy and fiscal policy are coordinated.

As of the end of December 2023, China's Treasury bonds are mainly held by domestic commercial banks (accounting for 65.2% of the stock), and the central bank's holding ratio is only 5.2%. The main holders of local government bonds are also domestic commercial banks (accounting for 81.9% of the stock). As of the end of October 2023, 14.6% of the U.S. Treasury bond stock is held by the central bank (before the tightening of quantitative easing in May 2022, this ratio was 18.9%), and the holding ratio of domestic banks is only 5.1%. It can be seen that China mainly relies on domestic commercial banks to provide financing for Treasury bonds and local government bonds, while the U.S. central bank holds a higher proportion of Treasury bonds, and the related monetary policy operation tool is quantitative easing. This reflects the differences in the coordination methods of fiscal policy and monetary policy between China and the United States.

Focusing on China, the People's Bank of China comprehensively uses tools such as open market operations (OMO), medium-term lending facilities (MLF), re-lending, and re-discounting to inject base money, while adjusting the money multiplier through reserve tools to maintain reasonable and sufficient liquidity, providing strong support for the reasonable growth of the scale of social financing and monetary credit. In this process, government bonds are an important factor affecting the operation of monetary policy tools, and the use of monetary policy tools will also have a counter-effect on the issuance and trading of government bonds. Therefore, from the perspective of the transmission of intermediate targets by monetary policy operations, the scale of social financing including government bonds reflects the coordination between monetary policy and fiscal policy. It is specifically manifested in the following three aspects.Firstly, open market operations smooth out short-term liquidity disturbances caused by government bond issuance payments. Since the People's Bank of China began piloting open market operations in 1996, the participants in the government bond trading market have expanded from residents and industrial and commercial enterprises to financial institutions represented by commercial banks. Currently, government bonds in China are mainly issued in the interbank market, which is also the venue for the central bank's open market operations. When government bond issuance payments cause short-term and phased disturbances to interbank liquidity, the central bank, based on monetary policy objectives, needs sufficient tools to smooth out these disturbances and maintain a reasonable and adequate short-term liquidity. At this time, monetary policy tools provide short-term liquidity support for government bond issuance, ensuring the smooth sale of government bonds. This is the current practice of central banks in major global economies for open market operations.

Secondly, the Medium-term Lending Facility (MLF) affects government bond yields through a dual mechanism of base money injection and policy rate guidance. The MLF is a monetary policy tool through which the central bank provides medium-term base money to the banking system, operated once a month, mainly with one-year term operations, and has become the main channel for base money injection in China. By the end of December 2023, the MLF balance was 7.075 trillion yuan. Relying on the MLF, liquidity is transmitted from the banking system to the entire financial system layer by layer, thereby providing funds for the financial system to invest in and trade financial assets. At the same time, the MLF rate plays the role of a medium-term policy rate, affecting the balance sheets of financial institutions and market expectations by adjusting the cost of medium-term financing from the central bank to financial institutions, thereby affecting the yield to maturity of government bonds, a core financial asset. Experience has shown that when the MLF operation rate is lowered, the yield to maturity of government bonds on the same day will also decline. The yield to maturity of government bonds is the basis for the pricing of the coupon rates of newly issued bonds, and the coupon rate is the financing cost of the government sector.

Thirdly, the reserve requirement ratio can adjust the long-term liquidity level of commercial banks, affecting their willingness to hold and purchase government bonds. As the main purchaser and holder of government bonds, the medium and long-term liquidity level of commercial banks is one of the main factors affecting their long-term holding decisions for government bonds. A reduction in the reserve requirement ratio will provide relatively abundant medium and long-term funding support for the asset allocation of commercial banks, and the allocated assets naturally include government bonds. Therefore, unlike the main global economies, reducing the reserve requirement ratio is a unique way for China's monetary policy to cooperate with fiscal policy, which stems from the fact that commercial banks are the main holders of China's government bonds.

It can be seen that, whether it is due to the need for operational purposes or the transmission of operational mechanisms, monetary policy tools interact with the issuance and trading of government bonds by adjusting short-term, medium-term, and long-term liquidity, which will ultimately be reflected in the changes in the social financing scale. If government bonds are not included in the social financing scale, it would be difficult to fully reflect the impact and cooperation of monetary policy with fiscal policy.

Revision of statistical standards is a routine operation internationally.

With the development of the social economy and the innovation of financial instruments, economic indicators are not static, and the revision of statistical standards is also a routine operation internationally. For example, the Federal Reserve began to calculate and release money supply statistics in the 1960s. With the development of financial practices, the Federal Reserve has revised the money supply statistics 16 times. Japan began monetary statistics before 1949. To adapt to changes in the economic and financial structure, Japan has also modified its monetary statistics multiple times.

Since China introduced the money supply indicator system in 1994, the money supply has undergone three major adjustments. Each adjustment stems from new situations and changes in the economy and financial markets. The adjusted money supply can more accurately reflect the scale of liquidity in the economic system, and the adjustment itself has improved the central bank's monetary monitoring work, increasing the precision of macro-control. Specifically, the three major adjustments to China's money supply statistical standards are: in 2001, the customer margin of securities companies was included in M2, in 2002, the RMB deposits of foreign banks and joint financial institutions in China were included in different levels of money supply, and in 2011, the deposits of the housing provident fund center and the deposits of non-deposit financial institutions in deposit financial institutions were included in M2.

The definition of the social financing scale seems simple, but in fact, a short sentence definition not only summarizes the essence of the social financing scale but also leaves room for future improvement and revision of the indicator. With the development and changes of the economy and finance, the revision of the social financing scale indicator is normal, and its revision should take into account two aspects: on the one hand, it should consider the principle of enhancing relevance, that is, to improve the sensitivity of the social financing scale to reflect economic changes and enhance the correlation with economic output, prices, and other variables. As calculated above, after including government bonds, the relationship between the social financing scale and nominal economic growth rate is closer. On the other hand, it should also consider the principle of measurability and statistical cost-benefit comparison. Data with small amounts and high statistical costs can be temporarily excluded, which does not hinder the application of the indicator.

Summary and Outlook

In summary, including government debt in the social financing scale indicator is timely and necessary, which can fully reflect the transmission of monetary policy and better reflect the cooperation between monetary and fiscal policies. Looking forward, proactive fiscal policy and prudent monetary policy are important measures for China to consolidate and enhance the upward trend of the economy. With the continuous development of the economy and the need to prevent and resolve risks, China's government debt scale may continue to rise in the next few years. Prudent monetary policy should cooperate with proactive fiscal policy to ensure the smooth issuance of government bonds and provide relatively stable financing interest rates for the government, thereby meeting the government's investment and purchase funding needs, boosting total demand, and strengthening the financial support for the real economy.