Monetary Management in Mainland China in the Face of Large Capital Inflows

Abstract

Recent surges of capital inflows to mainland China have prompted the People's Bank of China (PBoC) to improve its monetary management techniques. Increasing sophistication in open market operations has allowed the PBoC to sterilise the impact of foreign exchange intervention on domestic liquidity. The PBoC carried out 110 open market operations in 2004, through which 42 percent of the increase in domestic liquidity as a result of foreign exchange purchase was sterilized. By the end of 2004, the outstanding amount of central bank bills amounted to close to RMB1 trillion yuan, equivalent to about 17 percent of reserve money or 7 percent of nominal GDP. Preliminary econometric analysis shows that the reaction by the PBoC has been strong and swift. The central bank has also become more active in sterilisation operations in the last couple of years. Nevertheless, it is difficult to judge the effectiveness of these operations in insulating domestic monetary conditions from surges of capital inflows. Although there appears to be little indication that capital inflows have had a causal effect on domestic credit growth, this observation may simply reflect the possibility that there is no effective transmission mechanism between changes in the PBoC's balance sheet and those of the commercial banks.

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