China Money Supply: The New Normal
By Suyang Zhou - Research Analyst
China’s narrow money supply, M1, has outpaced its broad money supply, M2 since Oct 2015. The difference between the two reached a maximum of 15.2% in July 2016 and became slightly narrower afterwards. The major reason of such narrowing is due to a slowdown of M1 growth, rather than acceleration of M2 growth. In fact, y-o-y growth of M2 broke the 10% level and was trending down further in June.
Why does M1 Growth Accelerate?
By drilling into the breakdown of M1, we find spikes in current deposits of non-financial enterprises and government agencies are the major drivers.
The year-over-year growth of current deposits of the aforementioned has been closely moving together since the beginning of 2016 at around 20% increase. Why?
The first and foremost issue is the up cycle of the property market since early 2015. The booming home sales transferred household savings into the current deposits of property developers, which propped up growth of current deposit of non-financial enterprises. However, after local authorities started to tighten home policy, the up cycle ended in 3Q2016. This clearly led to slowing growth in current deposit of non-financial enterprises.
Besides, after several rate cuts since 2015, spread between current deposit and fixed term deposit has been shrinking significantly. For example, the difference between the one-year saving rate (1.5%) and the current account rate (0.35%) is only 115 bps for the time being. Thus, the opportunity cost of holding current deposits by non-financial enterprises is much lower.
The reason for the spike of current deposits in government agencies is increased local government debt swaps. Since there is a time difference between debt swap and final repayment, government agencies tend to save the swapped debt in their current account prior to repayment, resulting in increase of their current deposit.
Why does M2 Growth Lose Momentum?
Above all, we can break down M2 into two parts: 1) M2 held by financial sector, and 2) M2 held by non-financial sector.
We found that M2 held by the non-financial sector is pretty stable with growth rate above 10%, while M2 held by the financial sector slumped since Feb 2016, from 45% to less than 2% recently. It's safe to say declining growth in financial M2 leads to slowdown of entire M2.
According to PBOC, the Chinese Central Bank, the deceleration of financial M2 is a reflection of financial deleverage. With regulation tightened and escalated, year-over-year growth in equity and other investments, which are closely related with off-balance sheet and shadow banking terms, have tumbled in recent months. This results in declined M2 growth. Further M2 slowdown will become the 'New Normal' amid continued financial deleverage.
Monetary Policy Outlook
Monetary policy will be stable and neutral in the foreseeable future for two reasons. First, the economy is growing well, and GDP in 2Q2017 even beat market consensus. Second, the previously low-cost funding has spurred many problems, including the volatile property sector, heightened financial risk, corporate over-borrowing, and mounting debt by local government. So overall speaking, no monetary ease is expected.