Monetary policy of China likely to be prudent but moderately loose

China's Premier Li Keqiang had stated in February that the country in 2016 will continue to pursue a "prudent" monetary policy with a "proactive" fiscal policy. Li had also said that China will seek macro policy coordination with the G20. IMF, in its G20 policy agenda, mentioned that China has to accept a lower growth rate, give more support for demand using current policy space, while pushing structural reforms to release growth potential in the long run.

"We expect the central element of the monetary policy wording in the Government Work Report to remain prudent while moderately loose", says Barclays.

The cuts in the benchmark rate and RRR in 2015 have considerable eased monetary conditions, in spite of certain CNY REER appreciation. Also, "prudent" policy might indicate that the People's Bank of China will consider all existing and new parameters while think of further easing. Operational parameters cover a mix of monetary policy operations, including liquidity management tools, OMOs, FX policy, interest rate/RRR cuts, new interest rate corridor and the recently introduced Macro Prudential Assessment (MPA) framework.

Basically, China requires reconciling its desire to steady the Yuan amidst a leaky capital account against the requirement of further easing of policy domestically. The rise in demand for foreign assets because of diminishing domestic returns and accelerating domestic credit growth to contain the slowdown has speeded up capital outflows, increasing depreciation pressures on the CNY.

On one side the Chinese government is attempting to steady CNY expectations to avert volatility using window guidance and market intervention, while on the other side additional domestic easing with capital account liberalisation will weaken the first objective.