Central bank chief hints policy flexibility amid deflation risk

BEIJING -- When Chinese central bank governor Zhou Xiaochuan speaks, the market listens.

As China walks the economic tightrope of balancing steady growth, facilitating restructuring and combating deflation risks, Zhou said there may be room for flexibility despite consistent championing of a prudent monetary policy.

Policy leeway

Speaking at a press conference on the sidelines of the National People's Congress (NPC) annual session, Zhou said there would be some room for flexible adjustments of the prudent monetary policy.

His remarks were largely in line with the language used in the widely-scrutinized government report delivered by Premier Li Keqiang to lawmakers at the opening of the parliamentary session.

"The M2 money supply is forecast to grow by around 12 percent in 2015, but the actual supply may be slightly higher than this projection depending on the needs of economic development," noted the report.

M2, a broad measure of money supply that covers cash in circulation and all deposits, first found its way to the annual report in 2010.

This is the first time that the government has used the wording:"slightly higher than this projection depending on the needs of economic development" since the M2.

Zhou stressed that China is sticking to its prudent monetary policy despite the use of a string of new monetary policy tools unfamiliar to the public, adding that compared with the large size of Chinese economy, the scale of those policy tools is not big.

With slowing growth pace, the economy has entered a "new normal" era, however, this does not mean the economy is troubled by a particular problem nor that the monetary policy will shift gears, he said.

China's gross domestic product (GDP) expanded 7.4 percent last year, its lowest level since 1990. The annual economic growth target for 2015 was set at around 7 percent, half a percentage point lower than last year.

The press conference follows the release of economic data for January and February, which was far from optimistic.

Industrial output in the world's second largest economy grew 6.8 percent year on year in January-February, down 1.1 percentage points compared to December. Retail sales expanded 10.7 percent in the first two months from a year earlier, also down from 11.9 percent registered for December.

Deflation risk

The protracted economic weakness comes amid subdued price levels, which provided leeway for policy makers to further ease monetary policies, if needed. Central bankers usually follow the inflation and other key economic data to trigger policy easing or tightening moves.

When asked about the implications of China's inflationary change for monetary policy setting, Zhou said "enough attention should be given to inflationary pressure change and a long-term view should be taken."

China's consumer price index (CPI) edged up 1.4 percent year on year in February. The reading quickened from the 0.8 percent gain in January, the lowest level in more than five years, but was lower than the inflation increase target of around 3 percent set for this year.

The CPI is the most important gauge of inflation pressure and the central bank "is closely following" CPI and producer price index (PPI) changes, said central bank vice governor Yi Gang.

Analysts believe this level of inflation is unlikely to be sustained, heightening looming deflationary risk.

The deflation risk is a challenge facing the global economy.

"The People's Bank of China (PBOC) is managing the liquidity when pursuing a prudent monetary policy," said Yi, adding that the combination of a proactive fiscal policy and prudent monetary policy is a good choice.

Some major economies have been stuck in deflation, which will lead to a spiral of ever weaker consumption and growth momentum. Quantitative easing has been adopted by some central banks like the European Central Bank (ECB), and successive interest rate cuts were rolled out in countries such as Australia, Denmark and Canada to tackle deflation and anemic economic growth.

To arrest the economic slowdown and the onset of deflation risks, the PBOC has cut the benchmark interest rates twice and dropped the reserve requirement ratio (RRR) for banks over the past four months. Some analysts believe more easing moves will be needed.

"The deflation risk has put more pressure on the central bank to further cut interest rates and the RRR," the China International Capital Corp, a leading investment bank, said in a report.

Nomura forecast an interest rate cut in the second quarter and three RRR cuts over the course of the year.

When asked whether the recent monetary easing moves had spurred capital flow into the stock market, Zhou warned that some financial market transactions are speculations unrelated to the real economy, but sweeping generalizations should not be made.

"We can not say if there is some capital flowing into the stock market, it is not supporting the real economy, because businesses from many industries are getting financed through the stock market," he added.