(Yicai Global) Aug. 30 -- Starting this week, the Yicai Research Institute will publish its China Financial Condition Index, which includes both a daily and monthly index. The daily indexes will appear together on a weekly basis, while the monthly one will issue each month. These indexes are devised to provide new perspectives and measurement tools to enable analysts to better scrutinize China's macro-financial environment.

"The Yicai Research Institute is compiling its China Financial Condition Index to gauge the financing conditions, availability of funding and the degree of overall tautness of China's macrofinance and provide a significant reference to policymakers, financial market players and the general public," noted Dr. Yang Yanqing, director of the Yicai Research Institute. 

"The daily index responds with greater sensitivity and can help us pre-judge trends in the lead up to the release of often lagging macro-financial data, while the monthly index more comprehensively reflects changes in the financing conditions and situation of the entire society," she added.

The daily index of the China Financial Condition Index stood at 0.31 on Aug. 28, and its average figure registered 1.09 in the first half, and the monthly index posted 0.51 for last month, lower than June's 0.93. The changes in both indexes attest to the marginal relaxation of China's financial landscape, especially the rapid drop since late last month.

Based on transactional data, the daily index sets Jan. 5, 2015 as its starting point. The monthly index is based on transaction-related data and statistical data spanning a longer range, beginning from September 2008.

Zero represents the operational average of the index, i.e. the higher the index, the more restrictive the financial environment; the lower the index, the more lax it is.

Global Trend to Embed Financial Factors in Macro Policy Suits China's Conditions

After the financial crisis of 2008, countries' discussions of and retrospection on financial volatility and its influence on the macroeconomy have never ceased. One key achievement of his analysis is the inclusion of financial factors into macroeconomic models.

Per the theoretical model of Western central banks, China's central bank can impact consumption and investment only by adjusting short-term policies and interest rates. Monetary policy can be limited in various ways in implementation, however, empirical evidence shows, e.g. constraints on the regulatory regimes on financial institutions may lead to an insufficient supply of funds, while asymmetric information between a borrower and lender may cause funding costs to deviate from a balanced level.

Long-term loose monetary policy plus China's tight credit policy shows that neither money market short-term interest rates nor companies' long-term loan interest rates are suitable indicators of the circumstances of overall societal financing. 

Since 2018, the People's Bank of China has slowed the pace of its interest rate rises and only respectively improved five basis points of reverse repurchase rates via open market operations and medium-term lending facility interest rates, while implementing a 'targeted reduction of reserve requirement ratio' three times in mid-April to prompt financial institutions to support the financing of small and micro-sized companies.

However, the growth of the scale of non-governmental financing and broad money (M2) is still slowing. The increase in the rate of levels of such public financing dropped to 10.3 percent annually last month to reach the lowest point since the first appearance of 'societal' financing data.

Short-term loose monetary conditions and long-term tight credit expansion display a sharp contrast, however.

The financial market is undoubtedly proving pivotal in the mechanism for conducting monetary policy. The series of indexes of China's financial condition CNB Research Institute is issuing encompasses various market data and indexes such as interest rates in money markets, the curve of sovereign bond return rates, interest margins of credit debt, and asset price indexes. This series of indexes can help the public better measure the overall social macroeconomic environment by referring to the financing circumstances of various entities to the greatest degree possible.

Financial Condition Index Measures China Financial Market's 10-Year Development

Based on the monthly performance registered in the China Financial Condition Index  the Institute publishes, China's financial market has transited the following stages since September 2008.

The first phase was from September 2008 to December 2009 when the country implemented a loose overall fiscal policy in financial markets. Specifically, the monthly index plunged to minus 2.10 in March 2009 from 0.62 in September 2008 and hovered at a low level thereafter throughout the period. 

At the end of 2008, to weather the global financial crisis, the Chinese government introduced a policy of stimulus packages worth as much as CNY4 trillion, during which time PBOC reduced the interest rate five times and the RRR four times, resulting in an environment featuring loose monetary and credit policies. The great demand for financing boosted a series of off-balance sheet activities of banks and interbank innovations. This practice of banks bypassing trust schemes provides a financing platform for real estate companies and local governments, and spurring the rapid development of the shadow banking sector.

The second phase ran from January 2010 to September 2011 when China began to implement tight fiscal policies. The monthly index gradually increased to 1.86 in September 2011 from minus 1.23 in January 2010. To cope with the rapid surge of the consumer price index and asset prices, Chinese authorities gradually stopped implementing this stimulus package from 2010 to 2011 and PBOC respectively raised the RRR 12 times and benchmark deposit and loan interest rates on five occasions. 

China Banking Regulatory Commission frequently issued documents at this time on cooperation between banks and trust companies. For example, Document No. 72 of 2010 required the financial cooperation between banks and trust companies should transition from off-balance sheet to on-balance sheet and use set aside provisions, whereas Document No. 102 clarified that financial capital is not allowed to directly purchase credit assets.

The third stage began in October 2011 and continued to December 2014 when China was in the midst of a tight overall financial environment. The monthly index fluctuated between 0.21 and 1.72 during this period. In 2012, China came under great pressure for economic growth, with the increase rate of real gross domestic growth falling to 7.9 percent from 9.5 percent in the previous year, and CPI and asset prices retreating. PBOC cut interest rates and RRR twice during that year in a bid to alleviate the financing pressure on small- and medium-sized companies and boost economic growth, while brokers and funds relied on channel-type businesses to find their way into the off-balance-sheet assets of banks amid financial innovations encouraged across the securities sector. 

The CBRC issued Document No. 8 in March 2013 to control the scale of non-standard bond assets, mandating that the 'non-standard' balance of financial funds at any time could not exceed 35 percent of the balance of financial products and 4 percent of the total assets disclosed in the audit reports of commercial banks for the previous year, whichever was lower. To meet the requirement of 'non-standard' proportion, financial institutions inflated their denominators through inter-bank liabilities, resulting in mounting interest rate fluctuations in the money market, followed by a 'money crunch' in June and December 2013.

The fourth segment was from January 2015 to November 2016, when China ushered in a new loose cycle for its financial environment, as a decline in the monthly index from 0.51 in January 2015 to minus 1.05 in November 2016 attests. 

In 2015, GDP growth slumped below 7 percent and the Chinese economy entered the 'new normal.' That same year, PBOC reduced the benchmark deposit and loan interest rates five times and the RRR four times, and also built the interest rate corridor system to hold the lid on the turbulent money market in response to a potential decline in funds outstanding for foreign exchange and the risks of a downward economy. Loosened purchase restrictions on property and local debt replacement also pushed up financing demand, and eased capital fundamentals brought with them a growing risk appetite.

The fifth stage from December 2016 to June this year saw China's financial development fluctuating toward a tighter range, with the monthly index climbing from minus 0.43 in December 2016 to 0.93 in June. At the end of 2016, the Central Economic Work Conference set the tone of a prudent and neutral monetary policy amid a tightening monetary policy and financial regulation. 

The credit crisis triggered by the scandal of bonds 'forged' by Sealand Securities forced the regulator to crack down on financial chaos. In late March last year, the CBRC rolled out special measures in a series of documents to deal with 'three violations,' 'three arbitrages' and 'four improprieties.' In July, the State Council set up the Financial Stability and Development Committee to coordinate financial regulation. 

In November, the report of the 19th CPC National Congress proposed the dual regulatory frameworks of 'sound monetary policy and macro-prudential policy.' In the first half of this year, the financial environment tightened further compared with last year as the new regulations kicked in, accompanied by a marginal relaxation of monetary policy. 

PBOC took advantage of 'targeted reserve ratio cuts,' collateral expansion and other means to support the financing of the real economy in an effort to unclog the monetary policy conduct channel to flow from lax money to loose credit.

China's financial environment is likely migrating toward a new phase starting from July, but more data is needed to support a judgment as to its future course. The State Council executive meeting held July 23 raised the target of 'maintaining a moderate scale of social financing and reasonable and ample liquidity,' resulting in a significant decline in the daily index, which now fluctuates around zero, or the historical average level. 

China's financial environment is expected to be looser, following a meeting of the Political Bureau of the CPC Central Committee on July 31, under the principle of 'stabilizing employment, finance, foreign trade, foreign investment, investment and expectations.'

Yicai Research Institute/Think Tank is a non-profit independent research institute backed by Yicai which is committed to improving economic policies. Based on independent study and analyses of facts and data, the think tank offers innovative and feasible policy plans and suggestions from a global perspective to increase the quality and transparency of China's economic policies and promote the effective and equitable governance of the global economy and international finance. 

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Editor: Ben Armour