China's central bank has announced a slightly lower growth target for the money supply for this year, maintaining a prudent monetary policy stance as the economy continues on its rapid growth path, according to a working conference convened in Nanchang, east China's Jiangxi province on Jan. 5.

The People's Bank of China (PBC) also pledged to press ahead with reforming the renminbi exchange rate mechanism to let market demand and supply play a fundamental role in determining the exchange rate.

The growth target of the broad money supply M2, which covers cash in circulation and all deposits, and largely reflects the potential purchasing power in the entire economy, is set at 16 percent for this year, the bank said.

The target is lower than 2005's 17 percent, which was revised up from 15 percent at the beginning of last year as real growth outpaced expectations. The growth rate was 18.3 percent at the end of November.

"It indicates the central bank still wants to keep its control of money and has no intention to get expansive," said Li Ruoyu, an analyst with the State Information Center. "It is still emphasizing prudence."

Li's centre projects a higher 17 percent growth rate for M2, which she said partly reflects the tendency of slower circulation of money in the economy.

A slew of factors indicate that slower money supply growth is achievable this year.

The exchange rate reform and a foreign trade policy, which are aiming to reduce surpluses, are expected to take away some pressure on the central bank to release new money to mop up excess US dollars in the marketplace, she said.

The huge inflows of foreign exchange resulting from surpluses in China's balance of payment have been forcing the PBC to release new money into the banking system in the past two years, as it purchased excess dollars to enforce a floating band for the renminbi.

Greater flexibility for the exchange rate mechanism, which was achieved in a major reform on July 21 last year by linking the currency to a basket of foreign currencies, has helped reduce the pressure, analysts say.

The stronger restraint on commercial banks' impulse to lend, as a result of stricter requirements on capital adequacy, is another factor reining in loan growth, which drives money supply growth, Li said.

The widely perceived possibility of a rebound in the growth rate of fixed investment also justifies a slower growth of money supply. The rapid growth of fixed investment, which was expected to drop to 25 percent for the whole of last year from levels as high as 50 percent, was a major reason for worries about the Chinese economy overheating.

"Monetary policy has to be somewhat accommodative, since a tightening in credit will likely cause liquidity difficulties in businesses that are suffering from overcapacity," Li said.

Government officials have said overcapacity is already plaguing sectors like steel and car making, largely as a result over-investment, while some other sectors, like cement and textiles, are showing early signs of this trend.

The PBC said yesterday it would continue to improve the renminbi exchange rate mechanism, trying to let market forces play a fundamental role, but did not elaborate.

In a statement yesterday, the State Administration of Foreign Exchange pledged to take further steps this year to promote the development of the foreign exchange market, the basis for achieving the State's goal of building a market-driven exchange rate system.

The administration also said supervision of short-term debts will be strengthened, and regulations governing financial institutions' offshore businesses will be formulated to prevent speculative funds from entering China.

(China Daily January 6, 2006)