The People's Bank of China, the country's central bank, suspended bill sales on June 23 for the second time this year, following the first suspension about five months ago. Analysts said the move was made to inject liquidity into the market in response to the current tight money supply. Given the recent overheated economic and easing inflationary pressure, market watchers have become increasingly concerned about whether the central bank would ease the tight monetary policy in the second half of the year.

China will continue tightening monetary policy in the second half of the year, said Chen Dongqi, deputy director of the Macroeconomics Research Institute under the National Development and Reform Commission.

Local governments call for monetary policy easing

The central bank has lifted bank reserve requirements six times and raised interest rates twice since the beginning of the year. Using tight monetary policy to control market liquidity and to remove the monetary factors that are related to inflation has become the central bank's regular practice. As the economy growth slows, China's Consumer Price Index (CPI) may soon reach an inflection point.

Chen said that the negative effects of high inflation on economic growth are diminishing. He predicted that China’s inflation rate will likely peak at 6 percent or even higher in June or July and then drop in the fourth quarter.

Although inflationary pressure may ease in the future, expectations over future interest rate increases have caused growing concerns about the severe lack of monetary liquidity. Guo Tianyong, a professor at the School of Finance under the Central University of Finance and Economics, said that China used to adopt a loose monetary policy, and commercial banks had abundant capital and could grant massive loans at the time. However, after the policy turned "tight," the overall money supply was reduced, and the banks’ capital liquidity dropped, not to mention that they still had to grant certain necessary loans. The current financing difficulties facing small and medium enterprises were partly caused by the tight monetary policy.

However, Wei Jianing, deputy head of the Macroeconomic Research Department of the Development Research Center under the State Council, said that the real pressure on financing difficulties faced by small and medium-sized enterprises comes from local government finance platforms. Many local governments have initiated projects since a massive amount of money was lent since 2009, and now face increased financial pressure following the tightening of the lending policy. Thus, the local governments will possibly call for easing the monetary policy.

Easing monetary policy will lead to asset bubble

According to the economic data released since the start of 2011, the market generally expects China’s economic growth to slow down over the next two to three quarters. This will help to curb inflation and accordingly cause the central bank to consider relaxing the monetary policy.

However, Chen Changhua, head of the China Research Department of Credit Suisse, had a different view. He said that a slow decline in inflation is the main reason why it is difficult for the central bank to ease the monetary policy. Chen analyzed that the current domestic food inflation is not serious compared with the two highs in 2004 and 2008, but the inflation in the service sector is remarkably high. This means that a record high of CPI during this round of inflation will likely be lower than the peak of 8.7 percent in 2009, but a considerably broadened scope of inflation means that the decline in CPI during this round of inflation will be relatively slow.

Furthermore, Chen Dongqi believes that the reason behind the continuous tight monetary policy lies in that local governments' enthusiasm for investments remains high. If the monetary policy is relaxed too early, the CPI will rise too fast again. Furthermore, although the current money supply growth is slowing down, the scale of money supply is still expanding. It takes time to reduce the pressure brought about by earlier abnormal money supply growth.

Experts said that if the monetary policy is relaxed hastily, the asset bubble will continue to expand. Wei mentioned the lessons from Japan's experiences in the 1980s. After Japan implemented a proactive fiscal policy and a loose monetary policy, the Japanese economy suffered from a big asset bubble. In contrast, Germany withstood the pressure and prevented a bubble economy. He said that if China currently relaxes the monetary policy, it will probably repeat Japan’s mistake.

Dealing with different sectors individually and expanding some while contracting others

Although some people worry that slowing down the future economic growth will lead to a hard landing, most experts believe the macro policies will continue to maintain stability in the second half of 2011.

Li Xunlei, chief economist of the Guotai Junan Securities, believes macroeconomic regulation is now facing a dilemma. China's housing prices are still maintaining a relatively high level, and the rising labor cost and the extension of inflation have determined that the whole economy can only be fine-tuned.

"In order to withstand inflation, [the government] should simultaneously use the quantitative tool and the price tool," said Wang Songqi, deputy director of the Institution of Finance and Banking under the Chinese Academy of Social Sciences. Wang also believes the price tool should be more used than quantitative tool. In addition, improving the fluctuation space of exchange rates to boycott the imported inflation is also very effective.

Economist Gu Shengzu pointed out that as small and medium-sized enterprises are in a predicament under the market environment with expected rising interest rates and the credit tight, the government should implement the monetary policy of "dealing with different sectors individually and expanding some of them while contracting others" to reduce the impact of the deflationary fiscal policy on small and medium-sized enterprises to defuse the "money shortage" predicament of small and medium-sized enterprises. The government should also regulate informal finance and relax financial regulation to guide non-governmental capital to return to the real economy through the financial innovation.

"The monetary policy strength will be adjusted in the future because funds of small and medium-sized enterprises are relatively tight. We should properly provide them a little 'water.' Otherwise, many small and medium-sized enterprises will 'die of thirst.' That is the reason to implement the proper relaxation," Chen said.

Chen also said that the previous monetary policy mainly focused on increasing the deposit reserve rate. Although related departments still have some room to increase, it will cause damage to the relationship of currency supply and demand if the quantitative tool continues to be used. Therefore, the monetary policy in the next phase will take increasing interest rates as an alternative.