As 2020 is reaching its end, the year's economy is entering the final stage. For China, both fiscal and monetary policies are given priority to support the economy, so as to ensure all strategic targets can be met in the final year of its 13th Five-Year Plan. Judging from the recovery of the Chinese economy in the first three quarters, several institutions expect growth of more than 6% in the fourth quarter and more than 2% for the full year. A positive growth rate of 2% is a perfectly reasonable economic achievement at a time when most countries around the world are facing economic contraction due to the COVID-19 pandemic.

In terms of monetary policy, since 2020, the People's Bank of China (PBOC) has introduced considerable measures to cope with the impact of the pandemic, among which the PBOC has implemented three reserve requirement ratio (RRR) cuts, reduced the weighted average RRR by about 1 percentage point, and released RMB 1.75 trillion of liquidity by lowering the RRR. Since 2018, the PBOC has implemented RRR cuts 10 times, reduced the weighted average RRR by about 5.5 percentage points, and released RMB 8.1 trillion of liquidity.It should be noted that even in the face of the pandemic, the PBOC has adhered to a prudent monetary policy, and although it has introduced considerable measures, it has not implemented policies such as zero interest rates, negative interest rates, or quantitative easing like central banks in developed countries.

From an independent institution's perspective, ANBOUND conjectures that there are several reasons for the PBOC's cautious actions: First, central banks all over the world are implementing massive monetary easing policy, and the spillover effect of excess liquidity will affect the Chinese market. Therefore, the PBOC does not have to follow the massive monetary easing policy, but to adopt targeted policies. Second, while responding to the impact of the pandemic, PBOC is also alert to many of the "endogenous" problems of the Chinese economy, such as structural problems, debt problems, and systemic financial risks. These problems will not disappear, and will certainly emerge after the pandemic. Therefore, PBOC needs to consider the negative medium- and long-term effects of short-term stimulus policies. Third, the response to the pandemic is not just about monetary policy, the fiscal policy should also play an important role in supporting the economy.

Barring any further surprises, China's monetary policy will maintain its current tone this year, and the economy will continue to pick up through an extraordinary 2020.

So, what will monetary policy look like next year? Since the beginning of the fourth quarter, PBOC officials have been signaling to the market on various occasions about the tone and scale of monetary policy next year, among which the policy information disclosed deserves the market's attention.

At the Annual Conference of Financial Street Forum 2020 in October, Yi Gang, governor of the PBOC, expressed two views on monetary policy in his speech. First, the PBOC will continue to improve the effective structural monetary policy so as to accomplish the year's development tasks. The macro leverage ratio has risen in stages during the special period of pandemic containment this year. The PBOC will pursue a prudent monetary policy that is more flexible, appropriate, and targeted while striking a balance between stabilizing growth and forestalling risks, keeping the money supply in line with nominal GDP, and reflecting the growth rate of potential output.Second, the PBOC will make best efforts to maintain a normal monetary policy for a long time, as well as a normal, upward sloping yield curve, and provide positive incentives for economic entities. The macro leverage ratio will be more stable when the GDP growth picks up next year. The monetary policy needs to ensure that the valve on aggregate monetary supply is well controlled and smooth out the fluctuations of macro leverage ratio as appropriate, so as to keep it on a reasonable track in the long run.

Pan Gongsheng, deputy governor of the PBOC and head of the State Administration of Foreign Exchange, looked ahead to monetary policy in 2021. Pan said the next step will be to improve the "twin pillar" regulatory framework that is in line with China's national conditions. First, China will continue to improve the macro-prudential policy framework, issue macro-prudential policy guidelines in a timely manner, and enhance the overall design and governance mechanism of China's macro-prudential policies. Second, China will improve the system for monitoring and evaluating systemic risks. Emphasis will be placed on improving the macro-prudential monitoring, assessment, and early warning systems in key areas such as real-estate finance, the foreign exchange market, the bond market, shadow banking, and cross-border capital flows. Third, there is a need to strengthen regulation of systemically important financial institutions and financial holding companies, including banks, insurance institutions, securities institutions, and financial holding companies. Fourth, it is necessary for China to strengthen coordination between macro-prudential policies, monetary policies, fiscal policies, industrial policies, and credit policies.

From the PBOC officials' statements, it is not difficult to observe the central bank's cautious but clear policy stance. To put it simply, given the exceptional circumstance sin2020, monetary policy will prioritize stabilizing economic growth and accepting a relatively high leverage ratio and relatively high levels of bad debts. If the situation returns to normal in 2021, monetary policy will focus more on preventing risks, controlling leverage, and tightening liquidity. At that time, the flexible monetary policy will likely tend to be more cautious.In terms of financial supervision, PBOC will step up supervision over key financial institutions and quasi-financial institutions.

The latest changes in the Chinese financial market, i.e., a sharp rise in bond defaults by state-owned enterprises, the emergence of significant risks for some commercial banks, and the potential risks in internet finance, will further lead to a tightening of policies by financial regulators. A number of recent regulatory policies have been hastily introduced in an apparent attempt to fill in the market regulatory gaps. These changes will be reflected in monetary policy and financial regulation next year.

ANBOUND's researchers have noted that the Chinese capital market has begun to take a dim view of next year's monetary policy, where the main concern is the tightening of monetary policy tone. Despite there will not be a drastic policy shift, the likelihood of a gradual reduction in liquidity relative to this year will increase significantly.

Final analysis conclusion:

In the case where China's post-pandemic economic recovery goes smoothly this year, and when the situation returns to normal both in China and internationally, coupled with favorable growth figures next year due to this year's low base, China's monetary policy could be tightened next year.