Base money slipped back into contraction in March, after three months of expansion. The PBoC’s balance sheet shrank by Rmb963bn, driven largely by an Rmb715bn drop in base money. Changes in the major components of the central bank’s balance sheet are highlighted below:

Foreign assets fell by Rmb129bn. Although headline FX reserves returned to positive growth, it was mainly due to a large valuation effect amid the weakness of the USD. The decline in the PBoC’s foreign assets confirms a net FX outflow in March.

Claims on depository corporations declined by Rmb845bn. Following the record jump of the claims in the first two months, there was a significant pullback in relending operations.

Government deposits declined by Rmb217bn. As a result of accelerated fiscal spending, the decrease in this second largest liability component injected base money into the banking system. However, the boosting effect was small compared with the fall in foreign and domestic assets.

The money multiplier rose to its highest level since October 2006, driving the expansion of broad money in March:

The recent RRR cut should have lifted the multiplier. It allows banks to use previously frozen funds for lending and to hold less reserves for any deposits taken.

The shift from FX purchases to relending operations as the main engine for base money issuance may be associated with a larger multiplier. The credit extended by the PBoC allows banks to fund domestic activities, which can often be further leveraged up. For example, when the central bank provides the capital for an infrastructure project through a policy bank, it is typically co-funded by bank loans. In this way, central bank lending facilitates the process of private credit creation.

The recent rise in foreign liabilities is interesting, although its impact on the PBoC’s balance sheet is so far limited. This small component saw an increase of Rmb25bn in March. It might be a result of the required reserves on CNH deposits that offshore banks surrendered to the PBoC or due to the increased deposits with the PBoC by foreign central banks and financial institutions as they entered China’s interbank markets. Borrowing funds overseas for currency intervention could be another explanation, but the component did not expand much at the height of FX outflows last year.

Together, the March data reflects the impact of the RRR cut in February: An accelerated credit expansion without growth in base money. Looking forward, we believe monetary policy will maintain its easing stance until inflation pressures become more visible, but further policy loosening is limited.