The PBoC’s balance sheet shrank by Rmb283bn (prior: Rmb787bn), after 3 consecutive months of rises. Changes in major asset and liability components are highlighted below:

The PBoC’s FX purchase position declined Rmb191bn (prior: -Rmb98bn), confirming net FX outflows in July. China’s FX reserves lost US$4.1bn amid renewed RMB depreciation pressures in July. The contraction of the FX purchase position – the cumulative amount of RMB the PBoC has sold to purchase FX – shows that the central bank continued to sell FX in support of the RMB.

The PBoC’s claims on other depository corporations fell Rmb126bn (prior: Rmb898bn). This is a result of the PBoC’s liquidity withdrawal in July, after the large injection before the quarter-end MPA review to avoid a liquidity shock.
Reserve money, the PBoC’s major liability component, decreased Rmb495bn (prior: Rmb986bn).

Government deposits increased Rmb337bn (prior: -Rmb301bn). As fiscal revenue and spending both decelerated, the second largest liability component rose visibly in July.

Bond issue dropped Rmb290bn (prior: 0), as central bank bills matured. This is equivalent to an injection of liquidity.

The money multiplier climbed to a record high of 5.25 (prior: 5.16). M2 growth was lower than expected, but monetary base was in contraction. Thanks to the enlarged multiplier, the PBoC’s apparatus for money supply remained effective.

Together, the balance sheet changes seem to confirm the PBoC’s intention to neutralize monetary policy. The PBoC asserted in the 2Q16 monetary policy report that it will maintain a neutral policy stance to create a financial environment conducive to structural reforms in 2H16. The net liquidity withdrawal via relending operations amid shrinking monetary base indicates that the PBoC is trying to match its words with actions. The balance sheet contraction may be one reason behind the PBoC’s warning of the currency deprecation effect of frequent RRR cuts, operated through balance sheet adjustments. Looking forward, we think the PBoC will keep liquidity conditions largely stable, although it may be cautious in using RRR or interest rate tools.