Monetary Policy in a Dilemma， Again

　　Data released by the People’s Bank of China(PBC) show that funds outstanding for foreignexchange totaled 27.52 trillion yuan ($4.52trillion) at the end of September， with newly increasedfunds out standing for foreign exchang ereaching 126.4 billion yuan ($20.78 billion)， amonth-to-month increase of 100 billion yuan($16.44 billion). Minus foreign direct investment(FDI) and the current account surplus， this is thefirst net inflow since May.

　　Again， the substantial inflow of crossborder capital put China in a dilemma， leaving monetary policy little room to strike a balancebetween domestic and overseas markets， thereal economy and the financial sector， interestand exchange rates.

　　Moreover， in the third quarter， foreign exchang ereserves increased $160 billion to $3.66 trillion， far beyond market expectations， indicatingthat cross-border capital inflow has been intensifying.

　　An outcome of accelerated cross-bordercapital inflow is the surging exchange rate of theyuan. The central parity rate of the yuan againstthe U.S. dollar streng thened to 6.1352 on October 21， a record high since the exchangerate reform. The yuan has so far appreciated by2.4 percent this year， faster than last year.At the same time， major economies acrossthe globe maintain low interest rates， whileinterest rates in the Chinese market are stable.

　　Widening interest margins keep absorbing foreign capital， which in turn spurs cross-bordercapital flow and the appreciation of the yuan.Although the United States avoided adebt default， risks have just been postponedrather than completely eliminated. Whenit comes to mid-term elections next year，a seesaw battle between Republicans and Democrats is bound to take place over issueslike shutting down the government andthe debt ceiling. It seems that the FederalReserve will inevitably slower its quantitativeeasing (QE) exit.

　　Given that QE may continue to deepen in the world， the uncertainty of the external environment will make China stand at a nonplusin deciding its monetary policy. If the country doesn’t tighten liquidity， the risk of asset bubblesmay emerge； if it does， the foundation forrecovery may be undermined.

　　As the global economic situation has become increasingly complicated and downward pressure on the Chinese economy grows， macro-controls will be more difficult， resembling thecase at the end of 2012.

　　On the one hand， since inflation is gradually rising up and cross-border capital inflow is jacking up the housing market， the PBC maytighten credit. In the third quarter， the number of prime sites in major cities exceeded 131，an increase of 41 year on year. The transactionprices of land in first-tier cities like Beijing，Shanghai and Shenzhen saw new records，completely wiping out the effects of real estatecontrols. Sufficient liquidity means thePBC will not loosen its monetary policy.

　　On the other hand， structural reforms will be the theme of the fourth quarter. The deepening of structural reforms will add tothe downward pressure. Weak endogenousdynamic and a reduced policy stimulus maylead to a slight fall of economic growth. Inthis sense， the PBC is unlikely to significant lytighten its monetary policy.

　　Under such circumstances， China’s monetary policy should shift from quantitative tostructural adjustment by directing mid- andlong-term capital into sectors like urbanization，infrastructure construction， technological innovationand the financing of small and mediumsized enterprises.

　　A focus should be laid on retaining mid- andlong-term capital， and improving the efficiency of liquidity supporting the real economy， inorder to enhance the positive returns of the country’s monetary policy.