Many Challenge China’s Monetary Policy

The recovery of the American economy is moving along with a strong momentum and with steady improvement of employment and inflation， as indicated by its latest economic growth and job growth rates. The U.S. Federal Reserve（Fed） is widely expected to raise interest rates in the first half of 2015 for the first time since the eruption of the global financial crisis in 2008.

A rate hike will inevitably result in global assets price revaluation and assets redistribution， then massive capital movements， which may trigger drastic fluctuations of the global financial market. If the Fed moves up the date of raising interest rates， the Chinese economy will have to confront challenges with its financial management policy standing in the breach.

China is already dealing with the pressure of stabilizing economic growth and adjusting structure amidst an economic slowdown， dwindling demographic dividend， weak yuan appreciation expectation， declining trade deficit and new funds outstanding for foreign exchange.

Restrained by unpropitious domestic and overseas economic circumstances， an effective conduction mechanism has not yet been put in place. The central bank still maintains a cautious attitude and frequently resorts to structural monetary policies， and as a result， its monetary policy fails to come into full play. Considering the current monetary regulation framework， the elevation of interest rates by the Fed is bound to make it more difficult for the central bank to select a monetary policy.

If the Fed raises interest rates， the U.S. dollar will experience continued appreciation， and international capital will flow back to the United States. Of course， Chinas huge dollar reserves and capital control will shield it from falling into the mire of a financial crisis. As the Shanghai-Hong Kong and Guangdong-Hong Kong financial integrations keep forging ahead， profit-seeking capital may bypass the capital account and realize relatively higher returns through the current account. A rate hike by the Fed will affect other countries exports to the United States， dispirit global economic growth， and then add to the downward pressures of the Chinese economy. Given that， Chinas central bank will be in a dilemma.

The yuan exchange rate is near equilibrium and it will maintain two-way fluctuations against the U.S. dollar. However， if the dollar enters into a track of continued appreciation and the yuandollar exchange rates remain stable， the yuans real effective exchange rate will see a sharp rise， adding pressure to Chinas manufacturing industry. Meanwhile， a strong dollar will intensify the depreciating pressure on the yuan. Even though a depreciating yuan will relieve the tension on the current account， the internationalization of the yuan will become more arduous and painstaking.

As the Fed becomes more likely to lift interest rates， China should stay alert toward potential challenges to its monetary policy and economic growth. In the context of deepening reform and undergoing social changes， China cant depend entirely on monetary policies to tackle the predicament of structural transformation.

At present， the development of agriculture and farmers， small businesses， micro businesses and a public service system still heavily depend on bank loans and financial policies， while fiscal policies fail to play its due role. For this reason， the central bank should reinforce its independent position， align its policy target with the overall reform， strengthen policy coordination among government departments and lower its expectations of monetary policies role of advancing structural reform. Meanwhile， the selection of monetary policy tools should be diversified.

In addition， efforts should be made to steadily push forward the reform on the exchange rate system， optimize the currency basket that the yuan exchange rate is linked to， and prepare for a moderate depreciation of the yuan against the dollar and a mild appreciation of its real effective exchange rate.