In an important development poised to enhance the interplay between monetary policy and economic activity, the People’s Bank of China (PBOC) has announced a revision to its measurement of the money supplyThis adjustment is expected to substantially improve the responsiveness and completeness of monetary indicators, thereby better serving macroeconomic analysis and the formulation of monetary policy.

Starting from January 2025, the PBOC will implement a newly revised statistical definition of narrow money supply (M1). This refined definition will incorporate: currency in circulation (M0), demand deposits from enterprises, personal demand deposits, and reserve funds held by non-bank payment institutionsThis marks a significant shift in how monetary supply is quantified in China.

Traditionally, monetary supply is a crucial indicator, summarizing the total financial instruments available for circulation and payment within the economy at any point in time

Given the rapid transformation of China’s financial landscape and innovations in financial instruments, the traditional definitions of money supply, especially M1, have become outdated and inadequateA dynamic enhancement of the statistical measures of money supply was necessary to align with evolving economic realities.

In a recent question-and-answer session, officials from the PBOC clarified the rationale behind the modifications to the M1 measurementNotably, personal demand deposits, which were excluded when M1 was established three decades ago due to the lack of personal bank cards and mobile payment systems, are now integral to payment systemsWith technological advancements facilitating immediate transfers and payments, it becomes essential to categorize these deposits within M1 alongside enterprise demand deposits.

Additionally, reserves held by non-bank payment institutions exhibit substantial liquidity and can be readily employed for transactions, aligning their characteristics with the definition of M1. Comparatively, many major economies include similar types of liquid assets in their M1 measurements, highlighting a global trend towards more inclusive definitions.

The PBOC is scheduled to release the first set of M1 data utilizing the revised definitions in early February following the January 2025 implementation

Alongside this announcement, it will also disclose the revised M1 balance and growth rates retroactively from January 2024.

M1, recognized as an indicator of high liquidity, is often indicative of the immediate health and vigor of the real economyInvestors frequently regard M1 as a leading indicator of economic trendsThe updated M1 metric is anticipated to closely reflect the current shifts within China's economic and financial contexts, enhancing its utility as an economic and financial activity gauge.

This revision is timely; the PBOC had already signaled its intent to update M1's statistical criteria in previous forumsFor instance, in June 2024, PBOC Governor Pan Gongsheng emphasized that the existing M1 measurement was established 30 years ago and has since failed to incorporate the rapid advancements in financial services, mobile payments, and innovations in the financial sector.

As both economic and financial landscapes evolve at a breakneck pace, updated statistical measures are essential for policymakers, investors, and the broader society to make judicious decisions

This need for updates is underscored by the dramatic changes witnessed in economic fundamentals, necessitating a corresponding adjustment in how such data is compiled and interpreted.

Historically, the PBOC has previously adjusted various money supply metricsIn June 2001, for example, it incorporated customer margin deposits from securities firms into the broad money supply (M2) to reflect China's burgeoning capital marketSubsequent adjustments have included accommodating demand deposits from foreign-invested financial institutions following China’s WTO accession in 2002, and integrating deposits from non-deposit financial institutions in 2011 as non-deposit financial entities gained prominence.

While adjustments to M2 have become commonplace, this upcoming amendment marks the first-ever revision of the M1 metric

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Key changes entail the inclusion of personal demand deposits and reserves from non-bank payment institutions into the M1 calculation.

The foundational criterion for these revisions hinges on whether the financial instruments in question possess direct usability for paymentsThe nature of these transactions, according to analysts, should be immediate, with inherent qualities ensuring no value depreciation, delays, or penalties involved.

Furthermore, innovation in financial tools may lead to the emergence of new financial assets that align with these M1 characteristicsAs highlighted by the PBOC, personal demand deposits now facilitate immediate payment without the need for cash withdrawal, while reserves in non-bank payment institutions are explicitly destined for payments, thus justifying their inclusion in the M1 calculation.

Estimates suggest that under the new criteria, the volume of M1 will increase significantly, along with alterations in its structural composition

Assuming data from October 2024 holds, the revised M1 could expand by approximately 42 trillion yuan, representing a staggering growth rate of around 66.5%. The specific contributions to the new M1 will reflect diverse components including M0, enterprise demand deposits, individual demand deposits, and systematic reserves held by payment institutions, each maintaining distinct proportions within the new M2 classification.

This shift marks a notable evolution in China's financial landscape, particularly as consumer spending increasingly influences economic health and stabilityAs residents’ consumption patterns become more impactful within GDP calculations, fluctuations in personal demand deposits will predictably affect M1 growth rates, heightening the relevance of M1 as an economic indicator.

China Galaxy Securities further accentuates the analytical significance of this revised M1 measurement for economic forecasting

The newly formulated M1 is expected to reflect immediate consumption capabilities more comprehensively, thereby improving predictions regarding economic growth trends and inflation levelsNotably, insights indicate that both old and new definitions of M1 will likely converge around pivotal turning points, sustaining upward trends amidst improving real estate sales and favorable business climates.

Nonetheless, it is imperative to acknowledge that the correlation between money supply and economic shifts may have diminished in recent years, as the Chinese monetary policy framework transitions from quantity control to interest rate adjustmentsThis transformation suggests that even with periodic updates to money supply metrics, the intrinsic interaction between monetary indicators and economic conditions may not revert to prior levels of influence.

In conclusion, as articulated by the PBOC in its third-quarter monetary policy report, the evolving paradigm of high-quality economic development in China necessitates a reevaluation and recalibration of the monetary supply according to emerging financial dynamics, which may ultimately redefine traditional associations with principal economic variables.