Commentary: China’s Changes to M1 Money Supply Will Curb Volatility

The People's Bank of China (PBOC) has announced a significant change in how it measures M1, a primary measure of money supply, beginning January 2025. M1, often referred to as narrow money, includes the most liquid forms of money, and the current calculation considers currency in circulation and liquid assets like demand deposits of companies and government agencies. The new change will incorporate personal demand deposits and client reserve funds held by nonbank payment institutions. [para. 1][para. 2]

The market had anticipated this adjustment after PBOC Governor Pan Gongsheng hinted at it during a speech at the Lujiazui Forum in June, and this issue was also mentioned in the central bank's third-quarter monetary policy report released in November. As of October's end, M1 was valued at 63.3 trillion yuan under the old system, but it would have reached 105.1 trillion yuan under the new measurement. This change would have significantly narrowed the year-on-year decline rate from 6.1% to 2.3%. [para. 3][para. 4]

This adjustment will likely stabilize the volatility of year-on-year changes in M1. While corporate and government demand deposits fluctuate largely, personal demand deposits remain more consistent. Notably, since July 2020, corporate demand deposits have constituted about 30% to 40% of China's M1. [para. 5]

A noteworthy change happened in corporate demand deposits starting in April, led by a financial "water squeeze" instigated by regulators. This shift affected M1's year-on-year changes, causing deposits to migrate towards wealth management and other asset management products. [para. 6][para. 7]

Additionally, real estate sales have contributed to fluctuations in M1 growth as household demand deposits transform into corporate demand deposits. Another factor involves annual bonuses moving from corporate to residents' demand deposits before the Lunar New Year, affecting M1 growth patterns. The upcoming M1 measurement change will help stabilize these seasonal and market-driven impacts. [para. 8][para. 9][para. 10]

Despite new inclusions, M1’s growth may still lag due to pressure on corporate profits and constrained fiscal expenditure. For instance, the producer price index has dropped by 2.1% year-on-year in the first 10 months, hindering corporate profits' recovery. This decline was mirrored by a 4.3% year-on-year decrease in major industrial companies’ profits from January to October, affecting the growth of corporate demand deposits. Furthermore, broad fiscal expenditure—encompassing public budgets and government-managed funds—showed a year-on-year decline of 1%, thereby impacting government entity deposit growth. [para. 11][para. 12]

There is still potential for further M1 expansion in China. Comparatively, China's criteria for M1 remain narrow compared to the United States, the eurozone, and Japan. Even with the new inclusions, items like fiscal demand deposits and nonbank financial institutions' demand deposits are not included in China's M1. Other financial assets, such as highly liquid money market funds or banks' wealth management products that allow daily subscription and redemption, could also be considered for inclusion. [para. 13][para. 14]