The recent announcement by China's central bank that it would cut banks' reserve requirement ratio for the second time this year could mean that the country's money supply might be largely dependent on bank lending for the foreseeable future.

China's increases in money supply comprise mainly of three parts: bank lending, the purchasing of bonds and other assets by banks, and funds outstanding for foreign exchange.

In recent years, due to the continual growth of foreign exchange reserves and the central bank's policy of "sterilized intervention", there has been a sharp increase in funds outstanding for foreign exchange, which has remained the major channel for money creation in China.

In order to mitigate its impacts on the national currency, the central bank has, and continues to sterilize excess liquidity by raising the reserve requirement ratio (RRR). Since 2010, the RRR has been raised twelvefold, reaching 21.5 percent, a record high for large commercial banks.

However, the trend appears to be changing.

At the end of last year, China's foreign exchange reserves declined to US$3.18 trillion, registering the first quarterly drop in more than a decade.

Since the beginning of this year, the nation's foreign exchange reserves have continued to decrease. The funds outstanding for foreign exchange, therefore, have seen a month-by-month reduction, with the actual use of foreign capital slowing down its growth.

These signals might mean a change in the mode of money creation in the future, thereby underscoring the autonomy and flexibility of monetary policy.

By the end of the fourth quarter of 2011, the yuan funds outstanding for foreign exchanges fell by 153.1 billion yuan (US$24.2 billion) from the third quarter to 25.36 trillion yuan (US$4.01 trillion), registering the third consecutive month of negative growth. Although this year's first quarter saw slow positive growth, it suffered a 23.8 percent month-on-month decline in April.

Meanwhile, there has also been a slowdown in terms of capital inflow, with capital, both from abroad and unidentified domestic funds, accelerating outflow.

By the end of 2011, China's cross-border trade settlement in yuan held in current accounts hit 2.58 trillion yuan (US$408 billion). This also caused the outflow of domestic capital.

This situation is by no means unique to China. For the past twenty years, emerging economies have enjoyed the large-scale inflow of overseas capital, however, this trend has changed since the second half of 2011.

Due to the debt crisis in Europe and the structural adjustment of the U.S. and other developed countries, international capital has begun to flow back to developed countries from emerging economies.

The U.S. strategy of economic rebalancing has also attracted the backflow of international capital. This trend could potentially alter the global flow of capital.

Under such circumstances, it is possible that the changes in yuan funds outstanding for foreign exchanges might be the comprehensive reflection of China's economic structure in the long term.

Over the past decade, China's changing population demographics, the rising average age of the population and the migration of surplus rural labor to cities have resulted in the continuous rise of the savings rates. In addition, the trade surplus continued to expand and the funds outstanding for foreign exchanges increased rapidly. It is likely that this pattern will not be repeated in future.

As the funds outstanding for foreign exchanges drop, they could lose primacy as the major channel for money creation. The central bank has to raise the money multiplier by cutting the reserve requirement ratio. As a result, money creation will increasingly depend on domestic credit growth.

The author is an associate researcher from the State Information Center.

(This article was published in Chinese and translated by Wang Wei.)

Opinion articles reflect the views of their authors, not necessarily those of China.org.cn.

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