China cen­tral bank turns to liq­uid­ity fire­house

The Pak Banker - - COMPANIES/BOSS -

Hav­ing spent years out­lin­ing the move to­ward a price-based mon­e­tary frame­work and away from di­rectly chan­nel­ing credit, the Peo­ple's Bank of China (PBOC) is turn­ing to mar­ket-based liq­uid­ity mea­sures to ease a pre-Chi­nese New Year cash squeeze and off­set cap­i­tal out­flows stem­ming from its sup­port for the fall­ing yuan. Net in­jec­tions to­tal­ing more than 1 tril­lion yuan ($152 bil­lion) since mid-Jan­uary add about the same as a 1 per­cent­age point cut to banks' re­quired re­serve ra­tios -- the tra­di­tional way to boost liq­uid­ity.

The dif­fer­ence: RRR cuts are last­ing, while in­jec­tions via re­verse re­pur­chase agree­ments and new lend­ing tools have set time pe­ri­ods. That gives the PBOC more power to man­age liq­uid­ity by choos­ing whether or not to roll over funds as they come due. The newer liq­uid­ity tools also carry vary­ing in­ter­est rates de­pend­ing on the time pe­riod at­tached, help­ing cre­ate a yield curve the mar­ket can use for pric­ing other se­cu­ri­ties. That's im­por­tant for a cen­tral bank bal­anc­ing the need to avoid a short-term cash crunch with longer-term plans to rein in the pace of debt ex­pan­sion.

Greater trans­parency is form­ing around the new ap­proach too, with for­mer Deutsche Bank AG econ­o­mist turned PBOC re­searcher Ma Jun ex­plain­ing the moves to Chi­nese me­dia. The lat­est liq­uid­ity sup­port is act­ing as a "sub­sti­tute" for a RRR cut, Ma told state-run broad­cast­ing net­work CCTV Wed­nes­day. Overuse of RRR cuts may add too much pres­sure on short-term in­ter­est rates and would there­fore be bad for sta­bi­liz­ing cap­i­tal flows and the ex­change rate, Ma said in a China Busi­ness News re­port pub­lished Thurs­day. "The PBOC is shift­ing mon­e­tary pol­icy op­er­a­tions, from con­ven­tional RRR and in­ter­est-rate cuts to un­con­ven­tional tools," said Field­ing Chen, an econ­o­mist at Bloomberg In­tel­li­gence in Hong Kong. "The PBOC hopes the lat­ter can help to achieve two aims: tar­get par­tic­u­lar banks and thus help to fa­cil­i­tate re­bal­anc­ing the econ­omy; and help to build a bench­mark yield curve."

Still, Chen said the new tools don't spell the death of the old. He ex­pects two bench­mark in­ter­est-rate cuts in the first half, and a cou­ple of RRR re­duc­tions.

The PBOC's need to in­ject liq­uid­ity is a de­par­ture from the past, when vast trade sur­pluses, surg­ing cap­i­tal in­flows, and ef­forts to keep the yuan from strength­en­ing too fast meant the main ef­fort was drain­ing liq­uid­ity and forc­ing banks to lock away in­creas­ing pro­por­tions of de­posits. While trade sur­pluses are still vast, the cur­rency is now weak­en­ing and cap­i­tal is head­ing for the exit.

Each time the PBOC steps in to sup­port the cur­rency, it spends some of its for­eign-cur­rency hoard to buy yuan, thereby drain­ing funds. It's been do­ing the same in off­shore mar­kets like Hong Kong to plug an un­wel­come dis­count with on­shore rates that fans de­pre­ci­a­tion ex­pec­ta­tions. Liq­uid­ity in­jec­tions help pump yuan back into the econ­omy.

Then there's the Chi­nese New Year ef­fect -- a cycli­cal spike in cash de­mand as 1.3 bil­lion peo­ple plan trips and feasts for the week-long hol­i­day. Huachuang Se­cu­ri­ties Co. es­ti­mates the pre-hol­i­day de­mand for funds in­clude res­i­dents' need for al­most 2 tril­lion yuan, quar­terly tax pay­ments si­phon­ing off 300 bil­lion yuan, and the av­er­age monthly drain of about 700 bil­lion yuan due to the de­crease in for­eign ex­change po­si­tions.

The seven-day repo rate -- the cost of bor­row­ing funds for seven days be­tween com­mer­cial lenders -- sug­gests the PBOC's new ap­proach is help­ing steady rates, with a cor­ri­dor largely in place since late-Au­gust. The PBOC cur­rently pays a 1.62 per­cent in­ter­est rate to com­mer­cial banks on the funds they have locked away with the mon­e­tary au­thor­ity. By con­trast, the PBOC sets repo rates close to the mar­ket level, with the three-month tool charges 2.75 per­cent.

That means the PBOC is giv­ing money to banks at a higher price this time com­pared with a RRR cut. By do­ing so, it can keep liq­uid­ity flush and still avoid driv­ing mar­ket in­ter­est rates too low -- a move which could trig­ger more cap­i­tal out­flows and com­pro­mise struc­tural re­forms aimed at grad­u­ally delever­ag­ing the econ­omy.

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