China’s central bank launches new policy tool to manage liquidity

BEIJING – China’s central bank is expanding its monetary policy toolkit to get a better handle on liquidity in the financial system as it seeks to add more levers for fine-tuning the economy.

The People’s Bank of China (PBOC) will conduct so-called outright reverse repurchase agreements with primary dealers monthly for a timeframe of no more than a year, according to a statement on Oct 28. The move is aimed at maintaining a reasonable level of liquidity in the banking system and enriching its toolkit for monetary policy, the PBOC said.

A repo is a form of short-term borrowing used in money markets, which involves the purchase of a security with an agreement to sell it back at a specific date. Here, the securities will include sovereign bonds, local government notes and corporate debt, the PBOC added.

The central bank has been revamping its policy framework in a shift that could allow it to operate more like global peers and influence market borrowing costs more effectively.

It has been downplaying the role of the medium-term lending facility as a key rate while transitioning to using seven-day reverse repo as the main policy lever to deliver a clearer signal, with the new operations likely to sit between the two.

The new tool is likely to provide a longer-term liquidity injection to the interbank market and could help with an expected increase in bond issuance from China, according to Ms Becky Liu, head of China macro strategy at Standard Chartered Bank in Hong Kong.

“Outright repo has an underlying exchange of bonds, so banks can hopefully free up longer term liquidity,” she said. “The PBOC can prepare banks to facilitate a rise of government bond issuance ahead.”

Money market gauges have been flashing signs that China’s banks and non-bank financial institutions remain under a degree of funding stress.

The institutions are heading into a year end that may see a seasonal rise in cash demand and are also waiting for potential fiscal stimulus that may involve additional government borrowing.

Ensuring there is sufficient liquidity in the market is key to helping the economy, which has been weighed by a lack of domestic demand and a persistent property crisis.

Policymakers have unleashed a broad stimulus package since the end of September, including outsized cuts to interest rates and the amount of cash banks must hold in reserves. 

China is expected to allow local governments to issue more bonds to refinance their off-balance-sheet debt, and the central government could also potentially sell more treasury notes to fund more spending.

That means an increase in supply that may drain liquidity from the interbank market in the coming months, as commercial banks are the main buyers of bonds.
BLOOMBERG