MNI EXCLUSIVE: Call For PBOC To Take Firms' Debt As Collateral

     BEIJING(MNI) - The People's Bank of China should expand the range of

collateral it accepts against its lending to include high-rated corporate debt

and a greater range of local government bonds, policy advisors told MNI, arguing

that such a move would boost demand for the securities and ease financing

conditions for regional administrations and companies.

     China's highly-indebted local governments are facing difficulty rolling

over their liabilities, including implicit debts such as borrowing by

off-balance sheet financing vehicles, one advisor told MNI, asking to remain

anonymous.

     "Controlling local government debt risk should be as important as boosting

the economy, if not more urgent," the advisor said, noting that this year's

three cuts in banks' reserve requirement ratios have mainly been used to repay

PBOC medium-term lending facility loans, leaving companies in the real economy

still facing high borrowing costs.

     "Monetary policy has shown a strong neutral bias so far this year, with no

big interest rate cut," the advisor said. A record high money multiplier - the

rate at which base money created by the PBOC is transformed into real economy

money - may be more indicative of speculation on short-term bills and property

than a sign of healthy lending, the advisor said.

     Expanding PBOC collateral would be one of the more efficient manners of

delivering credit to the parts of the economy that most need it, the advisor

argued, noting that the central bank's balance sheet has shrunk so far this

year. Two other advisors told MNI they would support such a measure, which the

first advisor said would have a similar effect to the targeted longer-term

refinancing operations provided by the European Central Bank. Special-purpose

bonds issued by local governments to pay for infrastructure projects could also

be accepted as collateral, the first advisor said.

     The PBOC's balance sheet shrank by CNY426 billion at the end of September

compared to a year ago. Base money fell by CNY1.2 trillion.

     --FRESH RRR CUT?

     A more direct economic stimulus would be for the PBOC to buy government

bonds, something which advisors have increasingly called for in recent years as

central bank measures to maintain liquidity at a time of falling foreign

reserves have drained supplies of eligible collateral. But such purchases have

been forbidden since 1995, in order to maintain PBOC independence and curb local

government borrowing.

     A second advisor said the PBOC might also make an additional reserve

requirement ratio cut, perhaps by as early as the end of the year, to counter

the regular Spring Festival liquidity crunch. The high money multiplier, which

reached 6.38 in September, meant that only a small cut would be likely, the

advisor said, adding that monetary policy was suffering from diminishing returns

and that the authorities might also want to save ammunition in case of a more

serious downturn.

     Falling industrial profits and lenders' low risk appetite is sapping credit

demand, an official at a state-owned bank told MNI. Further targeted easing may

be positive, he suggested, but cautioned that he expected the central bank to

maintain a generally neutral stance, for fear of inflating speculative bubbles.

Local governments may also improve their funding position with plans to issue

longer-term bonds, which are comparatively attractive to banks, he said.

     This week's 5-basis-point cut in the PBOC's 1-year medium-term lending

facility rate may have come in recognition of the failure of previous moves to

ease real economy borrowing rates, the bank official said.

     Calls by China's government for banking regulators to make it cheaper for

companies to borrow are unrealistic at a time when the economy is slowing and

default risks are relatively high, he added.

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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