MNI EXCLUSIVE: PBOC To Stick To Secondary Bond Market-Advisors

--Amid Debate On Direct Monetary Financing, Advisors Say PBOC Will Stick To

Secondary Market

--Central Bank Could Also Cut Reserve Requirements To Boost Bond Demand

     BEIJING(MNI) - The People's Bank of China could facilitate a likely CNY1

trillion-plus issuance of special government treasury bonds by buying them in

the secondary market or by freeing up liquidity for banks to purchase them, but

the PBOC is unlikely to do what some policymakers have suggested and acquire

them directly, policy advisors told MNI.

     In the wake of the coronavirus shock, senior economic policymakers have

been debating whether the PBOC should directly buy special bonds the Finance

Ministry is set to sell in order to finance recovery and bolster official

finances. But Zhao Quanhou, director of the Financial Research Center at the

Chinese Academy of Fiscal Sciences under the Ministry of Finance, said this

would require a revision to Article 29 of the "People's Bank of China Law",

which stipulates that the PBOC cannot provide overdrafts to the government or

directly purchase or underwrite government bonds.

     Other policy advisors told MNI they were also concerned by potential

financial risks from any direct purchases, and not just by the legal

impediments.

     --BANK RESERVE REQUIREMENTS

     The central bank is more likely to purchase special treasuries in secondary

markets, or else make it easier for banks to buy them by cutting reserve

requirement ratios, Zhao noted. He said the Finance Ministry could issue

CNY1-1.5 trillion in special treasuries, using the money to set up funds to

provide loan guarantees, or to finance industrial investment and efforts related

to coronavirus, or to capitalise small businesses or banks.

     The size of the issuance of special treasuries, which are not included in

narrower measures of China's fiscal deficit, is expected to be announced at the

session of the National People's Congress starting on May 22.

     In 1998, the big four state-owned banks used liquidity freed by a cut in

reserve requirements from 13% to 9% to purchase CNY270 billion in the special

debt, recapitalising them in the wake of the Asian financial crisis. In 2007,

Agricultural Bank of China bought CNY1.35 trillion of special treasuries, which

were used by the Ministry of Finance to set up China Investment Corp, before

selling them on to the PBOC later.

     But direct monetary financing would transfer risks to banks and investors,

noted Wang Zecai, director of Government Performance Evaluation Research Central

at the CAFS, stressing that funds from special bonds should be directed at

profit-making ventures, or at efforts directed at pandemic protection.

     --FINANCING CHALLENGES

     China's different administrations face multiple challenges as they seek to

borrow at a time when many of them are already highly leveraged and now face

falling revenues.

     As of the end of May, authorities hoped local government special-purpose

bonds, whose interest payments are made from revenues from projects they fund,

would raise as much as CNY2.9 trillion this year, but Wang noted that officials

are struggling to find qualified projects. Regulators must also ensure funds are

not simply diverted to paying off old debts.

     Even accounting for special treasury bond issuance, China's overall ceiling

for the deficit/GDP ratio will have to be raised, although to no higher than 4%

of GDP, from 2.8% in 2019, Wang said, saying this would provide another CNY1.5

trillion in fiscal room. If growth remains above 3%, local government

special-purpose bond issuance would need to total as much as CNY3.5-4 trillion

for the year, he added.

     Given these challenges, some officials now argue that direct monetary

financing, debated for years on the margins of policy circles, may at last be a

valid policy option.

     Monetary financing could be conducted at a controlled pace in order to be

compatible with the PBOC's inflation and other objectives, said Chen Daofu,

deputy director at the Financial Research Institute of the Development Research

Center of the State Council. Spending should also be efficiently controlled, he

said.

     Expansionary policies are necessary after the first quarter's steep

contraction, and low producer price inflation indicates deflation risks, said a

fiscal advisor who asked to remain anonymous, pointing to pressures from

slumping tax revenues and also to the PBOC's difficulties in prompting banks to

lend to small businesses. Fiscal stimulus could reach as much as CNY10 trillion

in 2020, about 10% of GDP, he said.

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

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