MNI: PBOC Framework To Enhance Control, Transmission Concerns

The People’s Bank of China’s adjustments to its monetary-policy framework will help it consolidate control over interest rates across the economy, but a lack of depth in China’s treasury market and the disconnect between the central bank's benchmark and some segments of the loan market could weaken transmission and challenge its efforts, advisors and economists told MNI.

The central bank sent a clear signal in July that it would use the 7-day reverse repo rate as its main policy benchmark, replacing the MLF rate and simplifying its monetary system, said Tang Yao, an associate professor of applied economics at Peking University’s Guanghua School of Management.

China has a complicated policy-rate system. The PBOC has defined both the 7-day repo and MLF rate as its key policy benchmarks. The MLF previously played a prominent role as it more closely guided bank-loan rates due to its use calculating the Loan Prime Rate.

However, the PBOC has ensured the gap between the MLF and the 7-day repo rate remained unchanged by maintaining the same adjustment pace, making the existence of two rates less necessary, Tang explained. (See MNI: PBOC Eyes Lower Rate For GDP Target, RRR Cut Optional)

The 7-day repo rate can also more directly and effectively impact money-market rates, Tang argued. Linking it to LPR could increase connection between the wholesale money and retail-loan market, he continued.

SHORT-TERM RATE FOCUS

The LPR was lowered 10 basis points this month, following the PBOC’s 7-day reverse repo rate reduction by the same amount, and despite the one-year MLF rate remaining unchanged.

PBOC Governor Pan Gongsheng said last month 7-day repo rate would gradually become the main policy rate, while others would "soften their role,” and that the interest rate corridor needed to narrow to “clarify the main policy rate”. The central bank followed last week with a cut to the Standing Lending Facility rate – its interest rate corridor ceiling – by 10bp to 235bp. (See MNI: PBOC Repos First Step To Narrower Rates Corridor-Advisors)

A source close to the central bank told MNI the PBOC aimed to improve the transmission of monetary policy by targeting the 7-day reverse repo rate, introducing overnight repurchase and reverse-repurchase operations, and enhancing the yield curve.

An advisor with knowledge of monetary-policy operations said a narrower corridor may lead to less rates volatility, but make further PBOC intervention more likely. The Bank may shift to an even shorter-term facility, such as the overnight repo rate in future, as money-market rates are more sensitive to it, he added.

Lian Ping, chairman at the China Chief Economist Forum, said the move to the 7-day repo rate would help lower overall rates across the economy and lead to a single policy rate, similar to the U.S. Federal Reserve’s federal funds rate.

However, strong transmission will require sound money and bond markets, particularly greater treasury liquidity, to develop a useful yield curve, Lian added.

RATE RESPONSIVENESS

Zhao Xijun, co-dean of the China Capital Market Research Institute at Renmin University of China, said some market participants, such as state-owned companies, are not responsive to policy-rate changes as they enjoyed cheap loans with preferential interest rates, which had hindered monetary policy’s effectiveness.

Companies increasingly prefer bank loans for liquidity and short-term funding needs, and use capital markets – particularly bonds – for longer-term funds with lower costs, making a short-term policy rate more effective to guide loans, Zhao argued, adding the link between MLF and market rates had proven loose.

The PBOC’s recent framework adjustment would help the central bank to shift its focus from broad quantitative tools to rate facilities and improve the precision of its decisions as it attempts to curb overcapacity in certain sectors while encouraging greater competition.

The contribution and the efficiency of the money supply to GDP growth has fallen and expanding quantitative tools to stimulate production was not optimal, he said.