MNI POLICY: Call For China To Up Deficit To Boost Collateral

     BEIJING(MNI) - The Chinese government should raise its borrowing beyond 3%

of output in order to boost the supply of safe assets which can be used by banks

as collateral and enable the central bank to pump liquidity into the economy

when necessary, a former official at the People's Bank of China said Tuesday.

     "Our fiscal deficit (to GDP) ratio should break 3%," said Yao Yudong,

former director general of the Research Institute of Banking and Finance, the

People's Bank of China, and currently chief economist at Dacheng Fund, at a

forum held by Caijing magazine. "While it would not completely solve the problem

of the lack of long-term collateral, it is necessary to increase the fiscal

deficit ratio by at least one percentage point."

     Higher government borrowing would provide more bonds for banks to lodge

with the PBOC, he said, explaining that a shortage of securities eligible to be

used as collateral against cheap short-term loans is limiting the central bank's

capacity to pump liquidity into the economy.

     His comments came as government-related economists and advisors have in

recent months suggested that authorities target a higher fiscal deficit next

year, of around 3% of GDP, up from this year's projected 2.6%, to boost economic

growth amid a trade spat with the U.S.

     --POST-CRISIS REFORMS CRIMPED COLLATERAL SUPPLY

     Global reforms following the 2007-2008 financial crisis raised collateral

standards, restricting the pool available to banks for accessing central bank

liquidity.

     As Chinese banks have already lodged CNY26 trillion of collateral at the

PBOC, there is only scope to pump in a further CNY6 trillion in liquidity, on

top of the CNY20 trillion already provided via tools including repos and

overnight loans, Yao said.

     "The lack of collateral affects the transmission of monetary policy (to the

real economy)," Yao stressed, adding that the issue could limit further reserve

requirement ratio cuts for commercial banks.

     "This problem needs us to be on high alert," he said.

     While the PBOC expanded the range of eligible collateral for its

medium-term lending in June -- accepting AA-and-above-rated bonds backed by

credit to small and micro businesses, agriculture and the green economy, as well

as corporate bonds with AA+ and AA ratings - the move increased the total pool

by at most CNY2 trillion, Yao said.

     The PBOC is unlikely to further widen its collateral guidelines, as it

would be too risky, he added: "The central bank would need to consider the

safety of its balance sheet."

     However, while some influential voices have called for the government to

borrow more, others are more cautious. Gao Peiyong, deputy head of the Chinese

Academy of Social Sciences, a state think tank, said the fiscal deficit should

stay within 3% of GDP in order to give the government room to respond to

financial risks and any future crisis.

     China should avoid repeating the fiscal stimulus deployed in the 2007-2008

financial crisis, Gao argued, saying it had caused an asset price bubble.

--MNI London Bureau; +44208-865-3829; email: Jason.Webb@marketnews.com

--MNI Beijing Bureau; +86 (10) 8532-5998; email: iris.ouyang@marketnews.com

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