Bond comments by China’s Xi hint at possible expansion of PBOC toolkit

The PBOC now needs more flexibility in managing liquidity and more tools to expand its balance sheet, while the government bond market is deeper than before, said UBS economist Wang Tao. (File Photo: Reuters)
The PBOC now needs more flexibility in managing liquidity and more tools to expand its balance sheet, while the government bond market is deeper than before, said UBS economist Wang Tao. (File Photo: Reuters)

Summary

A months-old speech by China’s top leader has stoked speculation around aggressive liquidity boosts from Beijing.

A months-old speech by China’s top leader has stoked speculation around aggressive liquidity boosts from Beijing. While economists have generally shrugged off such a possibility, some say that more trading of treasury bonds could bring the country’s central bank more in line with practices adopted by peers in developed markets.

In remarks made in October but only published recently, Chinese President Xi Jinping called for the People’s Bank of China to supplement its monetary policy toolbox and gradually step up trading of treasury bonds in its open-market operations, a policy tool the bank has rarely used in the past two decades.

Economists say U.S.-style “quantitative easing," in which a central bank loads up on government bonds and other assets to push down yields, is unlikely in China, since Beijing still has relatively ample room to ease monetary policy with traditional measures, as interest rates in China are still well above zero.

Also, any further monetary easing would be constrained by factors including tepid borrowing demand, softer profit margins at banks, a weak currency and the uncertain timing around any future Federal Reserve rate cuts, they say.

Still, Xi’s comments represent a potential policy pivot that could help further enrich the central bank’s toolbox, some economists say, considering the shortcomings of existing tools at a time of a nascent yet fragile economic recovery.

Apart from regular open-market operations, China’s central bank can inject liquidity through various lending facilities to commercial banks as well as cut the amount of cash banks need to keep in reserve. However, after several rounds of cuts to the reserve requirement ratio in the past year, economists say authorities may only have limited room for further cuts in the future.

The PBOC now needs more flexibility in managing liquidity and more tools to expand its balance sheet, while the government bond market is deeper than before, said UBS economist Wang Tao. This makes the central bank’s trading of central government bonds and even local government bonds more necessary and feasible than before, she said.

Under Chinese law, the central bank is prohibited from directly purchasing government bonds in primary markets, and it has generally refrained from such purchases in secondary markets in the past 20 years.

Goldman Sachs economists said last week that the central bank is likely to alleviate any upcoming treasury bond supply shock that may stem from Beijing’s planned issuance of 1 trillion yuan ($138.30 billion) worth of special treasury bonds in 2024 via indirect purchases.

The economists said that would be similar to when the PBOC bought CNY1.35 trillion of special treasury bonds from Agricultural Bank of China to help establish the country’s sovereign-wealth fund in 2007.

“That said, the PBOC also has alternative options to accommodate the supply shock, such as RRR cuts and MLF operations," the Goldman Sachs economists added.

Write to Singapore Editors at singaporeeditors@dowjones.com

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