A woman walks outside the headquarters of the People’s Bank of China in Beijing. The PBoC plans to juggle gauges that include seven-day interbank rates, the levels of medium-term liquidity programmes for particular lenders and one-year lending benchmarks that are set to be phased out.

Bloomberg
Beijing


China’s monetary policy just got even harder to follow.
For years, the nation’s central bank had set commercial banks’ deposit rates, along with a floor for lending rates – creating a subsidised system that channelled savers’ cash into state-guided borrowing. That’s now gone, with a Friday announcement abolishing the deposit ceiling, two years after the People’s Bank of China ended the lending-rate lower limit.
The moves are part of a broader shift from a tightly regulated system where the PBoC conceived policy with quantitative outcomes in mind – such as the amount of new loans extended each month – to one where liquidity is determined by the price of capital.
The problem for China watchers is that there’s no clear sense of what rate the leadership wants to serve as the yardstick for the cost of money. The PBoC plans to juggle gauges that include seven-day interbank rates, the levels of medium-term liquidity programmes for particular lenders and one-year lending benchmarks that are set to be phased out.
“We don’t know what the real benchmark rate for China is,” says Larry Hu, head of China economics at Macquarie Securities in Hong Kong. His counterpart at Standard Chartered, Ding Shuang says it could be “confusing” having various rates in use. And Li-Gang Liu at Australia & New Zealand Banking Group sees a risk the set-up will have “little impact on the market rates before an effective policy transmission mechanism can be established.”
China is retooling its monetary policy framework at a time of slowing economic growth and capital outflows that have escalated since the central bank’s surprise currency devaluation on August 11. Meantime, global policy settings are splintering, with the Federal Reserve expected to tighten while the European Central Bank and Bank of Japan are seen adding to stimulus measures.
China’s latest interest-rate liberalisation step was announced on Friday along with the sixth interest-rate cut in a year and a reduction to the amount of cash banks must set aside as reserves.
The PBoC will use short-term repos and its Standing Lending Facility (SLF) to guide market levels, it said on Friday without specifying which short-term rate it will focus on. It will use its Medium-Term Lending Facility (MLF) and Pledged Supplementary Lending (PSL) rates to guide and stabilise mid- and long-term market rates, it said.
The PBoC on Tuesday cut the rate on seven-day reverse repurchase agreements offered in its open-market operations by 10 basis points, according to traders at primary dealers required to bid at the auctions. It conducted 10bn yuan ($1.57bn) of the reverse repos, which inject cash into the banking system, at a yield of 2.25%, according to the traders.
Ma Jun, chief economist at the PBoC’s research department, gave a primer on China’s monetary policy evolution in a paper in conjunction with the International Monetary Fund earlier this year, when he wrote: “A main task in the reform of China’s macroeconomic management during the next five-year plan is the transition from a quantity-based monetary policy framework to a price-based one.”
On Monday, as policy makers gathered in Beijing for a plenum session to formulate the nation’s 13th five-year plan, the PBoC issued a statement on aspects of its new stance.
The PBoC said it will continue setting benchmark saving and lending rates for “a period of time” to provide a key pricing reference for financial institutions. Once the formation, transmission, and management of market-based interest rates are in place, the PBoC said it will no longer set benchmark saving and lending rates.
Interest-rate liberalisation helps the PBoC’s shift from a quantity-based monetary policy framework to a price-based one, it said.
Claire Huang, a China economist at Societe Generale SA in Hong Kong, expects the central bank will begin to shift most focus to the seven-day repurchase rate.
“For easier communication they may pick a headline policy rate, which could be the seven-day repo rate, and that may be the new policy rate we need to follow,” Huang said. “They want to transition to a new framework that’s anchored by a set of policy rates and they want to form an interest rate corridor at the short end. For that you need at least two rates.” The PBoC’s policy evolution mirrors earlier moves by global peers.
In the US, Federal Reserve member banks keep accounts at the central bank and trade the balances they hold in the federal funds market at an interest rate known as the federal funds rate, which policy makers set at eight scheduled meetings per year. They’ve held the rate at a 0 to 0.25% target range since December 2008.
The Fed began announcing the funds rate in 1995. In the 1970s, it targeted the price of balances it held, and policy makers chose a target rate they thought would be consistent with their objective for money supply growth.
The main policy lever at the European Central Bank since the euro was introduced in the late 1990s has been the main refinancing rate, which is what it charges banks for weekly loans. Since the 2008 financial crisis froze lending, the deposit rate that banks receive or pay on overnight deposits has effectively become a de facto benchmark after the ECB flooded markets with excess liquidity.
The Bank of Japan relies mainly on buying bonds from banks on the open market in its easing programme, after moving away from its former benchmark, the Overnight Call Rate, in 2013.
While the experiences of other countries show the economy benefits from more developed financial markets and more efficient resource allocation, China’s reforms don’t mean it’s “leaving everything to the market,” PBoC deputy governor Yi Gang wrote this week in a commentary posted on the central bank’s website.
“There will still be monetary policy adjustments and macro- prudential regulation,” Yi wrote. “Interest rates are the outcome of resource allocation, determined by market supply and demand. At the same time, interest rates are also an important element of monetary policy and macro-economic management, as emphasised by the State Council.” Challenges remain for China’s monetary transition. For instance, a lack of depth and liquidity in the government bond market means there’s no credible yield curve which banks and other market participants can use to price risk.