Thursday, 30 October 2008
PBoC Scrapping Central Bank Notes: Back to the Bond Market
Although the market expects China’s monetary authority to further cut interest rates, the People’s Bank of China(PBoC), China’s central bank, has other moves to make. When tightening monetary policy, it would usually issue central bank notes before any interest cuts. With the situation reversed and increasing liquidity now its primary task, PBoC is going to scrap central bank note issuance to promote interest cut.
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PBoC Scrapping Central Bank Notes: Back to the Bond Market
29 October 2008
Although the market expects China’s monetary authority to further cut interest rates, the People’s Bank of China(PBoC), China’s central bank, has other moves to make. When tightening monetary policy, it would usually issue central bank notes before any interest cuts. With the situation reversed and increasing liquidity now its primary task, PBoC is going to scrap central bank note issuance to promote interest cut.
The PBOC will adjust the frequency of one-year note issuance to once every two weeks from the previous once a week. In fact, the PBOC is adjusting the structure of central bank note issuance during this half of the year. In July it suspended the issuance of the three-year note and restored the six-month note. Shorter terms and lower issuing frequency indicates that PBOC aims to weaken its status as an instrument.
The central bank note became PBoC’s main instrument for open market operations in this round’s macroeconomic regulation in 2005, mainly because it could see no other choice. Earlier, PBoC’s concern was focused on the liquidity surplus on the domestic short-term fund market. Due to lack of flexibility in the exchange rate system, a weak dollar led to the rapid growth of China’s sterilization costs. Because of the lack of sound liquidity on the short-term national debt market, it was not realistic for the PBOC to frequently operate in the bond market, so it had to issue a large amount of central bank notes to get funds back.
Now, however, due to the deepening crisis, American companies and financial institutions have made moves that have strengthened the dollar. After the dramatic rebound in July, USD again grew stronger at the end of September. The strong USD has greatly relieved sterilization pressure on PBoC. Its figures show that in August sterilization costs increased by 183 billion yuan, much lower than July’s increase of 344 billion yuan. So now it is reasonable for the PBOC to slow the issuing of central bank notes and begin buying them back.
Apart from concern over sterilization costs, PBoC’s adjustment of central bank note issuance also aims to increase liquidity. Although it has lowered the interest rate twice, liquidity is still under the thumb of commercial banks. In the current economic situation, due to lack of confidence and the conservative strategy of commercial banks, interest cuts are not particularly effective. PBoC’s withdrawal from the bond market, together with commercial banks’ balance sheets, is encouraging funds to return to the real economy.
Central bank notes have been favored by the market due to the large amount of issuance, and PBoC’s own credit, so their withdrawal from market is bound to trigger a reaction. China’s bond market has become very hot in 2008. Apart from government promotion of enterprise bonds, another reason is that a number of big central enterprise are very interested in bond financing channels with more flexible term structure, leading to the restoration of mid-term notes and short-term financing bonds. For companies with good credit, PBoC is their powerful rival. PBoC’s withdrawal helps to transfer dealers’ attention back to sound companies. Giants such as Vanke, PetroChina, and ICBC are going to raise money from the bond market and will enjoy lower costs.
Domestic banks accepted a large amount of central bank notes, especially issued to them, as a kind of punishment when PBoC was conducting tight monetary policy. Ironically, with the financial crisis gradually spreading to the real economy, enterprise bonds having to do with the crisis have been abandoned by the over sensitive short-term fund market, while central bank notes with low risk, have been welcomed by commercial banks. In effect, PBoC made its own notes a refuge for them, opposite its original intention. PBoC’s present move may aim to encourage commercial banks to transfer their assets from central bank notes to corporate loans and bonds, and therefore share risks with companies in the real economy.
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