Monetary Policy Toolkit Expands with New Tools

Following temporary open market repurchase agreements (repos) and government bond transactions, the People's Bank of China (PBOC) has introduced a new liquidity management tool. The central bank announced on October 28 that it would activate the outright reverse repo tool in open market operations. Experts say that the central bank's introduction of outright reverse repo operations at this juncture is conducive to better hedging the concentrated maturity of medium-term lending facilities (MLF) in the fourth quarter and has more capacity to maintain a reasonable and ample liquidity at the end of the year, providing a good monetary and financial environment for stable economic growth. Looking ahead, the monetary policy toolbox still has ample "ammunition," and a new round of reserve requirement ratio (RRR) cuts may be implemented in the fourth quarter.

According to the PBOC announcement, the outright reverse repo tool targets primary dealers in open market operations, and it is原则上 conducted once a month with a term not exceeding one year. The open market outright reverse repo adopts a fixed quantity, interest rate bidding, and multiple price bidding, with the repo targets including government bonds, local government bonds, financial bonds, and corporate credit bonds. The results of the operations will be disclosed to the public through the relevant sections of the People's Bank of China's official website.

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A journalist learned from sources close to the central bank that, unlike the MLF, which uses a single price for bidding, the newly introduced outright reverse repo uses a fixed quantity, interest rate bidding, and multiple price bidding. Institutions can choose different interest rates for bidding based on their own circumstances, and they will be awarded bids in descending order from high to low. The interest rate at which an institution wins the bid is its own bidding interest rate.

"This can reduce the 'free-riding' behavior of institutions during interest rate bidding and more truly reflect the extent of their demand for funds. Also, since it does not add new monetary policy tools to the bidding interest rate, it highlights the positioning of this tool solely as a liquidity injection tool," the aforementioned person said.

Reviewing the existing liquidity injection tools of the central bank, from short to long terms, they mainly include 7-day open market reverse repo operations, 1-year MLF, and long-term liquidity injections such as government bond purchases and RRR cuts, among which there is a relative lack of medium-term liquidity injection tools from 1 month to 1 year.

In response, Dong Ximiao, the chief researcher at China United, said that the central bank's introduction of outright reverse repos on the basis of existing tools is expected to cover terms such as 3 months and 6 months, enhancing the liquidity cross-period adjustment capability within one year and further improving the level of refined liquidity management.

The central bank's choice to introduce new tools at this time can better hedge the concentrated maturity of MLF before the end of the year. Wind data shows that there are 1.45 trillion yuan of MLF maturities in November and December, accounting for 40% of the current MLF balance. Coupled with government bond issuance and year-end cash injections, the liquidity of the banking system may face a significant shortfall pressure at that time.

In the view of Wang Qing, the chief macro analyst at Orient Jincheng, the activation of the outright reverse repo operation tool can effectively smooth the fluctuations in the money market caused by large MLF maturities, helping to maintain a reasonable and ample liquidity at the end of the year and providing a favorable monetary and financial environment for the recovery of economic growth momentum. At the same time, it also means that there will be no large-scale continuation of MLF in November and December, and the policy interest rate color of MLF operations will be further diluted.

This year, to support the economic recovery, the central bank's monetary policy toolbox has frequently "updated" to ensure a reasonable and ample market liquidity. In July, the central bank introduced temporary positive repo or temporary reverse repo operations, which, when the market liquidity is saturated, recover excessive liquidity from commercial banks through temporary positive repo operations to maintain the balance of market fund supply and demand. In August, the central bank bought short-term government bonds and sold long-term government bonds from some primary dealers in open market operations, further enriching the monetary policy toolbox.

In Dong Ximiao's view, whether it is temporary positive and reverse repos or government bond trading operations, they are all integral parts of the adjustment of China's monetary policy framework, which is conducive to enriching the channels for the injection of base money.Journalists have learned that in the next phase, the central bank will further implement a prudent monetary policy, closely monitor the effects of previous policies, and accelerate the implementation of policies. There is still ample room and reserves in monetary policy, and it will continue to perform counter-cyclical adjustments.

The governor of the central bank recently stated at the 2024 Financial Street Forum Annual Conference that it is expected to further reduce the reserve requirement ratio by 0.25 to 0.5 percentage points before the end of the year, depending on market liquidity. Previously, Deputy Governor Lu Lei also emphasized at a press conference held by the State Council Information Office that the central bank "will continue to adhere to a supportive monetary policy."

Zhou Maohua, a macro researcher at the financial market department of Everbright Bank, believes that in terms of the current domestic price environment, there is still ample room for conventional policy tools. Considering factors such as increasing support for the real economy by financial institutions, the implementation of additional fiscal policies, and seasonal disturbances before the end of the year, there may be some fluctuations in the capital market. To perform cross-cycle adjustments well, it is not ruled out that the central bank may again reduce the reserve requirement ratio. In addition, there is still room for interest rate tools, but the constraints are also quite obvious. The central bank needs to act according to the real economy and price situation, and take into account both internal and external balance.

CITIC Securities' research report pointed out that since the interest rate cut in September, the reverse repurchase rate has dropped to 1.5%, and the MLF rate has been reduced to 2%. In the short term, price tools may enter a period of policy effectiveness observation. It is expected that the central bank may judge the space for subsequent policy rate cuts based on the repair of financial data in the fourth quarter, and it is not ruled out that the MLF may continue to follow the reverse repurchase rate reduction in the next step.