The People’s Bank of China, China’s central banking institution, has announced that it will be expanding its monetary tools by introducing a facility for outright reverse repurchase agreement (repos).
This monthly tool allows banks and non-banking institutions to borrow against corporate, local government and sovereign bonds. The agreements will not last more than one year.
The central bank’s latest effort to improve its influence on market borrowing costs and inject stability in China’s banking industry is the introduction of outright reverse purchase agreements (repos) between primary dealers.
The facility opens on Monday.
The PBOC aims to maintain a reasonable level in liquidity in the financial sector, and to help cushion against seasonal spikes of cash demand, particularly as the end of the year approaches.
Reduced liquidity pressure amid surge in bond issuance
China is expected ramp up government bond issue to finance additional expenditure and refinance the local government debt. This raises concerns about possible liquidity pressures on the interbank market.
The new tool that allows for longer-term injections of liquidity is well-timed in order to absorb the market impact from this expected surge in bonds supply.
In a Bloomberg article, Becky Liu said that “Outright Repo has an underlying bond exchange, allowing banks the ability to free up longer term liquidity.”
This will enable the PBOC to prepare banks for a rise in government bonds issuance.
The reverse repo tool, which is used to ensure liquidity even when more bonds are sold for stimulus measures, will help as commercial banks are the main buyers of these bonds.
Market observers see this as part of PBOC’s broader shift towards a more sophisticated, market-driven monetary framework.
China’s benchmark yields did not react to the news much, although the offshore yuan fell slightly against the dollar.
Outright reverse repo : aligning yourself with global central banks
The introduction of outright reversals is part of a broader revamping of the PBOC’s approach to managing liquidity.
The central bank is moving away from the medium-term loan facility (MLF), which was the primary tool for setting rates, and instead favors shorter-term instruments such as the reverse repo of seven days to provide more clear signals to the market.
This shift brings the PBOC in line with the practices of global counterparts and allows for a more precise control over borrowing costs on the market and liquidity conditions.
The new outright Repo tool will be positioned between the shorter-term reverse repo of seven days and the longer-term MLF. It offers a medium-term solution for liquidity.
By offering 3-to-6-month outright repo contracts, the PBOC aims at providing more flexibility in its operation while alleviating the funding stress on the banking sector. The MLF maturities are expected to be significant in the final months 2024.
Bloomberg reports that China has approximately 1.45 trillion yuan (204 billion dollars) in MLF loans due to mature in November and December. This makes the timing of MLF loans critical for market stability.
New tool helps banks manage cash needs
China’s financial institutions prepare for what could be an especially tight year-end. Seasonal cash demand is likely to increase.
There is also uncertainty about the possibility of further fiscal stimulus. This could come in the form additional government borrowing or bond issuance.
Maintaining economic momentum is dependent on maintaining adequate liquidity, especially as China continues its struggle with weak domestic consumption and a property sector crisis.
The policymakers have already implemented a broad stimulus package that includes cuts in interest rates and a reduction in the reserve requirements for banks.
These measures are intended to support an economic recovery, but liquidity concerns remain.
Money market indicators are warning that some institutions have already underfunded stress.
The new repo instrument is expected to ease the pressure on banks by ensuring they can access liquidity and meet their needs, while also freeing up cash to purchase bonds.
While the outright reverse-repo tool is likely to reduce the pressure on the banks, its introduction may also signal a reduced likelihood of further reductions in the reserve requirement ratio (RRR).
Frances Cheung is a strategist with Oversea Chinese Banking Corp. She noted that the flexibility of outright reverse repos reduces the need for the PBOC’s other policy tools to manage liquidity, such as RRR reductions.
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