Xi Jinping's mysterious plans take shape with biggest change in years

It all started with an enigmatic quote from the president Xi Jinping buried in a 172-page book on the financial sector. Three months later, plans for potentially the biggest change in years to how China conducts monetary policy are beginning to surface.
Pan Gongsheng, governor of People's Bank of Chinaclearly acknowledged on Wednesday that the monetary authority was considering trading government bonds on the secondary market as a way to regulate liquidity.THE People's Bank of China is studying the implementation with the Ministry of Finance and it will be a gradual process, he said in a speech.
This responds to Xi's directive to enrich the monetary policy toolkit and gradually increase the buying and selling of government bonds under central banks' open market operations, in a speech delivered at a financial policy meeting last year, made public only in the book published in March.
In addition to this, Pan hinted at other changes in the interest rate system. The bank could consider using a single short-term rate to guide markets. It also plans to narrow the corridor within which market rates can fluctuate to signal a clearer policy objective.
Certainly, all of these measures are aimed at refining the technical tools that the PBOC uses to manage interest rates and money. They won't necessarily help answer some of the big questions facing Chinese policymakers now, such as whether credit can support the economy when households and businesses are unwilling to take on more debt, or how to reduce borrowing costs without weakening the yuan. Many details remain vague, as does the timeline for the change.
People's Bank of China observers view the proposals as part of a long-term effort in which the central bank ultimately seeks to steer market interest rates rather than directly setting them and moving a little further away from the command economy where those responsible determined both the price and the quantity of credit. . Pan said Wednesday it was time to pay less attention to targets such as the pace of loan growth, as borrowing by real estate developers and local governments is declining amid the economic transition.
Adopting a short-term interest rate linked to the financial market as the main policy rate would be an obvious further step in the gradual reform of China's monetary policy framework, said Louis Kuijs, chief economist for the Asia-Pacific at S&P Global Ratings. This would make the framework simpler and more transparent, and bring it closer to industry standards as practiced in most advanced economies.
One conclusion many analysts drew from Pan's speech is that the PBOC is preparing to downplay what has been one of its main instruments: the one-year policy loans known as the Medium-Term Loan Facility . Since its introduction a decade ago, the MLF has become a major channel for the central bank to inject money into the economy and guide market rates.
But in recent months, banks' demand for these funds has slowed as it has become cheaper for them to borrow from each other. The MLF interest rate has remained stable for 10 months, even as other borrowing costs in the economy have plunged, in part because the PBOC is wary of currency depreciation.
Additionally, MLF is also only available to certain banks. By buying and selling sovereign bonds as an alternative means of managing liquidity, central bankers can influence the financial conditions of a wider range of market participants. And compared to MLF, the rate of seven-day short-term loans offered daily to banks provides more flexibility for fine-tuning their policy.
Pan might believe that China's rates market is now mature enough for the central bank to stop using multiple pegs to guide it, according to Serena Zhou, senior China economist at Mizuho Securities Asia Ltd.
Financial News, a PBOC-run newspaper, on Thursday cited anonymous industry experts saying the central bank should weaken the link between the MLF, which represents banks' funding costs, and the prime lending rate, a benchmark for the interest rates granted to the real economy. The latter point is more important because borrowers' real costs matter more for economic growth, according to the report.
Currently, LPRs are based on the interest rates that 20 banks offer to their best customers. They are quoted as a spread compared to the MLF rate.
One likely objective is to provide a smoother transmission mechanism from short-term interest rates to longer-term interest rates.
The People's Bank of China's current setup of using two policy rates, the seven-day reverse repo and the MLF, reduces the signaling effect of its monetary decisions, economists at Macquarie Group Ltd. have argued. led by Larry Hu in a report released Thursday.
In addition, the current interest rate corridor constructed by the People's Bank of China and the range within which market rates are expected to move is too wide, they said, leading to a highly volatile market for loans seven-day interbank lending rates compared to the much more stable seven-day interbank lending market rates. United States and Europe.