The Chinese central bank has injected a record amount of money into the financial system this week to alleviate a cash crunch that had driven up borrowing costs.
The People’s Bank of China has poured Rmb365bn ($58bn) into money markets over the past three days through reverse repurchase agreements, the largest weekly amount in history.
The cash was effective immediately, causing the seven-day repurchase rate, a key gauge of interbank liquidity, to fall a full percentage point from the three-month high of 4.75 per cent that it hit earlier in the week.
With the Chinese economy grinding to its slowest growth in three years, analysts and investors have been looking to the central bank to intensify its monetary easing by cutting the portion of deposits that commercial banks must hold in reserve.
The central bank has confounded those expectations, relying almost exclusively in recent months on its open-market operations, especially reverse repos, to ensure that there is enough money flowing through the financial system.
The exceptionally large cash injection was precipitated by two upcoming events that had driven up money market rates.
First, a week-long public holiday begins on Sunday and, as usual in China, there had been a surge in demand for cash ahead of the holiday. Second, banks must meet strict deposit requirements at the end of every quarter and so have been scrambling to attract funds before the start of October.
Analysts have also been reading a deeper motive into the central bank’s decision to rely on open-market operations instead of adjustments to banks’ required reserve ratios, its preferred policy tool in the past for managing liquidity.
The amount pumped into the money market this week was roughly equivalent to what would have been injected had the central bank cut required reserves by 50 basis points, as it did three times over the past year.
Whereas shifts of the required reserve ratio make for long-lasting changes to the money supply, the open-market operations usually expire after just a few weeks, giving the central bank much more flexibility in its actions.
“The market is asking whether the People’s Bank of China is changing the market architecture,” said Raymond Yeung, an economist with ANZ. “They are probably trying to replicate what central banks in other jurisdictions are doing, building up a market between the commercial banks and the central bank.”
This development is crucial to the Chinese central bank’s plan to have more interest rate deregulation. In the past, it has controlled rates with an iron fist, dictating benchmark lending and deposit rates for banks. This year, it has begun to slacken its grip by giving banks more freedom to set rates. As this liberalisation continues, open-market operations will be its most powerful daily tool for influencing rates.
Nevertheless, the short-term nature of reverse repos means that the central bank might have to fall back on reserve requirement cuts in the fourth quarter if the economy continues to slow and it wants to bring about a more permanent easing of monetary policy.
“Every time we see reverse repos, the market reacts immediately but it is shortlived,” Mr Yeung said.