Zhou Plans Anchor After China Monetary-Policy Gyrations

People’s Bank of China Governor Zhou Xiaochuan is designing a policy anchor for money-market rates, after gyrating borrowing costs aggravated a slowdown in the world’s second-largest economy.

The seven-day repurchase rate, the benchmark short-term borrowing cost between banks, surged to 10.77 percent last June in the nation’s worst cash crunch on record, and in January the rate rose above 6 percent for the third time in eight months. While the rate rose to 3.15 percent today, it remains above consumer inflation of 1.8 percent, and its 100-day volatility is close to the highest since 2011.

China has made it tougher to gauge monetary policy since the central bank removed lending-rate controls in July and started on a course of liberalizing savings rates. Zhou is considering a system where the PBOC drains or adds funds if the policy rate deviates to the limits of a range from a midpoint, after money-market volatility spurred stock routs and dragged investment growth to the weakest start since 2001.

“What we have seen in the last eight months is that sometimes interest rates go up very high and they go down without anybody really knowing why,” said Louis Kuijs, chief Greater China economist at Royal Bank of Scotland Group Plc in Hong Kong, who formerly worked at the World Bank. “There isn’t that anchor where the government targets something.”

Benchmark borrowing costs have risen, with the yield on China’s five-year sovereign note up 89 basis points over the past year to 4.03 percent. The premium investors demand to hold AA rated similar-maturity corporate securities has climbed 33 basis points over the same period to 261 basis points. That gap has narrowed from as wide as 340 on Feb. 7 at the height of default concerns.

Rate Range

Zhou said last week at a conference in Beijing that the PBOC will consider adopting a short-term interest-rate range where the central bank would soak up or inject funds if the rate fluctuates too far from a midpoint, after it phases out the current system of state-set rates, according to a speech transcript published May 12 on the website of the Economic Observer newspaper.

The central bank could consider adding a medium-term policy rate to the short-term one, Zhou said in the transcript of the speech at Tsinghua University. China’s current benchmark one-year lending and deposit rates will only apply to a few areas, including policy banks, after interest-rate liberalization, Zhou was reported as saying.

Zhou spoke May 10 at the event, after organizers asked journalists to leave the auditorium. The PBOC didn’t respond to a faxed request for comment yesterday.

Extensive Comments

The Economic Observer’s Chinese-language transcript has since been removed from its website, which is based in Beijing. The comments were republished on websites including Hexun and Phoenix New Media Ltd., where they remained available yesterday.

The comments are Zhou’s most extensive available on China’s plans for a new market-based monetary policy after he said in March that the nation would liberalize state-set deposit rates within one to two years.

The central bank in its first-quarter monetary-policy report published May 6 highlighted the benefits of an “interest-rate corridor” system resembling Zhou’s proposal, saying it’s at the core of a framework to “effectively guide and adjust market rates.”

Using a corridor will help make China’s monetary policy operations more transparent and help the central bank manage money-market rates more consistently, without relying on auctions of securities on Tuesdays and Thursdays, said Ding Shuang, senior China economist with Citigroup Inc. in Hong Kong.

Prevent Crunch

“It can prevent a credit crunch like the one from last June, as people will know the range and know the central bank will intervene at a certain point,” said Ding, who previously worked at the PBOC and the International Monetary Fund.

China’s CSI 300 stock index fell 0.2 percent at the 11:30 a.m. local-time break and is down 16 percent in the past year. The yuan has lost about 2.8 percent versus the dollar this year and touched its weakest level since October 2012 last month. As analysts downgrade projections to account for a weak property market and depreciating yuan, China’s biggest non-bank stocks may extend this year’s drop to 20 percent, according to Chen Li, chief China equity strategist at UBS AG.

At the same time, local-government financing vehicles, railway builders and power companies have rushed to take advantage of a drop in borrowing costs. Sales reached 840.7 billion yuan ($135 billion) from April 1 to May 15, up from 583.5 billion yuan in the same period a year ago.

Decisive Role

Zhou’s reported plans are part of broader efforts by Chinese authorities to transition from a system of state-directed credit to one where markets play a “decisive” role in pricing capital. The PBOC has increasingly used tools including repurchase agreements to manage liquidity in the financial system and influence interbank rates as it shifts to a market-based system.

Setting up the new system would give the central bank more influence over the economy as it deals with what analysts project will be the slowest annual expansion since 1990. Growth in fixed-asset investment excluding rural households slowed to 17.3 percent in January-to-April period from a year earlier, the weakest for the period since 2001.

Implementing the new rate system will result in “greater clarity and less unnecessary uncertainty,” RBS’s Kuijs said. “It will be a very positive development for the monetary realm and financial markets.”

— With assistance by Xin Zhou, and Kevin Hamlin

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