China's Key Benchmark Turns Into Guessing Game. Here Are Some Clues

  • Economists say PBOC needs to clearly announce policy framework
  • Central bank tightens one rate while other stays at record low

The Federal Reserve has its funds rate. The European Central Bank has its refinancing rate. The Bank of Japan has two points on the yield curve. The People’s Bank of China? Well, no one is quite certain what its key benchmark is these days.

In a bid to add some clarity, Bloomberg News surveyed economists last week to see how they see policy evolving. Here are findings from more than 20 respondents:

  • 67 percent say the seven-day reverse repurchase rate -- the cost of PBOC funding in open-market operations -- is now the main policy benchmark
  • But it isn’t so simple: 86 percent say the one-year lending rate and deposit rates, the historical benchmarks, remain in use
  • As for money market instruments that include an alphabet soup of abbreviations such as MLF and SLF -- 73 percent of respondents say these have replaced the reserve-requirement ratio for banks as the main tool to manage liquidity
  • It’ll come as no surprise that 77 percent say the PBOC needs to clearly announce its new policy framework

Since liberalizing interest rates in recent years, the central bank has been experimenting with various rates in an attempt to build a more market-based monetary toolkit, all while tackling slower growth, currency weakness, and a swelling debt pile. Their expanded tool kit has been explained in bits and pieces, but a comprehensive explanation of how policy is now being formed remains elusive.

“The authorities can gain instead of lose influence through improving policy communications,” said Raymond Yeung, chief China economist at Australia & New Zealand Banking Group Ltd. in Hong Kong. “To modernize China’s interest-rate policy framework, the PBOC should officiate one policy rate, and the seven-day rate is the best candidate,” he said, referring to the cost of reverse repurchase agreements.

Read More: China Stirring Up Monetary Alphabet Soup Boosts Volatility

The central bank increased rates on medium-term loans last month and this month tightened monetary policy by raising the rates it charges in open-market operations and on funds lent via its Standing Lending Facility. Those announcements included little additional explanation.

Meanwhile, policy makers have kept the lending rate at a record low 4.35 percent since late 2015 to help underpin growth, which accelerated for the first time in two years in the fourth quarter. The reserve-requirement ratio for banks has been kept on hold for almost a year.

"Markets are confused by the latest hike of liquidity operation rates while benchmark lending and deposit rates are left unchanged," Harrison Hu, chief greater China economist at Royal Bank of Scotland Group Plc. in Singapore, said in a recent note. "This is the first time that China kicks off a tightening cycle by hiking its newly developed money market policy rates, while leaving conventional benchmark rates of bank lending and deposit unchanged."

Read More: China Raises Mid-Term Rates in New Signal of Tightening

The mixed messages come as the central bank tries to balance competing goals: Maintaining broad support for economic growth while also reining in emerging risks from excessive lending. Increasing the broad lending rate would be a blunt action felt across the entire economy, while more targeted tightening lets policy makers attack more specific objectives.

The PBOC last month increased medium-term rates, announcing the change in a brief statement posted on its Weibo social media account. The move came days after the central bank said it provided a one-month "temporary liquidity facility" to large banks, essentially announcing a brand new monetary tool without detailed explanation.

The new lending tools have eclipsed mandated bank reserve requirements as the main channel to inject funding, the Financial News, a PBOC publication, reported last month.

Read More: PBOC Newspaper Says New Credit Tools Now Main Monetary ‘Sluice’

One illustration of the uncertainty over China’s monetary policy is that some of the world’s biggest banks don’t agree which rates anchor its interest-rate corridor. While Goldman Sachs Group Inc. says the upper bound is the cost of Special Lending Operations, both UBS Group AG and Standard Chartered Plc say it’s the rate of the Standing Lending Facility.

Communication is one of the most important requirements for effective monetary policy, and a lot remains to be done, said Frederik Kunze, chief China economist at German lender Norddeutsche Landesbank in Hanover.

"The PBOC’s monetary policy framework is definitely changing," Kunze said. "However, with regard to the new benchmark interest rate everyone is going focus on, we aren’t there yet."