China’s Evolving Toolkit to Manage Monetary Policy

China’s monetary policy is in flux, as the central bank tries to weed out risky lending while ensuring money keeps flowing into the economy. To achieve those sometimes competing goals, the People’s Bank of China is engaging liquidity tools and pricing signals, while keeping its historical benchmarks dormant. An added complication: managing the impact of the prolonged trade standoff with the U.S. and calibrating the speed at which it opens the financial system to outsiders. The bigger picture is the PBOC’s transition from being China’s only lender under Mao Zedong to something resembling the Federal Reserve or the European Central Bank -- a modern institution that sets the price of short-term money using interest rates to lend in financial markets. But for now, it’s not clear what that lending benchmark will be. Yi Gang, who took over the reins at the PBOC last year, has signaled faster change, saying the bank may study stopping the release of the current benchmark lending rates -- a step toward making prices more market driven. How soon those changes will start remains unclear. That means investors need to keep watch on a variety of fronts to discern policy direction. Here’s a look at the main items in the PBOC’s evolving toolkit.

While OMOs cover a variety of tools, they usually refer to the PBOC offering reverse-repurchase agreements in the open market. The contracts are short-term loans to primary dealers -- mainly major banks -- and are the most common tool to smooth money-market rates. Reverse repo operations are gaining prominence as the PBOC increases the frequency of operations and adds different tenors (the amount of time to maturity). In a broader sense, open market operations also include tools with longer tenors such as central bank bills. Regardless of the tenors, the operations can result in either a net injection or withdrawal of cash from the financial system and hence have an immediate effect on the money market. There has been growing chatter that the central bank is planning to move forward with a long-awaited liberalization of interest rates, eventually scrapping the 1-year benchmark lending rate.