13/2/2017

The People’ Bank of China (“PBOC”) raised interest rate of various lending facilities in open market recently, not only raising interest rate on Medium-Term Lending Facility (“MLF”) by 10 basis points historically before Chinese New Year, but also raising interest rate on Standing Lending Facility (“SLF”) and repo rate on the first trading day after Chinese New Year. In addition, the PBOC skips open market operations for six straight trading days, suspending liquidity injection to the market. All these policies were interpreted by investors a start of interest rate hike cycle and the tipping point of monetary policy. Yet, we believe that all these recent policies implemented by PBOC mainly aim at deleveraging and risk-management, not intending to tighten the monetary policy.

PBOC adjusts market liquidity through various tools in recent years

In fact, reverse repos, SLF and MLF were monetary policy tools frequently used by the PBOC in recent years, with financial institutions receiving liquidity from the PBOC using equities as collaterals. Reverse repo is generally used to ease short-term liquidity tension; SLF targets policy banks and national commercial banks with a duration of 1 to 3 month(s); MLF targets commercial banks and policy banks with a longer duration, usually with the objective of fulfilling the needs of agricultural industry and SME. The PBOC also introduced a new tool called the Temporary Liquidity Facility (“TLF”) to provide temporary funds to large banks in order to ease the liquidity tension before the Chinese New Year. The TLF is a form of reverse repo without collateral.

Policy interest rate hike doesn’t imply the start of interest rate hike cycle

Although the use of different monetary tools by the PBOC to regulate market liquidity has become a new normal, the interest rate hike of those tools recently has caught the market’s attention. Part of the market participants even believe that the PBOC has switched from an expansionary monetary policy to a deflationary one. Yet, we believe the implementation of TLF before Chinese New Year implies that the PBOC will inject liquidity if necessary, and tightening liquidity through the use of SLF or MLF, aiming to ensure the stability of market liquidity. This move reflects that the PBOC is more focused on neutral monetary policy.

In addition, interest rate hike is not possible from the perspective of local debt environment. The total debt to GDP ratio in China has already exceeded 260%. A one percent hike of interest rate could possibly generate interest rate expenses by more than RMB 1 trillion. Corporate debt refinancing will become more difficult. In addition, the risk of corporate default wave or even bankruptcy wave may increase. The consequences will further drag down current slowing economy.

Thus, we believe the hike of policy rates recently by the PBOC doesn’t imply the start of interest rate hike cycle. It is merely aiming at deleveraging, intending to curb market bubble and prevent economic and financial risk. We expect the PBOC will continue to use various monetary tools with flexiblities to manage market liquidity.

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