China’s Central Bank Introduces Key Cash Management Tools

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China’s central bank has introduced a new cash management tool in the form of temporary bond repurchase (repo) agreements and reverse repos this week. This addition to its suite of open market operations is poised to become a key interest rate indicator.

Repos and reverse repos serve as short-term cash management instruments, allowing primary dealers to exchange government bonds for cash with the central bank either to borrow funds or park excess cash. In these temporary overnight repos, the People’s Bank of China (PBOC) sells securities to primary dealers, agreeing to repurchase them the following day, thus effectively draining cash from the financial system. Conversely, reverse repos enable the PBOC to inject funds.

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These new operations will be conducted in the afternoon between 4 p.m. (0800 GMT) and 4:20 p.m. on working days, only if deemed necessary based on market conditions. This schedule contrasts with the bank’s routine morning operations. The interest rates on these temporary repos and reverse repos will be 20 basis points below and 50 basis points above the seven-day reverse repo rate, or 1.6% and 2.3%, respectively.

The introduction of these tools is seen as a step towards enabling the seven-day reverse repo rate to become a new policy benchmark. This follows a statement by PBOC Governor Pan Gongsheng last month, suggesting that while the seven-day reverse repo rate essentially functions as the main policy rate, a narrower interest rate corridor might be warranted. This new interest rate corridor, with a width of 70 basis points established by the temporary repo and reverse repo rates, aims to replace the current wide 245 basis point range between the seven-day standing lending facility (SLF) rate and the interest rate on excess reserves (IOER).

The timing of this initiative aligns with the central bank’s recent warnings and measures, including plans to sell treasury bonds, aimed at cooling a long-running bond rally. Pan emphasized that the central bank should act swiftly to mitigate risks in financial markets and maintain a normal upward-sloping yield curve. A steeper yield curve, according to Ju Wang from BNP Paribas, could attract overseas investors to yuan bonds, potentially strengthening the yuan which has depreciated by 2.4% against a robust U.S. dollar this year, pressured by relatively low yields.

Looking ahead, the PBOC may consider adopting a single short-term interest rate as the principal policy rate. If the seven-day reverse repo rate takes on this role, it will help streamline policy transmission to other benchmarks and tenors.