China’s economic stimulus efforts, the People’s Bank of China (PBOC) kept its one-year policy rate unchanged in October, a month after slashing funding costs by the largest margin in history. The decision suggests that Chinese authorities are mindful of balancing the need to support the economy with managing liquidity and inflation risks, while signaling an intent to introduce longer-term monetary reforms.
The central bank maintained the interest rate on its medium-term lending facility (MLF) at 2%, a crucial rate used by the PBOC to manage liquidity in the financial system. Alongside this decision, the PBOC drained a net 89 billion yuan (approximately $12.5 billion) from the financial system in October, according to a statement released on Friday.
This outcome was widely expected by financial experts. Of the 15 economists surveyed by Bloomberg, 14 had predicted that the rate would remain unchanged, following a 30 basis point cut in September that represented the largest rate reduction on record. Despite the historic cut, the PBOC’s policy shift to use shorter-term tools, such as seven-day reverse repurchase agreements, indicates a nuanced approach in guiding the economy through volatile global and domestic conditions.
The decision to hold the one-year MLF rate steady reflects the PBOC’s cautious approach to monetary stimulus. Rather than adopting a broad-based strategy to flood the economy with liquidity, the central bank has opted for a more measured approach, using targeted tools to balance short-term needs with long-term structural reforms.
Xiaojia Zhi, chief China economist at Credit Agricole SA, noted that the central bank’s actions align with market expectations. “This is largely in line with market expectations, both the unchanged rate and a small net withdrawal,” Zhi said. “But it doesn’t mean that the PBOC is not supportive of liquidity.”
The bank’s move to withdraw a net 89 billion yuan of liquidity is consistent with the central bank’s recent strategy of injecting large amounts of cash when needed, but tapering those efforts once the economy shows signs of stabilization. In September, the PBOC had cut the reserve requirement ratio (RRR) for banks, a key move that freed up more cash for lending. However, analysts believe that the recent net withdrawal reflects a reduced demand for cash from banks, partly due to the RRR cut, as well as the fact that the MLF rate remains higher than market rates and other PBOC tools.
While the PBOC has held the MLF rate steady, it is gradually transitioning away from using this tool as its primary monetary policy lever. The central bank has increasingly relied on shorter-term tools, such as the seven-day reverse repurchase agreements, to signal its policy intentions and manage liquidity in the financial system.
The seven-day reverse repo is a short-term borrowing tool that allows the central bank to inject liquidity into the financial system on a daily basis, offering greater flexibility than the MLF, which is typically rolled over monthly. This transition allows the PBOC to have a more immediate impact on market borrowing costs, bringing China’s monetary policy framework more in line with global central banks.
As part of this shift, the PBOC recently moved the date for its MLF operations from the 15th to the 25th of each month. The change is intended to de-link the MLF from commercial banks’ benchmark lending rates, known as loan prime rates (LPRs). By doing so, the central bank hopes to provide a clearer signal to markets and allow for greater independence in managing liquidity conditions.
China’s decision to maintain a cautious approach to monetary policy comes amid a backdrop of significant economic challenges. The country’s economy expanded at the slowest pace in six quarters during the three months ending in September, with sluggish domestic demand and a prolonged property crisis weighing on economic activity.
The property sector, long a key driver of China’s economic growth, has been a particular area of concern. Several major real estate developers, including China Evergrande Group, have faced liquidity crises, leading to defaults and a sharp slowdown in property investment. This has had a ripple effect on other parts of the economy, contributing to weaker growth.
While recent data suggests that some areas of the economy are improving—retail sales, for example, picked up in September—overall growth remains sluggish. The government has set a growth target of around 5% for 2023, but analysts believe that achieving this goal may prove difficult without additional stimulus measures.
The PBOC’s role in supporting China’s growth target is crucial, particularly as the global economy faces headwinds from geopolitical tensions, rising interest rates in advanced economies, and continued uncertainty surrounding the COVID-19 pandemic. PBOC Governor Pan Gongsheng has emphasized the need for flexible and targeted policy measures to help the economy navigate these challenges.
Last month, Pan Gongsheng announced a series of outsized rate cuts and reductions to the reserve requirement ratio, moves that were seen as a strong signal of the central bank’s commitment to boosting growth. These measures are intended to free up cash for banks to lend to businesses and consumers, thereby stimulating economic activity.
At the same time, the central bank has been careful not to over-stimulate the economy. Excessive liquidity could fuel inflationary pressures, particularly at a time when global supply chains remain strained and energy prices are volatile. The PBOC’s decision to hold the MLF rate steady suggests that it is walking a fine line between supporting growth and managing risks.
Financial markets showed little reaction to the PBOC’s decision on Friday. The offshore yuan remained largely unchanged following the MLF operation, and the yield on China’s ten-year government bonds held steady at 2.15%.
Traders and investors continue to keep a close eye on any stimulus measures from the Chinese government, particularly as the global economic outlook remains uncertain. With the U.S. Federal Reserve and European Central Bank raising interest rates to combat inflation, China’s monetary policy stands in contrast, with policymakers focused on supporting growth.
Despite the subdued market reaction, analysts believe that the PBOC’s recent actions—including the shift to shorter-term policy tools—represent a significant overhaul of the country’s monetary policy framework. By moving away from the MLF as a key policy lever, the central bank is signaling its intent to operate more like its global peers, with a focus on providing clear and timely signals to markets.
Looking ahead, the PBOC’s ability to navigate a complex set of domestic and global challenges will be critical to China’s economic prospects. On the domestic front, the ongoing property crisis remains a major risk, with analysts warning that a prolonged downturn in the real estate sector could have far-reaching consequences for the broader economy.
In response, the government has taken steps to stabilize the property market, including easing restrictions on home purchases and providing financial support to distressed developers. However, these measures have yet to fully restore confidence in the sector, and further policy interventions may be necessary.
Meanwhile, external factors such as global trade tensions, rising interest rates in advanced economies, and the lingering effects of the COVID-19 pandemic continue to weigh on China’s economic outlook. The country’s export sector, which had been a bright spot during the pandemic, has shown signs of slowing as demand from key markets such as the United States and Europe weakens.
