In Depth: China’s Ultra-Long Bonds May Test PBOC’s Monetary Toolkit

After China’s Ministry of Finance initiated ultra-long special treasury bond sales in May, attention turned to the potential impact on capital markets and liquidity. The program involves issuing 1 trillion yuan ($138 billion) in bonds this year. The finance ministry sold its first batch of 50-year bonds in June, following earlier sales of 30-year and 20-year bonds [para. 1].

Premier Li Qiang had unveiled this multi-year bond program in March, setting the 2024 issuance schedule. The timetable spread issuance evenly through November to mitigate market volatility and liquidity impacts. Analysts expect the People’s Bank of China (PBOC) might need to deploy monetary tools like the reserve requirement ratio (RRR) to address any instability due to the expected surge in local government bond issuance [para. 2][para. 3][para. 4].

This year’s bond sale is divided into 22 tranches, averaging 45.5 billion yuan each, a manageable impact compared to historical figures, according to analysts from Zheshang Securities. The PBOC has commonly used the RRR to control liquidity, with Governor Pan Gongsheng affirming its effectiveness. Earlier this year, the PBOC injected 1 trillion yuan by cutting the RRR by 50 basis points. Analysts believe that despite the regular bond sales, a near-term RRR cut is unlikely, but it might occur towards the year-end when liquidity pressures are higher [para. 5][para. 6][para. 7][para. 8][para. 9].

Analysts at Minsheng Banking Corp. believe other PBOC measures like the medium-term lending facility (MLF) and open market operations (OMO) could ease short-term liquidity drains. However, Ding Shuang of Standard Chartered Bank argues that a potential reduction in the RRR is more likely than using MLF and OMO, given the higher borrowing costs associated with MLF. As local government bond issuance accelerates, the PBOC might reduce the RRR in the third quarter to support liquidity [para. 10][para. 11][para. 13].

The market is also monitoring when the PBOC could begin secondary market purchases of government bonds, which would enhance liquidity. Expectations rose after a recent publication of Xi Jinping’s speeches hinted at expanding the PBOC's policy toolkit, including government bond trading. PBOC trading could offer more permanent liquidity effects compared to OMOs, which are temporary due to their repurchase agreements. Wu Ge of Changjiang Securities expects this to trend as market government bonds increase, complementing the central bank’s OMO activities [para. 14][para. 15][para. 16][para. 17].

Trading government bonds, according to Ding from Standard Chartered Bank, provides more sustained liquidity injections compared to OMOs. Analysts do not foresee the PBOC rushing into large-scale bond purchases but rather anticipate gradual increases in transactions. Sheng Songcheng, a former PBOC director, noted that such trades can diversify monetary policy tools and improve monetary-fiscal policy coordination, predicting a gradual increase in these transactions [para. 18][para. 19][para. 20][para. 21].

This reporting underscores the balanced approach of the PBOC in managing liquidity through various tools while addressing any market volatility arising from the substantial bond issuance program [para. 22][para. 23][para. 24].