In recent months, the People’s Bank of China (PBOC) has been actively involved in adjusting its monetary policy instruments to ensure liquidity within the banking systemOn February 25, 2024, the central bank announced the implementation of a new Mid-Term Lending Facility (MLF) operation worth 300 billion yuanThis operation, set to mature in one year, carried a bidding interest rate of 2.00%. In conjunction with this move, the PBOC also executed a 3.185 trillion yuan reverse repos operation with a seven-day maturityConsequently, following the maturity of 4.892 trillion yuan in reverse repos on the same day, the net liquidity absorption amounted to approximately 1.707 trillion yuan.

Experts are predicting a continued trend of a reduced MLF as the PBOC seeks to maintain an orderly approach to liquidity managementAnalysts speculate that the balance of MLF will persist in its downward trajectory, as the central bank utilizes tools like Fixed-Rate Reverse Repo and other newly established instruments to substitute the existing MLF operationsThis approach is part of a broader strategy aimed at implementing an adequately loose monetary policy while safeguarding financial stability, particularly as the renminbi exchange rate stabilizes.

The decision to maintain the MLF operational interest rate has met market expectations, as articulated by Dong Ximiao, chief researcher at China's Zhuhai UnionHe observed that the MLF rate has remained at 2.00%, which is viewed as relatively high in the current economic environment, leading to a diminished demand among financial institutionsIn response to this shift, the central bank has mainly resorted to conducting reverse repo operations to replace the maturity of MLFs.

Wen Bin, chief economist at China Minsheng Bank, highlighted that the diminishing scale of MLF operations since March of the previous year, with current balances reduced to around 4 trillion yuan, signals a gradual effort by the PBOC to downplay MLF's importance within the overarching monetary policy framework

Advertisements

This transition is indicative of a revitalization of the seven-day reverse repo interest rate's significance, as well as an optimization of the varieties and maturity structures of monetary policy tools to enhance control over liquidity with increased precision and flexibility.

As the PBOC broadens its toolbox, significant liquidity injections have occurred through government bond trading and large-scale reverse repo operations since the latter half of 2023. From October 2024 to January 2025, the central bank injected significant amounts of capital, specifically 500 billion yuan, 800 billion yuan, 1.4 trillion yuan, and 1.7 trillion yuan through reverse repos, accumulating to a total of 4.4 trillion yuanAdditionally, transactions involving the purchase of government bonds totaled 1 trillion yuan during the period from August to December 2024. Notably, the PBOC also initiated a 14-day reverse repo operation the week before the Chinese New Year, underlining its commitment to maintaining ample market liquidity.

Wang Qing, chief macro analyst at Dongfang Jincheng, described the operational paradigm established since October 2024 as a shift towards executing large-scale reverse repos to gradually replace MLF initiativesThis serves to diminish the policy interest rate overlay traditionally associated with MLF operations.

The latest market developments have shown mixed shifts in interest rates as of February 25, impacting the Shanghai Interbank Offered Rate (Shibor). The overnight Shibor registered at 1.8620%, a slight decrease of 0.40 basis points, while the seven-day Shibor increased to 2.1280%, reflecting a rise of 18.70 basis pointsThe 14-day Shibor declined to 2.1730%, down 9.60 basis points, while the one-month and three-month Shibor rates saw minor increases as well.

Experts, including Wang Qing, have interpreted the PBOC’s preference for reversing market liquidity as a reflection of two main factorsFirst, following a shift in monetary policy signaling from "stable" to "moderately loose," regulatory agencies have emphasized the necessity of steering financial resources toward the real economy, simultaneously focusing on improving capital allocation efficiency and mitigating the risk of capital turnover

Advertisements

Second, regulators are actively employing various methods to mitigate the rapid decline in long-term bond yields.

Data from Wind reveals an impending maturity of nearly 30 trillion yuan in interbank certificates of deposit from late February to March, alongside 2.4 trillion yuan scheduled to mature in reverse repos from March to AprilThis has led to market speculation regarding persistent pressure on capital availabilityNevertheless, analysts maintain that the current liquidity tightness is a temporary phenomenon and caution against excessive worry, as the direction of the PBOC's moderate easing monetary policy remains unequivocally steadfast.

In alignment with directives from the Central Economic Work Conference, the PBOC has committed to implementing a moderately expansive monetary policy throughout the yearThis encompasses an emphasis on “forward-looking, targeted, and effective” approaches, and involves making strategic adjustments to optimize the intensity and pace of policies based on comprehensive internal and external conditionsOn the credit front, efforts to unearth effective credit demand have been underscored.

Mingming, chief economist at CITIC Securities, asserts that there remains potential for both interest rate cuts and reserve requirement ratio adjustmentsHowever, he warns that decisions around these modifications may unfold post the National People's Congress and into the second quarter, influenced by multi-faceted considerations of economic growth stability, currency exchange stability, and risk avoidanceAs a forward-looking assessment, he highlights that in a context where MLF gradually tightens, reverse repos are likely to become the primary mechanism for medium-to-long-term liquidity provisioning.

Looking ahead, Wang Qing anticipates that despite the MLF balance remaining relatively high, the ongoing replacement of MLF with reverse repos will persistIntegrating insights from the current housing market, external economic conditions, and overall price trends, he predicts a potential window for interest rate cuts could emerge around the end of the first quarter

Advertisements

Dong Ximiao also emphasizes that beyond managing liquidity expectations, a reserve requirement ratio reduction will serve to reduce funding costs for financial institutions, thus fostering stability in net interest margins and contributing to a gradual decrease in overall financing costs for the societyThe weighted average reserve requirement ratio among Chinese financial institutions currently stands at 6.6%, with certain smaller rural financial institutions operating under a 5% “implicit lower limit.” Therefore, expectations remain that the PBOC will further refine the reserve requirement system, amplifying the operational adjustments that these monetary tools can achieve.