China Economics Seminar

Current guidance is needed from the PBoC

Recently, forward guidance has become a new fashion in the world of central banks and Bank of England is the latest one to join this club. In the news conference last Wednesday, Bank of England Governor Mark Carney said that the BoE would not raise Bank rates from the current level of 0.5% until the unemployment rate, currently at 7.8%, dropped to below 7%. The BoE’s historic move was following in the footsteps of the Federal Reserve and European Central Bank, who introduced forward guidance in December 2012 and July 2013 respectively.





Unemployment threshold




Inflation threshold




Time frame of low rates

through mid-2015

An extended period of time (not 6 or 12 months)

Until 2016

Forward guidance is a non-traditional tool of monetary policy and the reason why central banks in the developed countries are adopting this tool now is probably because benchmark interest rates are already extremely low, which leaves little room for further downside adjustments. It could be very useful if the central banks communicate with the market well. As the Fed says, “By providing information about how long the Committee expects to keep the target for the federal funds rate exceptionally low, the forward guidance language can put downward pressure on longer-term interest rates and thereby lower the cost of credit for households and businesses, and also help improve broader financial conditions.”

Weird enough, although forward guidance has caught the headlines in the English newspapers and triggered lots of discussions in the English blogsphere, I have seen very few discussions on this topic in Chinese media. It seems that the Chinese think forward guidance is something quite remote and no one believes the PBoC is going to join this club any time soon.

I think people are right. In China it is still too unrealistic for China's central bank to discuss forward guidance, because we do not even have enough 'current guidance.' Forget about what will happen in 2015 or 2016. No one even knows what the PBoC will do in 3-6 months. 

Many analysts and traders have complained privately that the People’s Bank of China does not like communicating with the market. It seems that the PBoC enjoys making the market guess in the dark, and it has probably never held the belief that it is important to communicate clearly with the market, which is held by many central banks in the developed markets. But is it a good strategy to be working in a black box? I doubt it.

The most recent example is the interbank credit crunch in June. As I wrote previously, the PBoC failed to communicate properly with the market and it not only caused severe tension in the interbank market but also undermined its own credibility. The PBoC kept being very hawkish until June 24th when overnight repo surged to 30% and the stock market plummeted. On the next day its stance was completely reversed as an official announcement was released saying that the central bank had injected liquidity into the market. Its 2Q monetary policy report (in Chinese) told us that 416 billion yuan was injected to calm the market down.

Apparently the PBoC learned that it could not let the repo rate spike to double digits again, as it injected liquidity by reverse-repos when money market rates rose again in July. However, the lesson might not be learnt in a good way, even though the PBOC says “The bank ... will reinforce communications with the market and the public so as to stabilize expectations and guide the stable operation of interest rates” in its 2Q monetary policy report.

There were talks (in Chinese) that the PBoC was secretly managing the money market rate. When two rural cooperatives did a one-day repo at 5.92% on July 18th, the regulator asked them to cancel this transaction because “it was too deviated from the market price and had a bad influence”. As Reuters reported (in Chinese), repo rates could no longer reflect the real supply/demand of the interbank market as many banks turned to borrowing off-line from each other.

The PBoC's routine open market operations can also confuse the market greatly. In July, the PBoC secretly rolled over 183.8 billion yuan 3-years PBoC bills while it provided short-term liquidity to large banks who bought those bills.It was not known until the PBoC’s 2Q monetary policy report was published on August 2nd, and the report described it as “innovation in open market operations.” But people still do not exactly understand its purpose. 

This was not the first time we saw a major change in the use of open market operation tools without thorough explanations. The PBoC bill has been used frequently as a major instrument in PBoC’s open market operations since it was created in the beginning of this century, but its issuance was suddenly halted in December 2011 and no PBoC bill was issued at all in the year of 2012.

Instead, the PBoC started to use reverse repos extensively to withdraw liquidity. The market had no clue about the purpose of this shift in open market operations and the analysts can only guess that the central bank might want to promote the significance of repo rates and that it might become the benchmark rate - just like South Korea setting 7-day repo as its benchmark rate - when interest rate is fully liberalized in China in the future.

Since no bills have been issued in a full year, many were also speculating that the PBoC bill might have gone the way of history. These arguments all sounded very plausible, but all of a sudden the PBoC bills were issued again in May this year, after being absent for 17 months. This unexpected move made all the previous explanations and speculations look silly, but you can't blame the analysts, because the PBOC never told the market why they stopped issuing PBoC bilsl in 2012 and why they suddenly reissued them now. 

This year, as GDP growth keeps decelerating, many were asking when the PBoC and the government will loosen their policies. Again, the PBoC offered little information and left the analysts debating with each other.

The only thing that is close to a “current-guidance” is from Premier Li Keqiang, who said in July that 7% GDP growth is the bottom line of the government’s tolerance this year and the upper-limit for CPI growth is 3.5%.

Is 7% GDP growth enough to keep unemployment low? Does it mean the government won’t ease its policy until the targets are missed? What exactly will his government do if it fails to reach its targets? We still don't know. And please don't ask about 2014. 

Chen Long
Central banking seminar