China's Central Bank Swoops to The Rescue -- Heard on The Street

By Aaron Back 

        China's central bank is back again to save the day. Just don't call it quantitative easing.
        The People's Bank of China looks set to introduce new easing measures aimed at smoothing implementation of a local-government debt restructuring, The Wall Street Journal reported Tuesday. The aim is to encourage banks to buy new bonds issued by local governments.
        These bonds replace loans owed by local government financing vehicles, off-balance-sheet platforms set up by towns and provinces to get around restrictions on direct borrowing. The first wave of refinancing is under way, with an initial tranche of bonds worth 1 trillion yuan ($160 billion). The trouble is that the new bonds have longer duration and lower interest rates than the debt they replace, so banks are hardly keen to make the swap.
        Now the PBOC looks set to take up the burden itself. The PBOC would swap long-term loans for local government bonds now held by banks. This would give the banks added liquidity, and allow them to lend the money back into the real economy at a higher rate.
        Some have described the plan as China's version of quantitative easing, but this is misleading. Quantitative easing involves outright purchases of bonds or other assets by central banks, with the aim of effecting a broad monetary easing and spurring economic growth.
        Chinese officials liken the new program to the European Central Bank's long-term refinancing operations, begun in 2011, which allowed European banks to post sovereign debt as collateral for low-interest loans from the central bank. That program was pilloried for not being aggressive enough, and came years before outright quantitative easing by the ECB, which started only recently.
        What's more important is the context. China has long had a grab bag of monetary tools, some quantitative in nature. Currency intervention, for instance, expands the central bank's balance sheet and adds to the money supply when left unsterilized, as it has been in the past.
        Quantitative easing in advanced economies gives off a whiff of desperation, as a measure undertaken only when the traditional ones are exhausted. Yet China has plenty of traditional moves left. Deposit and lending rates are currently far above zero, at 3.25% and 5.35%, respectively. The PBOC could also further reduce the required ratio of reserves at banks, which it lowered earlier this month by one percentage point, to 18.5% of deposits. The ratio was as low as 7.5% as recently as 2006.
        That the local-government debt swap has hit snags further punctures the myth of an omnipotent Beijing able to manipulate the financial system at will. But at the same time, the PBOC's fast response signals that officials aren't complacent about the risks. There will be more policy improvisation as China keeps working through its debt load.
        Write to Aaron Back at aaron.back@wsj.com
        (END) Dow Jones Newswires

        April 28, 2015 06:19 ET (10:19 GMT)

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