By Lingling Wei
BEIJING--China's central bank is considering taking a page from
Europe's financial-crisis handbook to free up more credit as growth
in the world's second-largest economy slows.
The proposed strategy would allow Chinese banks to swap
local-government bailout bonds for cash as a way to bolster
liquidity and boost lending, said people familiar with the People's
Bank of China talks.
Adopting the strategy would mark a major shift in the central
bank's money-supply policy and underscore the leadership's deep
concern about missing already lowered growth expectations.
In recent months, China's leaders have directed the central bank
to try to beef up bank lending and lower borrowing costs as the
economy slows and capital leaves the country.
But a barrage of easing measures--including two interest-rate
cuts since November--has had limited success. Instead of
stimulating targeted areas of the economy, such as small
businesses, they have helped companies already heavily in debt.
The move also triggered a run-up in China's stock markets that
prompted the top securities regulator last week to rein in
speculative stock-trading activities. On Friday, China's Premier Li
Keqiang urged Chinese banks to do more to support the "real"
economy.
The central bank's one-percentage-point cut in the reserve
requirement, announced Sunday, was the second reduction in less
than a quarter and the biggest since December 2008, freeing up
about $200 billion for banks to lend. It comes just days after data
showing China's economy decelerated to 7% year-over-year growth in
the first quarter, the slowest pace in six years.
The move by Chinese authorities coincided with a weekend of
discussions in Washington among top economic policy makers at the
semiannual meeting of the International Monetary Fund. One of the
resonant themes at this weekend's conference was a dearth of global
demand, and persistent disappointments on growth.
The central bank is concerned about one issue in particular,
according to Chinese officials and advisers to the PBOC: preventing
a stranglehold on liquidity in the financial system at a time when
local governments are about to begin a debt-for-bond replacement
program to try to alleviate their repayment burdens.
The debt-restructuring program, announced by China's finance
ministry last month, seeks to reduce localities' financing costs
and stretch out the time they have to pay off debts. But it risks
choking off funds available for lending, and could drive up
interest rates at a time when many economists say more and cheaper
credit is needed.
To stave off the undesirable consequences of the debt plan, the
PBOC first tried freeing up more funds for banks to make loans. But
officials at the central bank are weighing other ways to help
mitigate the potential downsides, according to people with direct
knowledge of the discussions.
One option involves giving banks access to long-term loans with
the aim of improving lending to sectors that leaders see as crucial
for China's prosperity, such as farming, affordable housing and
small and private businesses. To obtain the loans, Chinese banks
would use bonds issued by local governments as collateral.
That strategy is similar to the long-term refinancing
operations, or LTROs, used by the European Central Bank, the people
said. In late 2011, the ECB doled out trillions of dollars in
three-year loans through such mechanisms, providing access to cheap
funds for struggling European banks.
The Chinese version would be aimed at ensuring adequate
liquidity in the system, as the central bank can no longer rely on
large amounts of capital inflows to maintain its monetary base.
Since late last year, there have been growing signs of money
leaving China's shores. Yuan positions on the PBOC's balance sheet,
a gauge of capital flows, declined a record 251.1 billion yuan, or
about $40.5 billion, in the first quarter.
"The LTRO was considered by some as an unconventional
monetary-policy tool adopted by the ECB and it was primarily
intended to provide temporary liquidity to European banks," said
Larry Hu, China economist at Macquarie Group Ltd. "In China's
context, the PBOC's main purpose for such a tool would be to create
base money."
Borrowing by China's various levels of government is a big
reason the country's debt load is expanding. The International
Monetary Fund says China's debt is growing more rapidly than debt
in Japan, South Korea and the U.S. did before they tumbled into
recession. Local-government borrowing, which totals about $4
trillion by some accounts, is responsible for a quarter of the
buildup in China's overall domestic debt since 2008.
Now, as local governments struggle with plunging land sales,
they are increasingly having trouble repaying their debts.
For instance, Haikou, the capital of China's Hainan province,
has warned it might not be able to repay its debt and asked the
provincial government to allocate a third of its bond-issuance
quota to the city.
Under the debt-for-bond program, localities are allowed to sell
1 trillion yuan of "special" local bonds to replace their existing
debts. The program, which likely will be expanded this year, could
save China's local governments a total of up to 50 billion yuan in
interest payments a year, the finance ministry estimates.
China's commercial banks, long the main providers of credit to
local governments and a key investor in Chinese bonds, are expected
to be the major buyer of those local bonds once they are issued, as
the banks would essentially replace the higher-risk loans on their
books with bonds with explicit government guarantee.
However, if banks use funds that could otherwise have been used
for lending to purchase those bonds, overall money supply would
tighten. Meanwhile, given the limited size of China's bond market,
a large-scale bond sale by local governments also risks pushing up
market rates just as the authorities are struggling to drive down
borrowing costs.
"To offset the monetary contraction resulted from the
debt-replacement program, the PBOC has to inject liquidity into the
market one way or another," said Li Daokui, economist at Tsinghua
University in Beijing and a former adviser to the central bank.
Under the LTRO-like strategy, commercial banks would be
permitted to use local-government bonds they purchase as collateral
to take out low-interest-rate, three-year loans from the central
bank. By doing so, officials at the PBOC would try to direct the
banks to lend to small and private businesses, among other sectors
favored by the government. The interest rates on those loans could
serve as a medium-term benchmark rate, potentially giving the PBOC
another tool to guide interest rates, according to the people with
knowledge of the central bank's thinking. Currently, the PBOC
influences market rates mainly through its benchmark lending and
deposit rates, and through the rates in the interbank market where
banks borrow from each other.
"As China starts to restructure the balance sheets of local
governments, the Chinese central bank can, should and likely will
play a more active role in the process," said Liang Hong, chief
economist at China International Capital Corp., an investment bank
in China.
William Kazer contributed to this article.
Write to Lingling Wei at lingling.wei@wsj.com