Maturation of 600bn Yuan in Special Treasury Bonds Puts Chinese Monetary Policy to the Test

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The maturation of 600 billion yuan (USD$89.9 billion) in special treasury bonds by the end of August could have a significant impact upon Chinese monetary policy and fiscal policy in the second half of 2017.

2007 saw the issuance of approximately 1.55 trillion yuan (USD$207.91) in ten-year special treasury bonds to provide long-term capital for newly established sovereign wealth fund China Investment Corporation  (CIC).

600 billion yuan of these bonds are slated to mature on 29 August, prompting analysts to speculate on the likely response from the Chinese government and its potential impact on liquidity.

CIC’s operations are reportedly proceeding as normal, with market observers expecting it to refund the 1.55 trillion yuan in treasury bonds by means of a new issuance.

Out of the 1.55 trillion yuan in special treasury bonds, approximately 1.35 billion yuan are held by the Chinese central bank.

For this reason the market is concerned that any shifts in the volume of special treasury bonds outstanding could have implications for Chinese monetary policy and market liquidity.

As of the end of July the Chinese central bank’s “creditor’s rights with respect to the government” consisted of 1.53 trillion yuan in government bonds, accounting for 4.36% of the People’s Bank of China’s total assets.

This is a small percentage compared to the treasury bond holdings of central banks in the US, EU or Japan, and has prompted some analysts to recommend that PBOC increase its purchases and long-term holdings of government bonds, and establish a monetary issuance mechanism based on government credit.

Chen Jianheng, fixed income analyst with China International Capital Corporation, told 21st Century Business Herald that there is little likelihood that the maturing special government bonds won’t be refunded via another issuance.

According to CIC’s 2016 annual report, the company’s foreign reserves have been invested in various assets abroad, most of which are illiquid, leaving little likelihood that they will be sold to replenish capital levels for repayment purposes.

Zhao Quanhou, chairman of the Chinese Academy of Fiscal Sciences, said to 21st Century Business Herald that the refunding could be performed via a public issuance or a direct placement to original holders.

While these methods are unlikely to have a major impact on China’s bond markets, the fact that the the 10-year special treasury bonds comprise a significant percentage of the PBOC balance sheet means that any changes could impact liquidity.

Analysts expect that the refunding of maturing special treasury funds will follow the precedent first set in 2007, with the Chinese government issuing new bonds indirectly to PBOC via development or policy bankers.

Given that the big state-owned banks, including ABC, are now listed concerns that could require the board approval for such an operation, it may be easier for the Chinese government to conduct refunding via policy bankers or other unlisted lenders.

There is also the possibility that PBOC may seek to reduce its holdings of special treasury bonds, with direct placements instead made to other entities on the market such as state-owned commercial banks and insurers.

This could also lead to sizeable contraction in liquidity, given that the excess reserve ratio of China’s commercial banks is currently at a low of 1.3%, and in turn necessitate counter measures on the part of PBOC. It would also exacerbate the risk of commercial banks in relation to their holding of longer-term debt.

A brief history of China’s 1.55 trillion yuan in special treasury bonds

In 2007 China saw a “double surplus” in its balance of payments, while PBOC’s purchase of large volumes of foreign exchange served to expand the base money supply.

With a view to containing inflation and preserving economic stability, PBOC sought to use monetary policy to help dial down the base money supply, yet still found it difficult to address the problem of excess liquidity.

In order to help deal with this dilemma, at the end of June 2007 the standing committee of China’s National People’s Congress gave its approval to the issuance of 1.55 trillion yuan in special treasury bonds to obtain foreign exchange for the establishment of the country’s new sovereign wealth fund, while also making a corresponding upwards adjustment in the government bond balance for the end of the year.

This produced a number of concurrent positive effects, the first of which was to help to contain liquidity, and ease the need for PBOC to undertake monetary buffering measures.

The second was that it reduced PBOC’s holdings of foreign exchange and increased its holdings of government bonds, enabling the central bank to use the later as an effective open market operations tool for expanding or contracting liquidity, and expediting the coordination of fiscal and monetary policy.

A third benefit was that the 1.55 trillion yuan in bonds was used to raise capital for CIC to make investments abroad, increasing China’s access to foreign exchange investment channels as well as its forex revenue.

China’s Ministry of Finance issued the first tranche of 600 billion yuan in special government bonds at the end of August 2007, with a rarely witnessed maturity of 10 years and a nominal rate of 4.3%.

Article 29 of the “People’s Republic of China People’s Bank of China Law” stipulates that PBOC cannot provide overdrafts to the Chinese government or directly purchase or underwrite government bonds, while Beijing also wanted to perform the bond issuance in accordance with market principles.

For this reason MOFCOM first issued the Agricultural Bank of China with 600 billion yuan in special treasury bonds to raise RMB funds, before then using the amount to purchase the equivalent sum of foreign exchange from PBOC.

Simultaneous to this, PBOC used the 600 billion yuan it obtained from the sale of foreign exchange to the central government to purchase the equivalent value of special treasury bonds.

At the time MOFCOM spokesmen said that the issuance of 600 billion yuan in special treasury bonds would be a “neutral” measure with respect to macro-economic policy.

Subsequent to this MOFCOM issued seven lots of special treasury bonds worth 1.55 trillion yuan in total, of which 1.35 trillion yuan were passed on to PBOC via ABC to obtain foreign exchange, while the remaining approximately 200 billion yuan were issued to the public.

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