SHANGHAI China's central bank is changing the way it conducts monetary policy as the world's second-largest economy looks inward for growth, and it is being felt first by people such as Madam Ju, a senior money market trader at a commercial bank in Shanghai.
"It's really a strange feeling that you have to look for the central bank to inject money into the market, after for so many years a flood of liquidity had kept the central bank needing to drain money from the market nearly every week," she said.
Ju and other Chinese traders who are finding it harder to borrow cheap money before holidays or the end of the month are at the sharp end of a big change in policymaking: the shift to a domestic-driven economy where interest rates are the main conduit of monetary policy.
For the People's Bank of China (PBOC), it is focusing less on draining liquidity from the market - which has been a necessary result of its controlling the exchange rate over the past years - and working towards using tools like the repo market to signal its interest rate intentions.
The changes have been facilitated by an easing of heavy capital inflows, once a major problem for policymakers as they sought to protect the growth engine of exports.
Rather than being a temporary response, the steps taken by the PBOC could take on a permanence that suggests it has seized the opportunity of slower inflows to advance its policy restructuring.
"Major changes in the PBOC's market activities are being unveiled as China shifts its economic focus to domestic consumption," said economist Wang Haoyu at First Capital Securities in Shenzhen.
"The PBOC has made itself a supplier of money in its liquidity management, reversing a trend of having to drain money from the market all the time, among other changes."
Indeed, rather than absorbing funds, in 11 of the 16 full weeks so far this year, the PBOC injected cash into the market. In total, it has injected a net 363 billion yuan ($58 billion) so far this year.
The policy shift began after the global financial crisis, when Beijing began weaning the economy off its dependency on exports and promoting greater domestic spending. Like other changes in China, it's a gradual move.
An early signal came in November 2010, when PBOC governor Zhou Xiaochuan said China would create "pools" to lock up excess funds, which could then be tapped in times of downturn.
The reserve requirement ratio (RRR) was ratcheted up nine times between November 2010 and July 2011 to a record high of 21.5 percent, draining around 3.5 trillion yuan from the banking system.
As the economy has slowed, the central bank has been less accommodating, cutting the RRR only twice to 20.5 percent and injecting less than 800 billion yuan.
That lack of easy money has kept China's benchmark seven-day repo rate firmly above 3 percent since late 2010, compared with levels of less than 2 percent for years before that. The rate has moved between 3.3 to 3.8 percent this week.
It has also helped curtail inflation pressures and asset price bubbles by making the cost of borrowing for speculation more expensive.
"China has already started a process to adjust its economic structure, making it unnecessary to keep abundant liquidity in the system, which was seen as a must just a few years ago," said a trader at a Chinese commercial bank in Shanghai.
In one big sign of that change, the PBOC late last year suspended weekly issues of central bank bills for the first time since it launched regular open market operations in 2003.
These bills had once been the main means to drain yuan released by its foreign exchange intervention to manage inflows from trade surpluses, foreign investment and speculative funds -- a process known as sterilisation.
Because the bills release liquidity back into the market on their maturity, the PBOC has over the past several years needed to issue new ones just to keep the cash in the market in check, on top of issuing more to sterilise the forex inflows.
By finding an opportunity to stop issuing bills for a period, the central bank could be paving the way for itself to no longer need to issue them routinely in the future.
Close to 2.7 trillion yuan of the bills matured in 2011. This has fallen by more than two-thirds to 785 billion yuan this year, and at the moment, there are no bills set to mature in 2013. That marks a shift that will give it more control in conducting its market operations in the future.
A slowdown in inflows of foreign cash into the economy requiring sterilization has been helpful in freeing its hand.
Central bank data shows its foreign exchange assets fell over the last three months of 2011, the first such falls in nine years. Assets have risen again this year, but the 238 billion yuan increase in January and February was about one-third of the increase a year earlier.
Similarly, other data shows liquidity created by foreign currency purchases fell for the first time in four years at the end of 2011, and in February it was just 25.1 billion yuan, compared to 214.5 billion a year earlier.
Freed from having to constantly fend off excess liquidity in its open market operations, the central bank has been able to turn its attention towards guiding interbank interest rates.
For example, the central bank has signalled its position on market expectations for an interest rate cut to boost slowing growth by keeping the repo rate largely stable. So far this year, the 91-day repo rate has fallen only once by 2 basis points in mid-March. By holding out, it signalled to the market that it did not intend to cut rates.
And as policymakers strengthen their hold over domestic money markets, they are loosening their grip on the exchange rate.
Last month, China doubled the yuan's trading band to 1 percent and permitted dollar short-selling for the first time, having earlier laid out the case for change.
Premier Wen Jiabao said in March that China would intensify reforms of its currency regime and allow the yuan to float more freely. PBOC governor Zhou also said conditions were ripe for the yuan's exchange rate to float more widely.
Those comments followed a PBOC paper in February that outlined a three-step currency reform process: easing curbs on outbound investments over one to three years, relaxing controls on loans for foreign trade, and then opening its real estate, stock and bond markets over the next five to 10 years.
"The present time is a strategic opportunity for our country to open up the capital account," the report said.
Traders said the PBOC's increased repo market action is a pointer that it will try to guide interest rate expectations in a similar way to how the Federal Reserve and some other central banks in mature economies signal their intentions in their open market operations.
"If you're short you have no choice but borrow at a rate guided by the central bank. If you're flush with funds you can choose not to follow the central bank but look for whatever products have higher returns," said a Chinese bank trader.
"The PBOC can now be more effective in imposing its intention on the interest rates, while letting the exchange rate move more freely, thanks to a slowdown in capital flows and its strategy to have a tight grip on cash flows by high RRR."
(Editing by John Mair)
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