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Thursday, December 27, 2012

China emulates the Indian repo model to keep stable liquidity


The People’s Bank of China in three days has poured nearly $58 billion equivalent of Rm into the banking system to ensure adequate money. This is one of the largest in its central banking history given the short span of the time.
    The Chinese economy was witnessing scarce fund availability indicated by increasing lending rate in the short term money market. Chinese interbank market rate which is synonymous to India’s call money rate has sky rocketed to 4.75%. The People’s bank is following the intra cyclical policy of maintaining high cash reserve ratio to keep bank activities tight. This was necessary to ensure soft landing because of the threat from global recessionary pressures.
    The present liquidity tight situation in China can be attributed to decline in foreign exchange reserves.
    The people’s banks’ intervention is not aimed to inject liquidity in a long term manner. Instead, it is targeted to ensure comfortable liquidity in the system. For this, the central bank has poured money into the banking system through the repo window. This additional liquidity will be automatically withdrawn within a week.
    The entire exercise is similar to the repo operations done in India by the RBI. In India, the RBI injects liquidity through the repo lending of Liquidity Adjustment Facility, whenever there occurs liquidity scarcity.
   
    In India, the RBI has introduced the LAF repo in 2000 to stabilize the liquidity situation in the country. The repo is used to inject liquidity and the reverse repo is used to absorb liquidity. Both are two legs of the LAF. Since the introduction of the LAF, the turnover under it is much higher than that of the call money market.  This has produced a surprising financial environment where the central bank or the RBI is the provider of ad hoc money in the financial system and not the call money market.
    China lags behind India in financial market and monetary policy reforms. The present repo mode liquidity injection in China is indicative of the future scenario.  A financial market observer has described the event that the PBC replicate what central banks in other jurisdictions are doing, building up a market between the commercial banks and the central bank.

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