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Why China Hasn't Cut Rates in What Feels Like Forever

Growth isn’t budging and economic data continues to underwhelm. But China hasn’t eased monetary policy in over six months. Or so it seems.

Growth isn’t budging and economic data continue to underwhelm. But China hasn’t eased monetary policy in more than six months. Or so it seems.

The People’s Bank of China has, however, resorted to more frequently using a range of instruments from its policy toolbox to shift money and credit around without cutting benchmark rates or freeing up cash to lend by cutting the banks’ reserve-ratio requirement, both of which would send signals of outright easing. It hasn’t cut the RRR since March and benchmark rates since last October.

Over the last week, for instance, the central bank injected into banks 400 billion yuan ($60 billion) in short-term liquidity. In addition to these so-called open-market operations, the central bank has used a range of other lending facilities to inject 1.1 trillion yuan of longer-term cash into the system this year, according to ANZ estimates. That equates to an RRR cut of at least one percentage point. China typically cuts the RRR half a point at a time when easing.

The reason for these quieter moves is that Beijing has a dilemma. It needs to ease, but it can’t signal broad-based easing for fear of stoking further capital outflows and pressure on the currency to weaken. The PBOC even highlighted risks associated with cutting the RRR in its latest policy report.

In the longer run, the monetary-policy maneuvers are also an attempt to modernize China’s policy making, which currently relies on window guidance, reference rates and loan quotas. By intervening heavily in the short-term money markets, the PBOC is aiming to develop fully an interest-rate corridor that it can eventually target as its main policy tool, similar to how most developed-market central banks operate.

For now, that seems far off. More than 80% of the interbank market uses the seven-day repo rate instead of, say, the Shanghai Interbank offered rate that the PBOC has shown a preference for. Meanwhile, rates on the upper and lower bounds of the corridor, which stretch out to three-month loans, aren’t actively traded.

And there have been side effects. Dangerous shadow-lending activities have picked up because the PBOC has kept ultra-short-term rates too stable, facilitating carry-trade-like investments. Partly to counteract that, last week the PBOC used a more expensive, 14-day lending facility, which it hadn’t touched for six months and is typically used ahead of expected cash crunches. The rates are higher there, and the move could even look a bit like monetary tightening. The International Monetary Fund this month recommended that higher interest rates could help by culling out precarious activity in parts of China’s financial system.

Using these tools has pushed off RRR cuts for now. Beijing may feel the need to reduce the reserve ratio down the road, along with benchmark rate cuts, given both are powerful signaling mechanisms in their own right. In the meantime, the frequency of these liquidity injections are what investors should monitor.

Write to Anjani Trivedi at anjani.trivedi@wsj.com

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