Analysis: China’s ‘Asset Famine’ Limits Central Bank’s Bond Trading Goals

China’s Central Bank Faces Challenges in Implementing New Monetary Policy

In a bid to enhance its monetary policy toolkit, China’s central bank, the People’s Bank of China (PBOC), announced plans to return to the treasury bond market after a 17-year hiatus. However, the scarcity of low-risk assets in the country’s financial sector poses a significant obstacle to this move.

President Xi Jinping’s speech in October 2023 served as the catalyst for the PBOC’s decision to incorporate treasury bond buying and selling into its operations. The goal is to improve the efficiency of the monetary policy transmission mechanism by deepening the bond market, enhancing liquidity, and reducing volatility.

Despite these ambitions, China’s financial landscape presents challenges. The government has historically relied on riskier local government issuers to fund investment projects, resulting in unsustainable debts. As a result, there is a lack of liquid benchmarks in the bond market, hindering the central bank’s plans.

Analysts have raised concerns about the dominance of credit in China’s economy, with state-owned firms receiving preferential treatment over private enterprises. This imbalance in credit allocation has led to capital misallocation and inefficiencies in the financial system.

While the PBOC aims to use treasury bonds as a policy tool, experts suggest a cautious approach to avoid triggering adverse market reactions. The timing and scale of bond trading will be crucial in navigating the complexities of China’s financial landscape.

As China navigates these challenges, the PBOC’s gradual entry into the treasury bond market will be closely monitored for its impact on the country’s economic stability and growth prospects.