THE DEVELOPMENT OF BOND MARKET & MONETARY POLICY ADJUSTMENT OF CENTRAL BANK

The development of bond market is the objective requirement of market-oriented financial adjustment

In 1998, the People's Bank of China made institutional reform on the monetary policy system: one was to replace the credit scale management of commercial banks with the instructive planning management at the beginning of 1998; the other was to reform the deposit reserve system by consolidating the legal reserve account and account of reserve against payment. The two reforms represented the formal transition from direct to indirect monetary policy by the Central Bank.

According to the practice of some developed countries and regions, bond market is the important carrier of monetary policy. The operation of the Central Bank in the bond market is an effective instrument of controlling the base currency

The open market bond operation by the Central Bank must be based on a developed bond market, which requires that commercial banks hold substantial amount of bonds with high liquidity and large trading scale. In recent years, the proportion of bond assets to the whole assets held by commercial banks has risen from 5% in 1997 to the present 13% due to the development of the interbank bond market, which provides sufficient operation instruments for the Central Bank to input and withdraw base currency.

The formation mechanism of interest rate in bond market and the formed interest rate signal occupy a significant position in the implementation of monetary policy

In June 1996, the People's Bank of China decided to liberalize the upper limit of the interbank funding rate to realize the full liberalization of the interbank interest rate. In 1997 interbank bond market was established and bond repo rate was fully liberalized; since the fourth quarter of 1998, the issuing rate in interbank bond market has gradually developed towards the market-oriented bidding.

In the meanwhile, taking advantage of the open market operation, the People's Bank of China adjusted the repo rate, and guided the interest rate levels of interbank funding and repo through the market transmission mechanism.

A developed bond market will stabilize the monetary policy transmission

The traditional direct monetary policy controls the liability of commercial banks the major component of the money supply through the direct control on their assets. In this way, the impact and restriction on the commercial banks were severe and the distribution of resource was irrational. Indirect monetary policy requires the Central Bank to control its own liability base currency through controlling its own assets, so as to influence the performance of commercial banks to achieve the goal of indirect control on the liabilities of commercial banks.

The development of the interbank bond market laid the market foundation for open market operation

Larger scale of bond issuing in the primary market, more market-oriented issuing, more varieties of bonds

The issuing volume of the interbank market from 1997 to 2001 was 189.8 billion yuan, 299.3 billion yuan, 377 billion yuan, and 390.4 billion yuan, and 471.4 billion yuan, respectively.

The current bonds issued include discount bond, floating-rate bond, fixed-rate long-term bond, and redemptive bond besides the government bond and policy financial bond.

More participation in secondary market, greater volume, and higher liquidity

The principal trading participants in the interbank bond market has shot up from 14 commercial banks at the initial stage to the over 700 members currently, including various types of financial institutions. The turnover of the interbank bond market from 1997 to 2001 was 71.4 billion yuan, 102.1 billion yuan, 396.6 billion yuan, 1630 billion yuan and 4094.053 billion yuan, respectively.

Since August 2001, bilateral bidder system has been established elementarily in the interbank bond market.

Market infrastructure has been strengthened

The Central Government Bond Registration & Settlement Company and the National Interbank Funding Center have continuously improved the systems of bond custodian and quoting.

Market regulations have been perfected successively

The Central Bank set rules and regulations for the operation of the interbank bond market.

Open market operation has become PBC's main instrument of monetary policy

In recent years, based on the interbank bond market, the People's Bank of China has developed open market operation on a large scale, handling base currency to adjust money supply. Up to now, the Central Bank has basically formed the open market operation system: selecting 40 commercial banks as primary traders in the open market operation; adopting the bulletin system of open market operation; realizing DVP settlement of the bond trading based on the technical platform of Central Government Bonds Registration & Settlement Company; increasing trading instruments, and taking government bond and policy financial bond as the instrument in open market operation; enriching the varieties of trading products and maturity, and selecting volume bidding or interest rate bidding according to the situation.

At present, the objective of open market operation by the People's Bank of China is the liquidity of commercial banks. In the future, the primary objective will shift gradually to the interest rate of money market according to the situation. The principle of the open market operation is to realize the objective of monetary policy and maintain the stable performance of financial system by selecting an active or defensive operation according to the trend of the economic and financial performance and the liquidity of banking system.

In conclusion, since 1998, the People’s of China has adjusted the base currency and the liquidity of commercial banks through open market operation and guided the interest rate of money market. Cooperating with other monetary policy instruments, open market operation has realized the scheduled goals of monetary policy and played a significant role in the financial control.

(by Shui Ruqing, Chief, Open Market Section, Monetary Policy Department, People's Bank of China)