Central bank injects more liquidity

China's central bank launched a fourth round of reverse repurchase (repo) operations Tuesday, only one week after the last round, underscoring cash strains in the banking system.

The 7-day and 14-day repo operations worth 143 billion yuan (22.70 billion U.S. dollars) came after the People's Bank of China (PBOC), or the central bank, conducted three other rounds in January, May and June, respectively, injecting at least 500 billion yuan of liquidity into the market.

The unprecedented frequency revealed the central bank's intent to ease fresh liquidity strains felt by the commercial banks as they will have to put aside more money in reserve to compensate for previous shortfalls, bank dealers said.

Reverse repo operation means the central bank purchases securities with the agreement to sell them at a higher price at a specific future date, a move to increase liquidity.

After the PBOC's last such move on June 26, the Shanghai Interbank Offered Rates, which measure the cost to banks of borrowing from one another as a key barometer of liquidity, were lower for short-term borrowing no longer than three months.

The PBOC Monday restated the prudent monetary policy that it would continue to implement this year, and vowed to keep the policymaking flexible to cope with slowing economic growth.

E Yongjian, an analyst with the Bank of Communications, said compared with the other liquidity injection tools, such as hike in Reserve Requirement Ratio (RRR), reverse repo operation affects the market in a more direct way.

Analysts said market liquidity is influenced by the amount of yuan funds outstanding for foreign exchange, which in turn decides the amount of yuan funds that the PBOC had to inject to offset the same amount of foreign exchange inflow from trade surplus and overseas speculative money, as yuan remained inconvertible under the capital account.

The deepening sovereign debt crisis in Europe and shrinking external demand has slowed China's foreign trade, resulting in a decrease of yuan funds outstanding for foreign exchange.

Under such circumstances, RRR hikes, reverse repo and repo agreements will become central bank's ammunitions to pump liquidity into the market over the coming months, according to analysts.

A report released by the China International Capital Corp. (CICC), an investment bank, said although the PBOC had lowered the RRR for three times and the benchmark interest rate once since November, the real lending and deposit rates remained high.

E Yongjian forecasted that the central bank would lower the RRR for one to three times in the rest of the year. Currently, China's commercial banks have to keep 20.5 percent of their cash in reserve.