Recently, the People’s Bank of China (PBOC) announced that it will conduct national debt borrowing operations in the primary market of government bonds. This news signifies a significant step taken since the Central Financial Work Conference held in October 2023, where it was proposed by the PBOC to “gradually increase trading of government bonds in open market operations”.
Market analysts believe that there are three main reasons behind the PBOC’s move. Overseas experts suggest that this operation by the PBOC signals the imminent arrival of the “unanchored printing of money” in China.
On July 1st, the PBOC announced that it would conduct national debt borrowing operations targeting select primary market dealers in the near future.
Following this announcement, national debt futures prices across the board experienced a decline, with the 30-year bond dropping by 0.6% and the 10-year bond by 0.15%. The yield rates on major interbank bonds also saw an increase. Prior to this, the yield rate on 10-year bonds had dropped to its lowest point since the end of April 2022. As of June 28th, the yield rates for the 50-year, 30-year, and 10-year bonds were 2.475%, 2.4282%, and 2.2058% respectively, all below the PBOC’s agreed level of 2.5%—3%.
National debt is usually issued at a fixed face value, and a decrease in yield rates indicates increased demand for government bonds in the market, driving bond prices up and subsequently compressing yield rates. Bond prices and yield rates are inversely correlated.
Regarding the PBOC’s move, the chief economist at Citic Securities, Ming Ming, described it as a measure to “guard against interest rate risks”. He explained that with the yield rate on 10-year bonds reaching historic lows, selling off government bonds would help stabilize long-term interest rates and mitigate interest rate risks.
This explanation seems to align with the warning issued by PBOC Governor Pan Gongsheng during his attendance at the Lujiazui Forum on June 19th. Pan Gongsheng mentioned the importance of paying attention to the mismatch in maturity and interest rate risks faced by non-bank entities holding a large amount of medium- to long-term bonds.
The warning serves to highlight the potential risks for banks with a mismatch in maturity, especially if they heavily invest in long-term bonds while facing pressure from high deposit withdrawals during periods of bond price depreciation.
Despite Pan Gongsheng’s warning being directed at “non-bank entities”, statistics indicate that amid a significant economic downturn in China, commercial banks are facing a shortage in demand for business loans, leading to a trend where large banks lend while smaller banks enter the government bond market.
Reports from several securities firms and commercial research institutions suggest that since 2023, there has been a phenomenon of “large banks lending and small to medium-sized banks buying bonds” in China. This indicates a shift towards smaller banks entering the government bond market.
According to an analysis by Kaiyuan Securities, large banks have been aggressively lending under regulatory guidance since 2023, leading to an oversupply of loans compared to actual demand, resulting in the phenomenon of “ultra-low price loans”. Facing higher funding costs and performance targets, smaller banks are inclined to increase their bond allocations to earn interest or engage in outsourced investments.
The second reason behind the PBOC’s move is seen as an effort to prevent a decline in long-term government bond yields and improve the interest margin income of commercial banks.
The yield rate on 10-year government bonds is generally a key reference rate in the financial market. Commercial banks typically base their loan and deposit rates on the 10-year bond yield rate, with loan rates usually slightly above government bond yields. A decrease in long-term bond yields, particularly if the 10-year bond yield is declining, could force the central bank to cut interest rates or compel commercial banks to lower their loan rates. This would further burden Chinese commercial banks already struggling with the housing crisis, as interest margin income is a significant source of their revenue.
The income structure of Chinese commercial banks shows that revenue from deposit and loan business, specifically net interest income, constitutes about 70%—80% of their total income. Data released by the China Banking and Insurance Regulatory Commission indicated that in the fourth quarter of 2023, the net interest margin of commercial banks decreased by 4 basis points from the previous quarter to 1.69%, the lowest value in 14 years.
Various industry insiders have noted that the net interest margins of Chinese commercial banks have been below the cautionary threshold of 1.8% for several consecutive quarters, leaving little room for further decline.
As per the “Implementation Measures for Qualitative Prudential Assessment (2023 Revision)”, banks with a net interest margin below 1.8% will be penalized in assessments.
The third reason behind the PBOC’s move is believed to be the need to protect the RMB exchange rate. One significant factor affecting the RMB exchange rate is the interest rate differential between Chinese and American bonds. As of July 5th, the yield rate on US 10-year government bonds stood at 4.28%, while China’s 10-year bond yield rate was 2.26%, resulting in a 2.02% difference between the two.
North American investment advisor Mike Sun told Dajiyuan that “the uncertain expectations regarding a Federal Reserve rate cut coupled with the declining trend in China’s government bond yields and the widening interest rate spread between China and the US will accelerate the depreciation of the RMB. The clear intention behind the PBOC’s move to boost government bond yields is to prevent a rapid devaluation of the RMB, which would lead to a substantial decline in assets priced in RMB and inevitably accelerate capital outflows, an unbearable scenario for China’s fragile financial system.”
Central banks trading government bonds in the bond market is a routine operation known as “open market operations.” It is worth noting that in democratic countries in Europe and America, government spending and issuance of government bonds are transparent and subject to scrutiny by the parliament, media, experts, and public opinion. The US government has faced government shutdowns multiple times due to insufficient budget approvals by Congress. However, the Chinese Communist regime operates as a dictatorship with a lack of societal oversight, prompting concerns from observers that the PBOC’s move may lead to uncontrolled currency printing.
Economist Wu Jialong from Taiwan pointed out on the “News Decoded” program on NTD on July 3rd that “both the Ministry of Finance, responsible for issuing government bonds, and the central bank, responsible for printing money, are under the control of the Communist Party. This results in a situation where the Ministry of Finance wants to issue more government bonds, and the central bank has to foot the bill, leading to uncontrolled money printing, a phenomenon almost inevitable during the decline of a regime.”
Wu Jialong also highlighted concerns around whether the next step for the CCP will involve breaking the existing ban on the central bank purchasing government bonds in the primary market.
Article 29 of the People’s Bank of China Law stipulates that “The People’s Bank of China shall not overdraw on government finance and shall not directly underwrite or purchase government bonds.” This prohibition aims to prevent the uncontrolled printing of money through “flood-like” measures.
While the PBOC has emphasized conducting national debt “borrowing operations” in the primary market, technically not violating the ban, it marks the first step towards potentially breaching the line. Given the absolute control the CCP exerts over the central bank, any future steps to break the rules may face minimal resistance.
Wu Jialong’s analysis suggests that large-scale money printing and unreasonable disguised taxation are two signs of a regime’s downfall; the current situation indicates that faced with China’s severe economic conditions and astronomical local government debt, the CCP’s resort to mass printing of currency may be inevitable. Wu stated, “Disguised taxation includes various fines imposed across China and a retrospective tax investigation on businesses for the past 30 years, actions that are leading down a dead-end path despite knowledge of the significant crisis they will bring.” According to Wu Jialong, “With the central and local finances in serious crisis and estimates by Goldman Sachs indicating local government debt at 95 trillion RMB (about 13 trillion USD) with the figure likely surpassing 100 trillion RMB (about 14 trillion USD) by now, disguising such massive fiscal deficits through fines and retroactive tax investigations is not sustainable. Ultimately, resorting to reckless money issuance by the CCP is foreseeable.”