China's central bank is increasingly mulling more unconventional tools to channel credit into the economy, after three cuts to interest rates and two to the reserve requirement ratio had limited results, economists said.
Both total social financing -- the broadest measure of credit in the economy -- and renminbi loans have steadily declined since the beginning of the year, according to the People's Bank of China (PBoC).
Meanwhile, growth of M2, the broad measure of money supply, has failed to hit the 12 percent growth target in three out of the first four months this year.
PBoC said earlier this week that it used pledged supplementary lending (PSL) to offer loans to China Development Bank, a policy lender.
This program was created last year to provide cheap funding to the policy lender as part of its targeted easing program.
Last year, the PBoC committed 1 trillion yuan (about 164 billion U.S. dollars) PSL to support the renovation of substantial housing.
The central bank has offered 262.8 billion yuan through PSL during the first five months this year, with the current cost of interest set at 3.1 percent. In an effort to be more transparent, this is the first time the central bank has released PSL operational data. It will continue to do so on a monthly basis from next month.
Easing measures since November have flooded the interbank market with excessive liquidity.
The seven day repo rate, a gauge of funding availability on the interbank market, dropped 2.1 percent from nearly five percent in March, while the overnight rate slipped to 1 percent from 3.5 percent during the same period.
However, funding costs remain elevated for companies, especially small businesses.
Various media outlets last week posited that the central bank had drained liquidity from selected lenders in the interbank market. Many believe this -- although not confirmed by the central bank -- is one of a string of factors that triggered a panic sell-off in the domestic market.
As commercial banks are reluctant to extend loans to the real economy due to rising credit concerns, the extremely relaxed short-term liquidity conditions could add fuel to the stock market, increasing the risk of financial instability, said ANZ economists Liu Ligang and Zhou Hao.
Many have mistaken the move as a sign that the central bank is shifting away from an easing bias. However, economists believe that the monetary policy would remain accommodative and further monetary support is needed to nurture a rebound in growth in the coming months.
"It should be viewed as part of the adjustment to control the magnitude of looseness instead of a change in the overall direction," said Goldman Sachs China economist Song Yu.
"For the past couple of months, the central bank has focused on managing interest rates, but now that they have moved to managing aggregate liquidity and targeted measures, [as such] PSL will get higher priority going forward," said Zhu Haibin, J.P. Morgan's chief China economist.
"This highlights the difficulties facing many central banks, not just China's, they have very strong influence over short-end yield curve but not as much over medium- and long-end yield," said Gu Ying, an Asia emerging market strategist at J.P. Morgan.
The excessive liquidity in the interbank market and borrowing cost remaining high in the real economy calls for stronger need for the central bank to use unconventional tools to influence the middle and long end interest rates.
"So far the curve is still very steep at the long end, and PSL is very useful in my view to address that problem," Gu said.
"If the new round of PSL was offered at 3.1 percent for three-year tenor or even longer, this clearly shows that the authorities are intensifying the effort to lower the cost of long-term borrowing," the ANZ economists said.