Changes in how China manages the massive liquidity in its financial system and the persistent capital inflows chasing faster yuan appreciation may make short-term debt auctions a key indicator of Beijing's policy intentions.
The People's Bank of China has been using targeted increases in banks' reserve requirement ratios (RRR) in recent months as one of its main tools to keep inflation at bay and prevent asset price bubbles.
In reaching for this new tightening lever, the central bank has moved away from using open market operations, a mechanism it has relied on for years, to soak up excess money.
The changes herald a significant step in long-awaited reforms in China's rigid interest rate system.
Market watchers say the central bank may be slowly shifting to use bill sale yields at auctions to signal its future interest rate intentions, a step toward transparency in an otherwise murky and centralized financial system.
Watching what the PBOC has done since October, you get the impression that RRRs are being used as the key tool to adjust market liquidity, said a dealer at a Chinese state-owned bank.
Open market operations have somehow become a rate barometer.
Major central banks around the world use market operations to hint on interest rate moves, but the PBOC has largely used them to balance money supply since starting regular open market operations in the early 2000s.
China's interest rate regime is still tightly controlled. Banks are only allowed to set deposit rates slightly lower than the government's benchmark rates, while lending rates may be slightly higher.
The PBOC does not have the final say in raising or cutting official rates. The State Council, or cabinet, is the final arbiter on rate moves after consultation with the PBOC.
The market is often left in the dark ahead of official rate changes, and the lack of transparency in the overall process has been a source of market volatility and an irritant for traders.
Beijing has promised to reform the rigid system, but such moves have been slow to materialize. The government, to guard against social instability, feels obliged to protect the interests of depositors in a populous country with a very high savings rate.
PBOC TAKES INITIATIVE
The PBOC has raised interest rates twice and RRR for all banks three times since October, partly to put a ceiling on asset prices at a time when the United States announced a second round of quantitative easing, pushing near record money flows to China.
It has also twice used differentiated increases in RRR for certain selected banks in the last three months without formally announcing it. Dealers see this paving the way for more punitive measures against banks who have lent excessively.
The PBOC appears to have shifted to using RRR as its main tool to drain liquidity while using open market operations to help stabilize expectations of interest rate hikes.
Most RRR hikes since October took place before PBOC bill yields in the secondary market jumped above yields at auction, making it difficult for the central bank to sell its bills.
The PBOC is apparently well prepared for the dilemma.
While it has sold symbolic amounts of bills in regular weekly operations since late November, it has first kept its auction yields flat, then let the yields rise at a measured pace after the latest rate rise on Christmas Day.
Again this week, the PBOC sold only 2 billion yuan ($302 million) of bills and refrained from bond repurchases -- a sign it will depend on other tightening steps to manage liquidity.
It appears open market volumes are no longer important to the PBOC, said a trader at an Asian bank. The central bank is using its bill sales mainly to indicate its rate thinking.
The reserve ratio for major Chinese banks has now reached a peak of 19 percent of total deposits, but traders see no major impact from potentially three to four more rises this year.
(Editing by Kevin Plumberg)