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bank-of-china 400BEIJING: China will use money market operations as its key tool to guide interest rates as part of a gradual liberalisation and reform of the way borrowing costs are set in the world's No. 2 economy, researchers at the People's Bank of China wrote in a new book.

Earlier this year, China began speeding up the liberalisation of interest rates, lifting the ceiling of deposit rates while lowering down the floor of lending rates when it cut borrowing costs in June and July.

The PBOC research team said the central bank will over time switch from setting policy rates to a system where market forces establish the equilibrium interest rate for the economy.

"Gradually, China will base policy rates on the central bank's open market rates instead of the benchmark deposit and lending rates," Zhang Jianhua, the PBOC's head of research, and his colleagues wrote in a recently-published book.

They said changes will entail establishing the central bank's open market operations rates and gradually expanding the floor on lending rates as well as the ceiling on deposit rates.

The book studied interest rate reforms in 14 countries and regions, including the United States, Germany, Japan and India.

They concluded that the reform and even the liberalisation of the whole financial sector happened when the economies faced stagflation, financial innovations were very active and global capital flow quickened.

"Right now, the timing is getting ripe for China to further press on the market-oriented reform of the interest rates," they said.

The PBOC injected a net 278 billion yuan ($43.77 billion) into the interbank money market last week, the largest net injection since early January, in a move that traders and analysts saw as a substitute for a cut in banks' required reserve ratio (RRR).

Analysts believe last week's injections to be symtomatic of a broader effort to shift monetary policy away from quantitative tools and towards price-based mechanisms used by central banks in advanced economies.

Analysts said the PBOC wanted to establish the Shanghai Interbank Offered Rate, known as SHIBOR, as the key benchmark for China's monetary policy, which would then bring China into line with countries such as the United States, where the Federal Reserve conducts repos in open market operations to target the Federal Funds rate.

However, Zhou Xiaochuan, governor of the central bank, said last week that the country must use all monetary tools available to manage policy settings in the current environment.

"All tools must be made available," PBOC governor Zhou Xiaochuan told reporters on the sidelines of a conference Tuesday in Beijing, when asked whether he favoured money market operations over interest rates, or reserve rate requirements (RRR) to manage policy settings in the current environment.

Copyright Reuters, 2012

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