Market liquidity supply sees big change

Wang said the central bank, the People's Bank of China, has to change the combination of liquidity management tools, although the tone of monetary policy would not be affected.

"For several years, with massive foreign inflows, managing domestic liquidity was fairly straightforward - ensuring that enough liquidity was mopped up. The central bank combined open market operations with higher reserve requirements to do this," said Louis Kuijs, chief China economist at the Royal Bank of Scotland.

"With trend inflows now lower, monetary policy needs to be more agile."

Cutting the reserve requirement ratio for commercial banks had been a commonly used tool of the central bank to deal with capital outflows.

"For example, from December to May, the central bank lowered the RRR three times as capital flew out and liquidity tightened," said a report from Guotai Junan Securities Co.

"But since July, despite capital outflows, it seems that the central bank has been reluctant to cut the RRR. A major reason behind that is probably the hike in foreign currency-denominated deposits," it said.

In the first six months, such deposits held by banks have increased by $130.1 billion, up $99.4 billion compared with the same period last year, according to data from the State Administration of Foreign Exchange.

Adjusting the RRR usually lacks flexibility, and once the yuan appreciates, enterprises and individuals would prefer to convert those deposits to yuan, adding extra liquidity to the market, said the report.

The central bank has been increasing its use of short-term money market tools such as reverse repurchase transactions to ease liquidity tension, after it last cut the RRR in May by 50 basis points to 20 percent for major banks.

It injected massive liquidity through another round of reverse repurchase operation in the last week of September.

From Sept 24 to 27, it injected 365 billion yuan, a record high weekly injection through open market operations.

On Sept 25, the central bank pumped a record 290 billion yuan into the market by conducting reverse repos to ease a cash crunch as the quarter came to an end and the Mid-Autumn Festival and National Day holidays approached.

In a statement published after its third-quarter monetary policy meeting in September, the central bank said it would continue to implement a prudent monetary policy, while fine-tuning the stance with more targeted, flexible and forward-looking tools.

It added it will closely monitor the impact of recent rescue and stimulus policies in Europe and the US, as global economic growth remains weak.

Zhao Xijun, deputy dean of the School of Finance at Renmin University of China, said the international financial market remains troubled at present and, judging from the current situation, there is no clear direction of capital flows.