Central bank should buy local government bonds

China's central bank should buy local governments' bond to guide market's expectation, a Chinese official suggested.

"It would be an important signal to the financial institutions who are reluctant to buy. More importantly, the Chinese central bank could buy bonds issued by governments who score high on reform progress, that way the market could shift more focus to the reform process," said Wei Jianing, Deputy Director-General of the Macroeconomic Research Department, Development Research Center of the State Council, at a conference held by Cheung Kong Graduate School of Business on Monday.

Earlier this year, the Finance Ministry allowed local governments to swap high-yielding legacy debt with new low-cost bonds. However, banks have shown their reluctance to buy these low-cost bonds, usually yield between 3 to 4 percent.

The market is under pressure to absorb the bond deluge after the ministry in August added another 1.2 trillion yuan debt-for-bond quotas after which total quota for this year becomes 3.2 trillion yuan. By comparison in 2014, only 400 billion yuan of such bonds were issued.

Many market analysts are calling for the central bank to purchase the bonds in order to alleviate the pressure and rein in possible hike of long-term interest rate. The People's Bank of China (PBOC) has resisted the temptation out of concern the direct purchase would amount to "quantitative easing", an unconventional monetary policy adopted by the US Federal Reserve in the aftermath of the global financial crisis.

Wei said instead of all-out purchases, the PBOC's purchase should be conditional: a reward for those who've done well in implementing reforms.

"That's at least better than instructing banks to buy those bonds." said Wei.