ALTHOUGH in its infancy, China's treasury bond market is poised to expand as domestic debt is used to finance a bigger portion of the national budget deficit. Within two financial years, the number of treasury bonds issued has increased fivefold. From 30 billion yuan (about HK$27.53 billion) in 1993, it went to 100 billion yuan last year, rising to 150 billion yuan this year. Along with the increase came a startling change in investor attitude. Two years ago, acting on official directives, employers deducted the salaries of their employees, channelling the deductions into bonds. Commercial banks and financial institutions had to do their bit. Not to do so was seen as unpatriotic. Now, force is unnecessary. When the government issued the first portion of the 150 billion yuan issue recently, investors queued up for them of their own volition. Treasuries - whose coupon rates are higher than interest paid on savings deposits of the same maturities - are now regarded as attractive investments although real returns are still negative because of high inflation. That bodes well for Beijing, which wants to develop bonds as a monetary instrument to influence the supply of credit in the open market and the direction of the economy. But much needs to be done before treasury bonds can be used efficiently as a macroeconomic tool. First, a proper legislative environment to regulate the market is urgently required. Here, a crucial start will soon be made as the skeleton of a treasury bond law is being drawn up by the Ministry of Finance. But the proposed law will have to address, at some length, several fundamental issues necessary for the growth of a healthy bond market. One of these involves interest rates which are not dictated by supply and demand of money. Rather, they are determined by the policy makers, primarily, on the basis of political considerations. A freeing of interest rates is a prerequisite of open market operations, which involves sale and purchase of government securities to influence money supply. This is probably the toughest decision Beijing will face, as the liberalisation of interest rates touches state enterprises. Next, there is a need to spell out the ratio of Treasury bonds in commercial banks' portfolio of liquid assets and to promote an active discount and secondary market. Besides, Beijing will have to expand the variety, maturity, coupon rates and par value of these instruments. The bonds issued so far are primarily treasury notes with a maturity of three or five years. More Treasury bills - instruments which mature in a year or less, and whose sale and purchase by the central bank would have a more immediate impact on money supply - will have to be issued though a tentative start was made last year with the five billion yuan worth of bills maturing in six months. That also goes for bonds with longer maturities - 10 years or more - which tend to be of interest to insurance companies and mutual funds with longer term liabilities. But whether they are Treasury bills, notes or bonds, the supply will need to increase dramatically so that the central bank can use them meaningfully. Despite the bigger issues of the past two years, the volume is still too insignificant to make an impact on the money supply. Finally, there must be a willingness to punish those who profit from inside information. Decisions on whether to buy or sell treasuries to influence interest rates must be guarded closely if they are to achieve their intended goals. Unfortunately, securities trading in China has a strong element of insider trading, which hampers the development of a fair and robust market. Rumours - many of which are later confirmed by official announcements - have a way working themselves into investment decisions. Beijing cannot avoid these issues. The sooner it demonstrates the political will to resolve them in the proposed Treasury bond law, the faster and better it can resort to Treasuries as a monetary tool to fine tune the economy. And, more importantly, a robust bond market will give Beijing greater leeway to resort to domestic debt to finance its growing budget deficit. That, in turn, will soak up idle savings and potential consumer spending, which must be welcome in a time of stubborn inflation.