China’s cash squeeze over the past two weeks is testing the management skills of new Communist Party leaders saddled with risks from a record credit expansion under their predecessors.
The one-day repurchase rate touched an unprecedented high of 13.91 percent yesterday, prompting speculation the central bank was forced to pump liquidity, before diving today by the most since 2007. Premier Li Keqiang signaled determination to stamp out speculation funded by cheap money with a June 19 State Council statement saying banks must make better use of existing credit and step up efforts to contain financial risks.
Any prolonged constriction of interbank liquidity risks triggering a broader credit crunch, further depressing an economy that’s already slowing. The dangers add to burdens on a global recovery contending with the prospect of reduced Federal Reserve stimulus in coming months.
“It’s really hard to deflate these things in an orderly way,” said Michael Pettis, a finance professor at Peking University in Beijing. “The problem is that when debt levels have got so high, and it’s more debt that keeps the existing debt afloat, you absolutely have to stop the process but it’s very difficult to stop the process in an orderly way.”
Pettis said the situation is putting pressure on smaller banks because they fund more of their long-term loans from interbank borrowing. The government aims to direct money toward growth rather than speculation after a credit boom that has fueled property-price gains, local-government debt risks, and a wave of wealth-management products.
The one-day repurchase rate dropped 442 basis points, or 4.42 percentage points, to 8.43 percent, according to a daily fixing compiled by the National Interbank Funding Center. The seven-day rate fell 227 basis points to 8.5 percent.
The PBOC used reverse-repurchase agreements yesterday to provide funds to selected banks, Chinese financial news website Hexun reported today, citing an unidentified person close to the central bank.
Shares of Chinese lenders have been under pressure this week. China Minsheng Banking Corp. (600016) fell 5.1 percent, while Ping An Bank Co. was down 5.3 percent.
The PBOC said today in its 2012 annual report that it will maintain stability in monetary conditions this year and keep “reasonable” liquidity in the market. The central bank also reiterated it will pursue a prudent monetary policy. The report may not necessarily reflect the current situation, as it contains comments by Governor Zhou Xiaochuan dated April 18.
Growth has unexpectedly slowed since March, when Li took office as premier, Communist Party chief Xi Jinping became president and the government extended Zhou’s 10-year tenure. Besides the hangover from the credit expansion, the economy is hampered by a declining working-age population and rising costs, with analysts surveyed by Bloomberg News this month projecting expansion will decelerate this year and next.
Xi and Li have signaled they’re reluctant to loosen monetary or fiscal policy, instead emphasizing the need for more-sustainable growth in the longer term and policy changes to achieve it.
Bank of China Ltd. said on its microblog yesterday that it made all payments on time yesterday and has never had a capital default. A spokesman for Industrial & Commercial Bank of China Ltd. declined to comment on whether the lender received any financing from the central bank.
The yield on top-rated commercial banks’ six-month debt rose 91 basis points yesterday to 5.87 percent, the highest in ChinaBond data going back to 2007.
Li’s face-off with banks over money-market rates may help determine whether he can push through policy shifts on interest rates and the capital account, said Yi Xianrong, a researcher with the Chinese Academy of Social Sciences in Beijing. Some changes may be decided at a Communist Party gathering in October.
“It seems the government has decided that it will keep disciplining banks and is ready to sacrifice a few small banks to pave the way for necessary structural reforms,” Yi said. Li’s government is “trying hard to control banking risks and to gradually solve the risks accumulated in the last decade.”
The risk is that higher interbank borrowing costs spread to the broader economy, further undermining confidence. The comments from China’s State Council, or Cabinet, indicate that liquidity will remain tight and that industries facing overcapacity may see corporate defaults in the second half, according to Nomura Holdings Inc.
The government and central bank have made no official comments on the increase in money-market rates and didn’t respond to faxed questions from Bloomberg News. By comparison, the Fed responded to a 2007 jump in interbank rates that presaged the global financial crisis by announcing it would provide liquidity “to facilitate the orderly functioning of financial markets,” though it came under criticism for being slow to contain the burgeoning turmoil.
China’s lack of communication to guide investor expectations may stem in part from “practical difficulties in making the reasons for its decisions explicit,” Goldman Sachs Group Inc. said in a report yesterday.
The government’s broadest measure of credit rose 58 percent to a record $1 trillion in the first quarter, with the increase driven by shadow-banking transactions such as trust loans.
Existing liquidity in the market is “still large” and the monetary authority has no intent to inject large amounts of funding, according to a June 17 opinion piece in Financial News, a daily published by the central bank. Some banks are relying on interbank borrowing to fund irregular practices including hidden loans and forged letters of credit, the article said.
The PBOC may be refraining from easing the cash squeeze because it and other regulators want to “punish” some small banks that had used interbank borrowing to finance purchases of higher-yield bonds, Bank of America Corp. said in a report yesterday.
The costs to the economy from allowing a jump in interbank rates for a limited period are “very, very low,” said Alicia Garcia-Herrero, chief economist for emerging markets at Banco Bilbao Vizcaya Argentaria SA in Hong Kong. She cited a lack of “transmission mechanisms,” such as any link between interbank rates and mortgage rates.
“An interbank rate level of 10 percent is definitely not sustainable, and certainly not in line with the central bank’s true intent,” said Shen Minggao, head of China research at Citigroup Inc. in Hong Kong. “If such a high level continues, it can be very damaging to the economy.”
Elsewhere in the Asia-Pacific region, New Zealand’s consumer confidence rose in June. Pakistan’s central bank will probably keep its key rate unchanged at 9.5 percent, economists surveyed by Bloomberg News predicted.
In Europe, data from the French labor office reiterated that wages rose 0.7 percent in the first quarter from the previous period.
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