Markets

Christopher Langner is a markets columnist for Bloomberg Gadfly. He previously covered corporate finance for Bloomberg News, and has written for Reuters/IFR, Forbes, the Wall Street Journal and Mergermarket.

China's penny-stock market could be bringing the giant to its knees.

For the second time in less than a year, the ChiNext venue for small-cap companies is weighing on the nation's equities. It's probably healthy for the market to correct, but the fact that this is happening amid a cash crunch means the effects threaten to be far more damaging than usual.

On Tuesday, the overnight Shanghai Interbank Offered Rate, a key gauge of liquidity among financial institutions, jumped 11.4 basis points. 

Spiking the Punch
Shibor jumped on Tuesday after two days of heavy losses on the ChiNext small-cap index
Source: Bloomberg

At the same time, the two-week repurchase rate, another measure of lending conditions, rose as much as 2.4 percentage points, equaling the biggest intraday gain since 2013. That happened even as the People's Bank of China injected 330 billion yuan ($48 billion) into the market through reverse repurchase transactions. 

Suspicious Lenders
The two-week repurchase rate also spiked on Tuesday, at one point equaling its biggest rise since 2013
Source: Bloomberg

If Bank of America Merrill Lynch strategists are to be believed, the spike may have been caused partly by the selloff in the ChiNext, though it's hard to establish a foolproof connection. The problem, Merrill says, is that almost a fifth of shares traded on the ChiNext are being used as collateral to back loans.

Sudden drops in the stock market can trigger margin calls and losses for brokerages. As the carnage crosses the radar of banks, they become wary of lending to other financial institutions, a phenomenon that usually results in big moves in the interbank and repo markets. These funding venues dictate the cost of borrowing to buy bonds, a practice that's become very common, especially among wealth-management products.

The timing couldn't be worse. With less than two weeks before the Lunar New Year holiday, people across China are pulling cash out of investments and deposit accounts to pay for trips home and buy presents for relatives. Money is traditionally scarce and expensive at this time, but it's been particularly bad this year.

The danger of a domino effect should be clear. It was to China's authorities, who intervened in the stock market, including the ChiNext, on Tuesday, people familiar told Bloomberg News. In tandem with the reverse repo operations, they may have averted any wider fallout. This time.

On top of all the other things that could go wrong in China this year, investors now need to keep an eye on penny stocks.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Christopher Langner in Singapore at clangner@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net