PBOC Seen Lowering Shibor as Growth Top Priority: China Credit

China’s interbank borrowing costs are set for the longest slide in almost two years as policy makers curb activities of higher-risk finance companies and channel cash toward larger lenders.

The three-month Shanghai interbank offered rate fell 43 basis points in May to 5.07 percent, on track for a fourth month of declines. The cost of locking in the rate for one year in the swap market is even lower at 4.75 percent today. Shibor has dropped from as high as 5.8 percent in June 2013, when the People’s Bank of China choked the supply of cash to discourage trust companies and issuers of wealth-management products from using money borrowed from the market to finance risky loans.

The PBOC is easing monetary policy as growth in the world’s second-largest economy cools to the slowest pace since 1990, property prices fall and investment fades. It also needs to ensure plentiful demand as China’s banks embark on sales of preferred shares to allow them to absorb potential defaults, while regional governments expand a municipal bond-market trial.

“Growth is the highest priority,” said Chen Qi, a strategist in Shanghai at UBS Securities Co. “Investors are betting on lower money-market rates. Policy makers are trying to curb off-balance sheet lending and encourage development in the bond market to become a substitute for corporate financing.” She forecasts the three-month Shibor will decline to 4.5 percent in the third quarter.

Funds Return

China is taking more measures to protect a 7.5 percent annual growth target, after the economy expanded at a 7.4 percent in the first quarter. The 21st Century Business Herald reported yesterday that the PBOC provided a 100 billion yuan ($16 billion) loan to China Development Bank for shantytown development, while the State Council said on May 21 it will double the amount of venture capital it makes available to emerging industries.

“The central bank has come quite a long way from last summer’s tightening bias, and with weaker economic activities in mind, a repeat of June 2013 is looking very unlikely,” Qu Hongbin, chief China economist at HSBC Holdings Plc in Hong Kong, wrote in a report yesterday. “Funds are coming back to the interbank market as a result of increasing regulatory scrutiny on off-balance sheet lending activities.”

The Chinese Academy of Social Sciences, a state-run research institute, this month described the interbank market as a “critical link” that could exacerbate systemic risks in times of a shortage of cash. Regulators have told lenders to limit interbank borrowing to less than a third of liabilities, while lending to another financial firm shouldn’t exceed 50 percent of Tier 1 capital, the PBOC said last week.

Cash Crunch

The risks associated with interbank lending were underscored last year when the June cash crunch forced two branches of China Everbright Bank Co. to delay repaying 6.5 billion yuan of short-term interbank loans after they failed to receive proceeds from counterparties.

Finance companies in China circumvented restrictions on lending to property developers and local government financing vehicles by creating a web of shadow financing, estimated by JPMorgan Chase & Co. at 46.7 trillion yuan. That often involved interbank lending.

The PBOC’s open-market operations injected a net 120 billion yuan into the financial system this week, the most in almost four months. Shibor may bounce back ahead of quarter-end cash requirements next month as the PBOC may keep monetary policy neutral unless growth “surprises to the downside,” said Sameer Goel, Singapore-based head of Asia macro strategy at Deutsche Bank AG.

Seasonal Spikes

“They will want to manage liquidity very prudently at this point of time,” said Goel. “Shibor has already normalized. It’s corrected very significantly. There will always be the seasonal spikes in the middle of the fiscal year.”

The economy is forecast to expand 7.3 percent this year, the slowest pace since 1990, according to the median estimate in a Bloomberg survey. New home prices rose in April in the fewest cities in a year and a manufacturing gauge stayed below 50, the dividing line between expansion and contraction, for a fifth month in May, data this week showed.

PBOC Governor Zhou Xiaochuan called for “vigilance” to monitor whether growth slows further even as he said the nation can achieve an expansion rate of 7.5 percent, which would match the government’s target for the year. He spoke in an interview in Kigali, Rwanda.

The slowdown has hurt the ability of borrowers to repay debt and driven up bad loans. Nonperforming loans at Chinese lenders increased for the 10th quarter to 646.1 billion yuan in March, the highest since 2008, official data show.

Preferred Stocks

The China Securities Regulatory Commission in March allowed banks to issue preferred stocks. Bank of China Ltd., the nation’s fourth-largest lender by market value, is seeking as much as 100 billion yuan by selling the securities, which count as equity-like capital and allow banks to expand their businesses.

A preferred stock sale “provides another channel for banks to raise capital,” said Ken Peng, an investment strategist at Citigroup Inc.’s private bank in Hong Kong. “There’s been a continuous crackdown on shadow banking. If corporates have more trouble finding credit, banks will be able to provide more through the sales.”

Shibor may fall to around 4 percent as there is ample supply of yuan in the financial system after the PBOC’s steps to spur two-way currency swings, according to Wee-Khoon Chong, head of Asian rates strategy at Nomura Holdings Plc.

Yuan, Bonds

The yuan has slipped 3 percent this year, the worst performance in Asia, and was trading at 6.2372 per dollar as of 12:03 p.m. in Shanghai today. The 10-year government bond yield has declined 38 basis points this year to 4.18 percent yesterday.

Chong expects the PBOC to cut banks’ reserve requirement ratio by 50 basis points before the end of June and deliver another reduction in the third quarter. The amount of cash China’s biggest banks must set aside as reserves has remained at 20 percent since May 2012.

“There is a chance for Shibor to fall back to June 2013’s pre-tightening levels,” Chong said in Singapore. “Shibor is falling due to active open-market operations, partly unsterilized intervention and anticipated further easing.”

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