PBOC Failure to Trim Shibor Flags Bank Reserve Cut: China Credit

China’s policy makers face pressure to cut lenders’ reserve requirements as soon as this month after the first interest-rate reduction in two years failed to lower borrowing costs between banks.

The Shanghai one-month interbank offered rate, a gauge of funds banks have on hand to lend to each other, has added 15 basis points to 4.22 percent since Nov. 21, the day the one-year benchmark lending rate was decreased by 40 basis points. The rise in Shibor contrasts with a drop of 113 basis points in July 2012, the last time the policy rate was reduced.

“Clearly, the increase in Shibor despite the rate cut shows fund tightness,” said Zhou Hao, a Shanghai-based economist at Australia & New Zealand Banking Group. “Bank balance sheets are already tight and they need funds to ease the thirst. The reduction in reserve ratios is likely to take place this month and more will come in the coming year.”

ANZ joins Bank of America Corp. and Credit Agricole CIB in forecasting the People’s Bank of China will lower the reserve ratio, now the highest among major economies at 20 percent of deposits, before a cash squeeze in the money market worsens. The recent rate cut doesn’t signal a change in the central bank’s prudent monetary policy, PBOC Deputy Governor Hu Xiaolian said on Nov. 27, indicating policy makers want to revive growth in the world’s second-largest economy without fueling a buildup in debt.

Cash Shortage

Rising year-end cash demand and equity offerings are adding to a fund shortage in the money market. The rate for overnight loans on the Shanghai stock exchange rose to as high as 5.8 percent today from 2.51 percent. It surged to 42 percent on Nov. 25 as new share sales locked up 1.6 trillion yuan ($260 billion), according to a Guotai Junan Securities Co. estimate.

The one-year interest-rate swap surged 13 basis points today to 3.26 percent as a stock-market boom sucked in funds and cooled speculation over imminent monetary easing. The Shanghai Composite Index jumped 20 percent in the past month, more than double the gain of any other nation’s benchmark gauge.

The central bank, which cut its one-year lending rate to 5.6 percent and the one-year deposit rate by 0.25 percentage point to 2.75 percent, refrained from draining funds from the financial system in the past week by suspending the use of repurchase agreements for the first time since July.

The current cash squeeze stems partly from capital outflows indicated in a record $105.5 billion slide in foreign-exchange reserves during the third quarter. The situation could worsen as a $126 billion loan that the PBOC extended to banks through a newly created Medium-term Lending Facility expires this month.

BlackRock View

“The MLF will mature in the middle of December, so they could do something,” Joel Kim, Singapore-based head of Asia-Pacific fixed income at BlackRock Inc., told reporters on Dec. 2. “Guiding down official policy rates is probably not enough. Capital is moving out of China. You’d really need to inject more liquidity.”

BlackRock, which has $4.5 trillion of assets globally, will continue to buy Chinese medium-to long-dated government bonds, Kim said. Rajeev De Mello, who manages $10 billion of Asian bonds at Schroder Investment Management in Singapore, also said yesterday that he is bullish on Chinese bonds.

“China is slowing down, but the government is quite keen on cushioning the slowdown,” De Mello said. “Once they feel growth is slowing more than they’re comfortable with, they will cut the RRR. They cut interest rates already, and we expect them to do more. It’s very positive for Chinese bonds.”

Bonds, Yuan

The yield on 3.53 percent sovereign bonds due October 2019 rose 25 basis points from Nov. 28 to 3.69 percent, data compiled by Bloomberg show. The yuan rose 0.07 percent today and fell 0.08 percent this month to 6.1502 per dollar, extending its first monthly drop since April, according to China Foreign Exchange Trade System prices.

Targeted easing by the PBOC did little to spur lending and credit growth. Aggregate financing in October was 662.7 billion yuan, down from 1.05 trillion yuan in September. New yuan loans were 548.3 billion yuan, compared with 857.2 billion, after falling to 385.2 billion in July, the least since December 2009.

“The rate cut wasn’t complemented with policies that boost the monetary aggregate,” said Cici Wang, a Beijing-based fixed-income analyst at Citic Securities Co., the nation’s largest brokerage by assets. “This means, whether it’s the real economy or financial markets, liquidity didn’t become looser.”

More Cuts

There will be two more reductions in benchmark interest rates by mid-2015, each of 25 basis points, and banks’ reserve-requirement ratios will be lowered by 150 basis points cumulatively next year, HSBC Holdings Plc forecast last week. Eleven of 14 economists in a Nov 21-24 Bloomberg survey predicted the reserve ratio will be lowered by March, with a level of 19.5 percent the median estimate.

China’s decision to cut borrowing costs was triggered by rising real interest rates that climbed to the highest since 2009 last month, PBOC’s Hu said. Goldman Sachs Group Inc. expects the monetary authority to continue using MLF or other new tools to keep interbank rates accommodative.

“The probability of further rate cuts or system-wide reserve ratio cuts in the near term is relatively low, but would increase if meaningfully lower interbank rates fail to jumpstart growth,” M.K. Tang, Goldman’s economist in Hong Kong, wrote in a Nov. 26 report.

Slowing Economy

China’s official Purchasing Managers’ Index fell to an eight-month low in November, data showed this week. Factory production rose 7.7 percent in October from a year earlier, the second-weakest pace since 2009, while retail sales gains missed economists’ forecasts. The economy will expand 7 percent in 2015, less than this year’s estimate of 7.4 percent and the slowest pace since 1990, according to median estimates in Bloomberg surveys.

“The timing of the PBOC rate cut suggests that China’s disappointing economic conditions were the trigger,” Jianguang Shen, chief Asia economist at Mizuho Securities Asia Ltd. in Hong Kong, wrote in a Dec. 1 report. He said he expects reserve ratios to be cut as early as this month, followed by a series of reserve- and interest-rate reductions, to prevent the risk of a hard landing.

Before it's here, it's on the Bloomberg Terminal.