PBOC to Extend Cash Crunch as Zhou Discovers Flaws
China’s finance companies predict central bank Governor Zhou Xiaochuan will extend a cash crunch, albeit without June’s dramatic swings, as he calls for the market to “discover and correct” excessive lending.
The seven-day repurchase rate, which measures interbank funding availability, may average 4 percent in the third quarter, compared with 3.62 percent in the past year, according to the median estimate in a Bloomberg survey of eight analysts. The rate surged to a record 10.8 percent on June 20, and averaged 4.49 percent last quarter, the highest since the National Interbank Funding Center started compiling the data in 2003. The similar rate in India fell 73 basis points.
“While inflation remains controlled, the central bank may want to keep money-market rates elevated to reduce banks’ off-balance-sheet assets,” said Huang Wentao, a bond analyst at China Securities Co. in Beijing, the country’s second-biggest brokerage underwriter of bonds. “We probably won’t see a return of the extreme tightness in June, but a 4 percent repo rate is still very high.”
Shares of China’s four biggest banks plunged an average of 12 percent last month and yield premiums on their bonds soared as the cash crunch underscored concerns excessive lending to property projects and local governments will end in rising defaults. President Xi Jinping said last month that officials shouldn’t be judged solely on their record in boosting gross domestic product, signaling that the new administration is prepared to tolerate slower economic expansion.
Repo Rate, Swaps
The worst cash squeeze in at least a decade has eased after the central bank pumped capital into some finance companies. The seven-day repo has plunged 694 basis points, or 6.94 percentage points, since June 20 to 3.83 percent today, according to a daily fixing published by the National Interbank Funding Center at 11 a.m. The measure fell 15 basis points today.
The three-month swap contract, the fixed cost needed to receive the floating seven-day repurchase rate, declined six basis points to 3.9 percent as of 11:52 a.m. in Shanghai, according to data compiled by Bloomberg.
Zhou, in his first public comments since the cash crunch, said in a June 28 speech in Shanghai that “financial markets have always been very sensitive. They react very quickly to any signals. This helps discover and correct problems.”
The cash crunch was a reminder to lenders to adjust their “asset businesses,” Zhou, the G-20’s longest-serving central bank chief, said in an interview reported July 1 by China Business News. While the PBOC will step in if individual financial institutions are in extremely difficult situations, it doesn’t want banks to ignore the need for adjustments, he was cited as saying.
The yield spread for one-year AAA bank bonds over similar-maturity sovereign notes jumped 47 basis points last month to 154.6 basis points, according to ChinaBond data. The similar AA gap widened 50 basis points to 179.6.
Twelve-month non-deliverable yuan forwards fell 0.1 percent this week to 6.2975 per dollar today on speculation the Federal Reserve may reduce monetary stimulus that helped spur fund inflows to emerging-market assets. The yuan has strengthened 0.14 percent in the same period to 6.1293, according to the China Foreign Exchange Trade System. The discount to the spot rate was 2.67 percent, after touching 2.78 percent on July 3, the biggest since February 2009.
“It’s possible that the PBOC will tighten further,” said Xu Hanfei, an economist at Guotai Junan Securities Co. in Shanghai. “While yuan depreciation expectation is rising, the central bank will have to passively keep money-market rates at high levels to increase the opportunity costs of capital outflows.”
He added that central bank auctions of 91-day bills may resume as early as next week, draining money from the market.
The monetary authority has refrained from selling bills since June 20, when both the overnight and seven-day repurchase rates climbed to all-time highs. An index compiled by the operations office of the People’s Bank of China shows that cash supply still isn’t inadequate, the Financial News, which is owned by the central bank, reported on July 3.
“If money market rates fall, cash would flow into the real estate sector or local government financing vehicles,” said Hu Hangyu, a Beijing-based bond analyst at Citic Securities Co., the nation’s biggest listed brokerage. “All the efforts the central bank made in June would be in vain.”
The central bank signaled on June 25 that liquidity support would be focused on banks that lend to help the economy. It warned commercial banks should “appropriately” handle the pace of regular lending and bill financing and control risks resulting from rapid credit expansion.
China’s aggregate financing, which tallies bank loans, corporate bonds, equity raising and other off-balance-sheet credit to provide a broad picture of funding, surged 50 percent in the first five months of this year to a record $1.5 trillion, the central bank said. About a third of that went to entrusted loans, trust lending and bills, which together with underground lending are known as shadow banking, which allows banks to bypass controls and capital requirements.
The nation’s total credit, including off-balance-sheet loans, swelled to 198 percent of gross domestic product in 2012 from 125 percent four years earlier, Fitch Ratings estimated in May. This exceeded increases in the ratio before banking crises in Japan and South Korea.
China may have difficulty realizing its 7.5 percent annual growth target this year, the 21st Century Business Herald reported yesterday, citing Fan Jianping, chief economist at the State Information Center. A government report may show July 15 that China’s economy grew 7.6 percent in the second quarter, the slowest since the three months through September last year, according to a Bloomberg News survey of 22 economists.
“The elevated borrowing costs may hit the economy in three to six months,” said Chen Ying, a bond analyst at Sealand Securities Co. in Shenzhen. “We can’t exclude the possibility of policy easing in the fourth quarter if there is an obvious slowdown in growth and the unemployment rate rises,”
Economic growth may decelerate to 7.3 percent in the fourth quarter, said Chen. She forecast the seven-day repo may be an average 4 percent for the whole of the second half, the same as the median estimate in a Bloomberg survey of nine analysts.
Tian Jiachao, a bond analyst at China Merchants Bank Co., said the cash crunch will probably ease in the third quarter because the central bank will come to the rescue if the money shortage returns.
“Banks will work on deleveraging after taking the credit squeeze in June as a lesson,” said Tian at China Merchants Bank, the nation’s sixth-biggest lender. “The central bank will no longer stand aside if any banks get into liquidity trouble.”
Economists led by Song Yu at Goldman Sachs Group Inc. predicted that the M2 (CNMS2YOY) measure of money supply rose 14.8 percent in June, the least in six months, because of tighter regulatory controls on interbank products, according to a report yesterday. The gauge has exceeded the government’s target of 13 percent in the first five months of this year.
The cost of protecting China’s government debt from default increased one basis point to 124 basis points yesterday in New York, according to prices from data provider CMA. The contracts pay the buyer face value in exchange for underlying securities or the cash equivalent if a borrower fails to adhere to its debt agreements.
“A reduction in cash supply is what commercial banks are most afraid of,” said China Securities’ Huang. “Monetary policy will be tighter in the second half even though the PBOC will still publicly stick to a so-called prudent policy.”
Below are the forecasts for China’s seven-day repurchase rate from finance companies surveyed by Bloomberg News.
Third Quarter Second-Half China Securities Co. 4.0 percent 3.5 percent HSBC Holdings Plc 4.2 percent 4.2 percent Sealand Securities N/A 4 percent Evergrowing Bank 4.5 percent 4.2 percent Guotai Junan Securities 4.0 percent 3.8 percent China Merchants Bank 3.5 percent 4 percent Foshan Shunde Rural Commercial 4 percent 4 percent Citic Securities 4 percent 3.7 percent Societe General 3.5 percent 3.5 percent
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