When China’s interbank rates shot toward 6% last week, bankers and investors had a brief flashback to the boiling point on June 20 that saw the overnight Shanghai Interbank Offered Rate (Shibor) spike to 13%.
Everyone has since calmed down. The overnight rate on the cost of borrowing for banks was near 4% on Monday and analysts expect it to stay within the normal 3-4% band for the month, especially as the major policy meet, the Third Plenum, convenes on November 9. But such fluctuations (the hike started on October 19 then fell on October 30) can scare companies in need of capital, their investors, as well as banks that need to hand out cash to keep their lending business growing.
Since June, interbank liquidity and the specter of another cash crunch have been no laughing matter. The People’s Bank of China (PBOC), which controls the rate by injecting cash into the banking system, has been called irresponsible for letting liquidity dry up during a time of flagging economic growth. Analysts have accused the bank of sending dangerous signals to the market and even at times losing control.
So now onlookers are asking themselves: Why doesn’t the PBOC keep things stable?
The crunch in June was largely an attempt to rein in irresponsible lending in China’s banking sector and perhaps the PBOC’s way of telling the country’s financial institutions that they must be amply liquid in case of future shocks to the system.
Yet, in September, total social financing (TSF), China’s broadest measure of credit growth, was in line with most expectations, showing that banks had not over extended themselves. TSF was US$229.5 billion down from US$257.3 billion in August. A report published by the PBOC on October 16 gave the impression that credit growth was at reasonable levels.
Investors were understandably nervous when interbank rates began to climb just three days later.
Analysts at Barclays say that instability in the interbank market could be the new norm. The PBOC has stated that it will maintain what it calls a “prudent” monetary policy and a slowdown in credit growth. “We think episodes of volatility are likely to recur,” Barclay Research said in a note last week, while also noting that “market psych has not fully recovered since June.”
The average interest-rate levels since June have been significantly higher than in the first half of the year, Yao Wei, China economist at French bank Societe Generale, said from Hong Kong on Monday. It’s not just sudden spikes such as the one at the end of October. The central bank is tightening the cash supply and that could be the new paradigm.
“The liquidity tension in the market has never really gone away,” she said. “The central bank has no intension to return conditions to the easy status we saw in the past.”
At a deeper level, as Lu Ting at Bank of America Merrill Lynch pointed out in a note late last week, interbank rates at Shibor pose a dilemma for the central bank. Never has the PBOC said that these rates are its benchmark rate, skirting some responsibility for keeping it stable. At the same time, it has said it will develop Shibor into its official benchmark as it continues to liberalize lending rates.
Therefore, until the central bank commits to the rate as the benchmark, it may not respond with cash injections as quickly as the markets would like.
In this new environment, investors should brace themselves for further market turbulence.