When China’s interbank lending rates hiked in mid-December, analysts told investors to keep calm. This would not be a repeat of the cash crunch that afflicted markets in late June. Even toward the end of last week, as rates continued to rise, they ensured that the People’s Bank of China would step in with a cash injection.
The central bank did that. But analysts were wrong about the severity of the drain on the banking system. By Monday, the seven-day bond repurchase rate hit 8.94%, not far from the peak at 9.29% it reached in June.
Rates for seven-day bonds, a key marker for the cost of borrowing between banks, have returned to the new norm, which has spiked above 5% several times since the first cash crunch six months ago. That has eased tensions for now at banks and relieved both business owners needing loans as well as their investors. The seven-day rate was 5.33% Thursday afternoon.
The brief but acute squeeze on liquidity can’t be written off as a flash in the pan. This year’s second crunch shows that not only has volatility in China’s money market rendered forecasts increasingly difficult, it’s also eroded confidence in the central bank’s strategy for managing dry spells in the country’s monetary system. What started with strategy in June appeared less calculated this month. At times it looked like a scramble.
After letting interbank rates soar in June, PBOC issued a statement saying that banks must better manage their balance sheets. Liquidity, it said, was at a reasonable level. This was a signal from the bank that it would be less likely in the future to inject cash into the system during periods of stress.
That’s a drastic change in attitude from the past five years, where PBOC has kept markets highly liquid in order to promote lending and growth. The move in June came at a great expense to mainland stock markets. On June 24, the Shanghai Composite Index closed at a four-year low after falling 5.3% that day.
Rates climbed again last week after nearly three weeks without the central bank offering up reverse purchase agreements, its favored tool for injecting cash into the market. It was here that PBOC strategy became muddled.
Last Thursday, the central bank said via a social media service that it had conducted US$49 billion in short-term liquidity operations. PBOC rules state that such operations, known as SLOs, can be announced only one month after completion.
The bank’s urgent announcement demonstrated the tight spot it had gotten itself into. Yet, even that operation failed to alleviate the crunch as banks held tightly onto their cash. The seven-day bond rate peaked on Monday forcing PBOC to offer up US$4.8 billion in reverse repurchase agreements. Only then did rates subside.
Analysts have said that PBOC’s strategy for reining in rampant credit growth would again take a toll on the market as it did in June. The SCI has fallen 185 points since the beginning of the month, killing a rise that followed government promises for reform in November.
“Targeting the stability of Shibor [Shanghai interbank offered rate] could lead to too high credit growth and a too rapid rise of leverage, but targeting credit growth could lead to too volatile interbank rates,” Lu Ting, China economist at Bank of America Merrill Lynch, wrote last week in a note.
Perhaps worst of all, banks are growing accustomed to hoarding cash as soon as rates begin to climb. Last week, even big state banks that usually lend to smaller banks when liquidity dries up panicked, holding onto their cash.
PBOC has a reputation for being insensitive to the market. Despite what analysts have said about the central bank learning its lesson from the episode in June, PBOC has shown that the priority is deleveraging.
The December squeeze was likely not the last. Holidays in China usually present seasonal stress on liquidity. Investors will be watching rates before and after the Chinese New Year, which falls on January 31, for another sign from the central bank.