Credit crunch

China’s credit crunch deepens as PBoC ignores call to action

Financial stress is spreading out from China’s interbank market and threatens the real economy. Rates analyst notes signs of intervention.

The credit crunch in the Chinese interbank lending market ratcheted tighter on Thursday after policymakers signalled that the central bank wouldn’t always be the lender of last resort.

China’s State Council met Wednesday and said it will maintain prudent monetary policy while accelerating interest rate and capital account liberalisation.

“The statement sent a clear signal that no monetary easing will come in the near term,” said J.P. Morgan in a note to clients. The tough line prompted a spike in interbank funding costs.

While the central bank refuses to unleash more liquidity on demand, the stress in the interbank market is spilling over into other areas of China’s financial system and threatening the real economy, which is already slowing down.The trades mark a step change in the fear building in China’s banking market and test the resolve of China’s new leadership to gradually opening the country’s capital account, which could place even greater pressure on the banking system.

Drilling into the individual repo trades, banks were seen to have paid as high as 30% on Thursday to get hold of overnight cash. This is a significant departure from the 1.7% to 4.3% range seen in the first four months of the year, according to HSBC’s head of Asia-Pacific rates research, Andre de Silva.

China’s seven-day repo rate, a key measure of interbank lending rates, tightened dramatically from about 8.5% on Wednesday to more than 12% by midday on Thursday, the highest level since 2006, according to data provider Bloomberg and economists.

China government five-year credit default swaps (CDS), or the cost to insure government bonds against default, rose by 12.575bp to 103.075bp.

A person responsible for selling investors protection through the CDS market said that because many investors want to hold onto Chinese bonds they are selling credit default swaps to minimise potential losses.

The financial system’s distress will bleed into the real economy as the banks pass on their higher cost of borrowing to their clients, Chinese companies. The three-month Shanghai Interbank Offered Rate, which is usually more stable, has also increased significantly to 5.4%.

Debt market bankers said fear is growing that a negative credit cycle is starting in China and that smaller, poorly capitalised Chinese banks will struggle.

Economists called on the People’s Bank of China to reintroduce reverse-repo operations soon to quell the panic.

To be sure, some think the worst is past. HSBC’s de Silva noted that five large overnight repo rate trades were priced around 4% Thursday late afternoon, even though the volume-weighted average rate about 12%. This may indicate that the government intervened with assistance and that the central bank will not tolerate an increase in funding rates from these levels, he said in a research note.

China’s repo market has been steadily tightening over recent weeks with financial pundits citing several possible causes. On the side of demand for liquidity they name tax payments, which tend to remove between Rmb200 to Rmb300 billion from the system, half-year capital adequacy reporting, and maturing wealth management products as well as supply-side factors, such as a large decline in capital inflows due to crackdown on fake exports.

Fear has been aggravated by media reports about rumours that an interbank payment between two mainland Chinese banks failed to happen. This rumour was roundly denied by Chinese authorities.

But concerns are growing that the repercussions from the financial system’s gyrations will multiply in the world’s second largest economy.

“We think that the jump in interest rates is signalling a rising financial risk for China’s financial sector,” said China economists at ANZ. “If the policymakers do not act pre-emptively and decisively, the financial risk could become a macroeconomic risk.”

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