Central bank injects liquidity into market

Last week’s credit squeeze in China was a stark reminder of continuing stresses in the financial sector, Xie Yu reports from Shanghai

Traders sighed with relief on Tuesday, after cash rates in China’s money market eased in response to fresh liquidity from central bank open market operations.

But the volatility isn’t over — indeed, it will be a regular feature in the future, experts warned.

“Seasonal factors contributed to the recent tight conditions, but they’re not the fundamental problem,” said Xu Gao, chief economist and head of economic research at China Everbright Securities Co Ltd.

It seems the central bank is trying to use high rates to force financial institutions to cut credit to certain sectors, including property and local governments, in the face of inflated asset prices, Xu said.

But China’s capital market isn’t entirely rate- sensitive, and it will experience frequent “liquidity crunches”, especially at the end of months or quarters, he added.

The continuing process of interest rate liberalization is making it even harder to price capital, and that intensifies rate volatility, said Chen Li, chief China equity strategist with UBS Securities Co Ltd.

The People’s Bank of China, the country’s central bank, suspended open market operations in late November. That was well before money market rates surged last week.

The seven-day repurchase rate, a gauge of liquidity in the financial system, increased 100 basis points to a six-month high of 7.6 percent in Shanghai last Friday, compared with 7.22 percent during the June crunch.

On that day, the PBOC injected 300 billion yuan ($494 million) to targeted recipients, but the move didn’t calm fearful investors. The seven- day repo rate finally declined on Tuesday when the central bank resumed reverse repos.

Sitting on about 20 trillion yuan of reserve deposits, which can always be released into the interbank system, the central bank is more than capable of keeping a liquidity squeeze from turning into something more severe, analysts said.

“What happened this time and back in June actually resulted from the PBOC’s hands-off policy,” said Xu.

The authorities have been worried about asset price bubbles and funds being diverted from where they are needed.

Also, the PBOC has been urging banks to better manage liquidity, cut their off-balancesheet loans and match the maturities of assets and liabilities.

“I think the PBOC keeps warning banks about using cheap official funds to finance the shadow banking sector,” said Vivien Li, a money market trader with a midsized bank in Shanghai.

The central bank understands that the goal can’t be achieved instantly, and it will make sure financial institutions don’t run out of cash. But that’s not the same as engineering an easing in funding conditions, Xu said.

During the squeeze in June, there were rumors that a Chinese bank had defaulted on a loan to another bank. Ahead of its recent initial public offering in Hong Kong, China Everbright Bank Co Ltd disclosed in its prospectus that two of its branches had failed to pay 6.5 billion yuan of interbank loans due on June 5. The payment was later made.

A just-released report from the Chinese Academy of Social Sciences said the debts of the nation’s local governments may have reached almost 20 trillion yuan.

The official statement from the Central Economic Work Conference earlier this month defined “controlling and defusing” local government debt risks as “an important economic task”.