China’s latest cash liquidity crunch – Is this an over-reaction?

The ongoing cash liquidity crunch happening in China has taken some headlines recently about how the People’s Bank of China (PBOC) conduct its monetary policies and there were many investors trying to interpret some of the actions taken by the PBOC lately to calm down the money markets, and restore order to the overall financial system. They were also trying to understand the causes to the latest round of money market rate spikes.

Readers might have recalled the various episodes during June 2013 when PBOC tried to crack down on ‘shadow’ banking activities brought on by the largely unregulated wealth management products being marketed in China through both the financial and non-financial entities. The delayed intervention moves resulted in some jitters being expressed by traders and investors, sending money market rates soaring overnight to almost 14.0 to 16.0 percent. The overnight increase in the Shanghai Interbank Lending Rate (SHIBOR), and the seven-day repurchase (repo) rates resulted in a sudden rise in cost of borrowing, which impacted many businesses seeking for business loans needed to sustain their operations. In addition, PBOC did not act promptly and waited for almost two weeks before finally stepped in to calm down the money markets. The delayed intervention coming from the PBOC was highly criticised by many investors on the central bank’s open-market operations, and its obligations to restore overall market confidence.

During September 2013, there was also a brief spike in the interbank lending rates and it was not directed solely on curbing ‘shadow’ banking activities, but to send a signal to banks, financial firms, and the property sector in particular that home prices in the country have risen almost to ‘bubble’ territory, and the central bank was getting quite uncomfortable, hoping to restrict the amount of loan approvals. At that time, the initial reaction to the cash crunch resulted in rates shooting up by approximately 100.0 to 200.0 basis points (bps) from an average of 3.0 percent to almost 5.0 to 6.0 percent, before backing down to its former levels. However, PBOC intervened timely in order to restore market confidence, thus easing some of the concerns among investors and traders that it was about to face a repeat of the June 2013 episode, where overnight lending rates shot up at an uncontrollable rate.

In recent weeks during December 2013, it appeared that this issue is coming back to ‘haunt’ the markets, and it is starting to develop as a quarterly trend where the Chinese money markets tend to repeat itself in reaction to monetary actions taken by the PBOC to tighten liquidity conditions. In a news report by the Chinese financial news portal, last week, there were market rumours being circulated around saying that one of the Mainland-based financial entities was denied of liquidity coming from the PBOC. When interviewed, many financial firms refused to confirm or denied that they were facing cash liquidity shortages. As the news trickled down, the overnight Chinese money market lending rates, including the SHIBOR and the seven-day repurchase (repo) rates shot up by approximately 200.0 to 300.0 basis points (bps). Bloomberg News reported on December 23, 2013 that the seven-day repo rates jumped 328.0 bps last week, which was regarded as the most since January 2011. The rise in the seven-day repo rates came during the week when the US Federal Reserve (US Fed) was going to pare back its asset purchases by USD 10.0 billion a month from the current USD 85.0 billion a month, and vowed to keep interest rates low for the foreseeable future, starting in January 2014. The move sent global stock markets up, but both the Shanghai Composite and the CSI300 Indices fell hard and ended the week as one of its worst weekly declines for the past several years. Again this time round, the PBOC did not offer any explanation, except many traders and investors interpreted the latest round of cash ‘crunch’ as steps needed to restore normality to the loan markets. It is also being interpreted as a move seen by market observers that the PBOC was carrying out the ongoing reforms regarding market liberalisation policies as outlined in the November 2013 Third Plenum meetings, and does not want to give an impression that PBOC will always be there to restore overall market calm.

Despite the dilemma facing the PBOC, the central bank managed to relent, and according to Thomson Reuters news, it injected more than 300.0 billion yuan on December 19, 2013, thus restoring market order. However, it also warned banks and financial firms that they do have obligations themselves to ensure the orderliness of the local money markets, and should do more in order to avoid repeats of these episodes of cash liquidity crunches through adjustments to their liability structures. Although markets were briefly restored to order, financial markets remained unconvinced resulting in those money market rates soaring back up to approximately 8.00 percent on December 20, 2013. This is despite the 300.0 billion yuan intervention undertaken by PBOC to calm the markets during the previous day. At the time of this writing, the Mainland Chinese markets are still closed. Although it is hoped that we will not see a repeat of such money market rate spikes this week, however with the ongoing reforms being carried out by various levels of the Chinese government entities, and the shortened trading week, it remains to be seen whether the PBOC will continue to enforce its tough stance on the liberal loan approval guidelines undertaken by many financial firms, despite the various warnings issued to the financial firms that they have obligations to meet.

So far, there has not much major reaction in the latest credit shortage issues in China. Many market observers, including Mr. Vasu Menon, head of the wealth management advisory team from Singapore’s Overseas Chinese Banking Corporation (OCBC), spoke on a Bloomberg Television interview broadcasted during the early Asian trading hours on December 20, 2013, indicating that on a short-term basis, it is expected to result in market volatilities and jitters being felt across the financial systems in Mainland China, but on a long-term basis, it is not likely to have a long-lasting effect, as the Chinese government has outlined in various policy statements, including the November 2013 Third Plenum session that it will maintain close vigilance on the financial system, and will be prepared to intervene into the markets in order to restore calm and confidence. However, it will not want to be seen as an interventionist of last resort in the financial markets, preferring to yield such responsibility to the financial sector to restore market calm and overall confidence.

About Hock Meng Tay - Chief Editor, Asia-Pacific Region

Hock Meng Tay, CAIA has written 181 post in this blog.

Chief Editor, Asia-Pacific Region Hock Meng Tay is a CAIA holder and is currently taking CFA qualification. He has over 10 years of experience working as research associate in several investment companies.He is an expert in financial analysis and has published research reports in his current role. He obtained his Masters of Business Administration in Integrated Management and Masters of Arts in Economics while serving his internship in Starsource Inc