Is the cash crunch in China finally over?

Thomson Reuters reported on January 03, 2014 that after last year’s various episodes of liquidity crunches taking place in China, the money market rates appeared to have returned to normality, with the benchmark money market rate, or the seven-day repurchase (repo) rate last recorded at 4.71 percent on a weighted-average basis by midday on January 03, 2014, falling by approximately 39.00 basis points (bps) from the end of last week, while the overnight repo rates fell by 41.00 bps to 2.98 percent. A chart illustrating the daily movements of the benchmark seven-day repo rates is as follows:

Chart showing the seven-day repo rates in China - January 06 2013

Source: Thomson Reuters click on image to get a better view of the chart).

As most of the readers can see on the chart, two critical spikes of extreme volatilities took place during 2013, where the first episode took place on June 20, 2013, with rates spiking to 11.00 percent or approximately 650.00 to 700.00 bps overnight from its previous close of around 4.00 percent. The second episode close to the end of last year on December 23, 2013, with rates spiking to as much as 8.84 percent, before the People’s Bank of China (PBOC) stepped in on December 27, 2013 through injections of liquidity into the financial system, bringing down the overnight rates close to 5.00 percent.

The question on most investors’ minds is whether those benchmark seven-day repo rates might spike again as we entered into 2014, and with the current lull shown in the Chinese money markets, could there be any emerging signs that another round of repo rate spikes be up on the horizon?

It is understandable that these questions and other concerns regarding the Chinese financial system are being brought up time and time again due to relative opaqueness of the country’s entire banking system, lack of transparencies, and disclosures, among various issues, including corporate governance. It is also difficult to tell regarding the timing of any intervention by the PBOC to inject liquidity into the financial system should there be another episode of repo rate spikes.

According to various interviews/polls conducted by Thomson Reuters on money market traders dealing with the Chinese rates, most of them have expressed caution and uncertainties over the possible actions PBOC might take to bring down money market rates permanently. Neither the PBOC is not obliged to publish, nor is it required to disclose daily movements of money market funds across the Chinese financial system. This has left traders with not many choices, except to guess and forecast what the next possible moves PBOC might take are. The consensus view among traders is that the PBOC is generally maintaining its tight monetary stance, given that the Chinese property market prices, loan books data, demand, among others have not shown much signs of waning down in terms of the amount of money being lent out or borrowed, despite several fiscal moves made by the Chinese central and other provincial governments to tame down the over exuberance seen in these markets for the past year. In addition, PBOC is also implementing some of the reforms that were being outlined in the November 2013 Third Plenum meetings, where it was announced that the Chinese government will be maintaining a non-interventionist stance in its management of the overall economy, with the exception of stepping into the markets if things were to go out of hand, such as the recent temporary injections of liquidity into the financial system by the PBOC.

According to the January 03, 2014 article by Reuters, some traders indicated that improved cash conditions are expected to last only about two weeks. The possible reasons that might cause another round of repo rate spikes could be holiday disruptions as a result of the Lunar New Year or Spring Festivals coming up at the end of January 2014, and seasonal trends such as quarterly and mid-year cash top-ups by most Chinese financial institutions in order to meet regulatory requirements on maintenance of the overall capital requirements. Historically, these are some of periods where liquidity conditions are one the most tightest.

The overall reluctance for the PBOC to intervene in a timely manner to quell the rising money market rates do reflect the serious opinions made on the slow internal reforms being undertaken by various Chinese financial institutions to get their acts together in conforming to regulations regarding their lending policies. The PBOC is also trying not to create any impressions that they tolerate such slow progress being made by these Chinese financial institutions, as it might result in a ‘moral hazard’ mentality that there will always be a liquidity lifeline available. There are also questions pointing to the apparent slow lending reforms being undertaken by these Chinese financial institutions, and whether they are the main targets for all the various episodes of rate spikes that took place last year, given their lack of firm action in undertaking the necessary lending policy reforms.

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