Last updated: June 20, 2013 6:58 am

PBoC dashes hopes of China liquidity boost

China’s credit crunch worsened on Thursday after the central bank rebuffed pleas to inject more cash in to the financial system, adding to the problems of overstretched lenders.

Short-term money market rates surged to all-time highs. The seven-day bond repurchase rate, a key gauge of liquidity in China, jumped 270 basis points to 10.8 per cent, nearly triple where it stood just two weeks ago.

Interbank lending rates were also pushed higher and the pain spread to the stock market. The Shanghai Composite Index, the country’s main stock index, fell 1.4 per cent in the morning trading session, also pressured by the news that the US Federal Reserve may start to unwind its monetary policy easing later this year.

China’s credit squeeze occurred despite fresh signs that the world’s second-largest economy has slowed further. A survey of the Chinese manufacturing sector published by HSBC indicated that industrial output probably contracted in June.

HSBC’s flash purchasing managers’ index fell to 48.3 in June from 49.2 in May, pointing to a steeper decline in growth.

The main reason for the lack of liquidity has been the central bank’s reluctance to pump liquidity into the money market, wrongfooting banks that had expected Beijing would continue to support them with large cash injections.

Signalling that the cash crunch could persist for a while, the China Securities Journal, a big state-run newspaper, ran a front-page commentary saying China was at a turning point in monetary policy. “We cannot use as fast money supply growth as in the past, or even faster, to promote economic growth,” the newspaper said. “This means that authorities must control the pace of money supply growth.”

Interbank rates began to rise earlier this month ahead of a public holiday – a normal pattern as demand for cash typically increases before festivals in China. Bankers and analysts had expected rates to fall when the country got back to work.

Instead, the central bank has remained on the sidelines of the market over the past five working days, refusing to provide the short-term cash injections that banks had expected. On Thursday, the PBoC said it would not conduct repo business at a scheduled auction, disappointing market players who thought it might relieve pressure on them by making a cash injection.

“The only explanation is that the central bank wants to send a warning signal to commercial banks and other credit issuers that unchecked credit expansion, particularly through the shadow banking system, will not be accommodated,” said Na Liu at CNC Asset Management.

Overall credit has grown by about 22-23 per cent in China this year, up from 20 per cent in 2012, after a surge in “shadow” lending by trust companies and banks through off-balance-sheet vehicles.

Wang Tao, an economist with UBS, said the central bank’s goal may be to bring the rate of credit growth down to about 17 or 18 per cent, to limit the leverage that has built up in the economy.

We cannot use as fast money supply growth as in the past, or even faster, to promote economic growth. This means that authorities must control the pace of money supply growth

- China Securities Journal

The central bank has many tools to add liquidity to the market if needed, from injecting short-term cash to lowering lenders’ required reserves. However, Ms Wang warned that the consequences of the regulatory tightening were harder to predict because of the growing complexity of Chinese financial markets.

“A liquidity crunch could happen unexpectedly somewhere,” she said. “There could be a disorderly deleveraging in the interbank market.”

China’s economic growth slowed to 7.7 per cent year-on-year in the first quarter, compared with 7.9 per cent growth in the final quarter of 2012. Many analysts expect a further slowdown in the second quarter.

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