Fearful Chinese hold off lending

Interbank rate soars overnight

A floor trader sleeps Thursday on the Hong Kong Stock Exchange. Interest rates that China’s banks pay each other to borrow money rose to a record high of 13.44 percent Thursday, and stocks on Asian markets plummeted.
A floor trader sleeps Thursday on the Hong Kong Stock Exchange. Interest rates that China’s banks pay each other to borrow money rose to a record high of 13.44 percent Thursday, and stocks on Asian markets plummeted.

HONG KONG - China’s financial system is in the throes of a cash crunch, with interbank lending rates spiking Thursday, even as growth in the economy displays signs of slowing further.

The interest rates that Chinese banks must pay to borrow money from each other surged overnight to a record high of 13.44 percent Thursday, according to official daily rates set by the National Interbank Funding Center in Shanghai. That is up from 7.66 percent Wednesday and less than 4 percent last month.

Other comparable rates in China’s interbank and money markets have spiked over the past two weeks, meaning banks and other financial institutions are growing afraid of lending to one another. Those in need of short-term cash, or liquidity, must pay dearly; failure to do so raises the possibility of defaults.

“China’s interbank market is basically frozen - much like credit markets froze in the United States right after Lehman failed,” said Patrick Chovanec, managing director and chief strategist at Silvercrest As-set Management. “Rates are being quoted, but no transactions are taking place.”

China’s policymakers have an arsenal of options at their disposal to inject more money into the financial system, including conducting open market operations - trading in securities to control interest rates or liquidity - or, more drastically, freeing up some of the trillions of renminbi that banks are required to keep on reserve with the central bank, the People’s Bank of China.

“China’s central bank, by allowing a spike in interbank rates to persist for longer than usual, is sending a message to the market that liquidity needs to tighten and credit growth slow at the margin,” Andrew Batson and Joyce Poon, analysts at GaveKal Dragonomics, wrote Thursday in a research note. “Indeed, the central bank has been using its open-market operations to drain liquidity from the interbank market since January, setting the stage for just this kind of showdown with banks.”

If the central bank’s inaction toward the deepening liquidity squeeze is a form of financial brinkmanship, some analysts see it as aimed at reining in smaller banks that had been tapping the interbank market as a source of low-cost funding for their investment in higheryielding bonds, or to finance off-balance-sheet activities, or shadow banking.

“The PBOC and some other regulators could be taking the opportunity of the tight funding conditions to ‘punish’ some small banks which had previously taken advantage of the stable interbank rates,” Ting Lu, China economist at Bank of America Merrill Lynch, said Thursday in a research note.

Lu said that although the surge in interbank lending rates could have its desired effect on reckless lenders, “it will undoubtedly disrupt both the financial markets and the real economy if the liquidity squeeze lasts too long.”

China’s economy has been showing signs of a slowdown in recent months.

On Thursday, a preliminary survey of factory purchasing managers in June suggested that output in China had fallen to its lowest level in nine months, as manufacturers cut production at a faster pace in response to slack demand both at home and overseas.

The preliminary purchasing managers’ index, published by HSBC and compiled by Markit, dropped to 48.3 points in the first three weeks of June, its lowest level since September and down from a final figure of 49.2 in May. A reading above 50 indicates growth, and anything below signals contraction.

Stock markets across greater China fell Thursday on news of the liquidity situation and manufacturing survey and were the worst performers in Asia. The Hang Seng Index in Hong Kong dropped 2.9 percent, while the Shanghai composite index fell 2.8 percent.

“Manufacturing sectors are weighed down by deteriorating external demand, moderating domestic demand and rising destocking pressures,” Qu Hongbin, HSBC’s chief economist for China, said in a statement accompanying the survey results. “Beijing prefers to use reforms rather than stimulus to sustain growth,” he added. “While reforms can boost long term growth prospects, they will have a limited impact in the short term.”

The combination of slower economic expansion and the liquidity crunch in the financial sector offer one of the biggest challenges yet to the newly installed leadership in Beijing.

Prime Minister Li Keqiang, who took office in March, has said he plans changes that will promote sustainable growth, as opposed to relying on easy credit from state-controlled banks, which helped the country rebound strongly in the years since the 2008 financial crisis.

“While the economy faces up to many difficulties and challenges, we must promote financial reform in an orderly way to better serve economic restructuring,” China’s State Council, or Cabinet, said in a statement Wednesday after a meeting presided over by Li, according to Xinhua, the state-run news agency.

Louis Kuijs, an economist at Royal Bank of Scotland and former China economist at the World Bank, said Thursday in a research note that Beijing’s response to HSBC’s preliminary survey was unlikely to be drastic.

“Policymakers would want to see this weakness confirmed by the official PMI and hard activity data before making bold decisions,” Kuijs said. “Nonetheless, this kind of data will test the resolve of the government to maintain its current relatively firm macro policy stance.”

The surge in interbank lending rates is a similar test for the People’s Bank of China, which, unlike many other central banks, is not independent and reports to the State Council.

Business, Pages 28 on 06/21/2013

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