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China Manufacturing Contracts to Lowest Level in 9 Months Lending in China Chills as Borrowing Costs Spike
(about 9 hours later)
HONG KONG — Manufacturing output in China has been contracting worse than economists expected in June, a closely watched survey showed on Thursday, challenging Beijing’s stated goal of driving growth through economic overhauls rather than resorting to more more lending to stimulate the economy. 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.
A preliminary survey of purchasing managers for the month of June showed that output in China has fallen to its lowest levels in nine months, as manufacturers cut back production at a faster pace in response to slack demand both at home and overseas. The interest rates that Chinese banks must pay to borrow money from each other overnight surged 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.
The preliminary Purchasing Managers’ Index, or P.M.I., published by HSBC and compiled by Markit, dropped to 48.3 points as of the first three weeks of June, its lowest level since last September and down markedly from 49.2 in May. A reading above 50 indicates growth, and anything below that level signals contraction. 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.
“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. “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 Asset Management. "Rates are being quoted, but no transactions are taking place.”
“Beijing prefers to use reforms rather than stimulus to sustain growth,” Mr. Qu said. “While reforms can boost long-term growth prospects, they will have a limited impact in the short term.” China’s policy makers 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.
Markets fell Thursday on news of the survey data. In Hong Kong, a subindex of shares in mainland Chinese companies was down more than 3 percent at noon — outpacing declines on the broader Hang Seng index, which had fallen 2.5 percent and was one of the worst performers in the Asia-Pacific region. “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.”
China’s slowing economy is posing a challenge for Prime Minister Li Keqiang, who took office in March and has said he plans overhauls targeting sustainable growth — as opposed to relying on loose credit from statecontrolled banks, which helped the country rebound strongly in the years since the 2008 financial crisis. 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 higher-yielding bonds, or to finance off-balance-sheet activities, or shadow banking.
Data released earlier this month showed that China’s economic performance had worsened in May, with industrial production dropping to its lowest growth rate since last September, imports and fixed-asset investment having their weakest growth since last August, and producer prices continuing to accelerate downward, having declined every month for 15 months in a row. “The P.B.O.C. 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.
On Wednesday, economists at HSBC joined counterparts at several other banks in slashing their growth forecasts for the Chinese economy this year. HSBC said it now expected gross domestic product to expand 7.4 percent in 2013, down from a previous forecast of 8.2 percent. Mr. 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.”
Such downgrades raise the risk that China’s growth could fall short of the government’s official target of 7.5 percent growth this year. 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.
Louis Kuijs, an economist at Royal Bank of Scotland and former China economist at the World Bank, wrote Thursday in a research note that Beijing’s response to the new preliminary P.M.I. survey was unlikely to be dramatic. The preliminary purchasing managers’ index, published by HSBC and compiled by Markit, dropped to 48.3 points in 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.
“Policy makers would want to see this weakness confirmed by the official P.M.I. and hard activity data before making bold decisions,” Mr. Kuijs said. “Nonetheless, this kind of data will test the resolve of the government to maintain its current relatively firm macro policy stance.” 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 overhauls 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 Mr. 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. "Policy makers would want to see this weakness confirmed by the official P.M.I. and hard activity data before making bold decisions," Mr. 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.
The rise in interbank rates began to take off two weeks ago, before China went on a three-day national holiday to observe an ancient dragon boat festival. Banks typically face higher demand for cash before public holidays, and the initial uptick in rates was not considered abnormal at the time.
But as the situation has worsened, the central bank refrained from injecting new money into the system. Benchmark seven-day repurchase rates, another measure of borrowing costs, briefly soared as high as 25 percent on Thursday, up from 8.5 percent on Wednesday, before closing at 11.2 percent.
Some analysts interpret the central bank’s move to allow the cash crunch as part of a campaign to crack down on shadow banking, which they say can sometimes rely on the interbank market as a source of funding.
According to this theory, the central bank is attempting to rein in the issuance of so-called wealth management products in China. These are short-term debt investment products that are marketed by banks as paying stable returns akin to normal bank deposits, but at higher interest rates. The total amount of such products outstanding in China as of March was about 13 trillion renminbi, or $2.1 trillion, according to estimates by Charlene Chu, a senior director at Fitch Ratings in Beijing.
Banks are able to increase their fee income from the sale of these products, but because they do not appear on banks’ balance sheets, there can be little transparency regarding what loans, bonds or other assets have been packaged together under a given product. Moreover, although the products themselves are typically for a short term of, say, three months, the underlying loans they support are often of longer durations — two years, for example.
“To some extent, this is fundamentally a Ponzi scheme," Xiao Gang, then the chairman of the Bank of China, wrote in an opinion column in China Daily last October, referring to the mismatch between the maturity of wealth management products and the loans they pay for. "The music may stop when investors lose confidence and reduce their buying or withdraw" from the products, he wrote. Mr. Xiao now serves as the chairman of the China Securities Regulatory Commission.