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China Facing Cash Squeeze as Rising Rates Crimp Lending
Credit Tightens in China as Central Bank Takes a Hard Line
(about 7 hours later)
HONG KONG — China’s financial system is in the throes of a cash squeeze, with interbank lending rates spiking on Thursday and bank-to-bank borrowing nearly stalled, as the government tries to restructure the economy and punish speculators.
HONG KONG — China’s financial system is in the throes of a cash squeeze as the government tries to restructure the economy and punish speculators, with interbank lending rates spiking on Thursday and bank-to-bank borrowing nearly stalled.
With China’s interbank and money market rates soaring over the last two weeks, banks and other financial institutions are 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 and money market rates have soared over the last two weeks, and banks and other financial institutions are afraid of lending to one another. Without that lending, an economy can quickly stultify. Those in need of short-term cash, or liquidity, must pay dearly or risk default.
China’s central bank has refused to step in and provide additional liquidity to the credit market. Analysts say the government is holding off for a reason: the government is trying to restructure the economy and punish speculators.
China’s central bank, the People’s Bank of China, has refused to provide large amounts of additional cash to the credit market. Analysts say the government is holding off for a reason: it is trying to reshape the economy while reducing its future role. The bank is not independent, unlike many other central banks, and reports to the State Council.
A huge shadow banking operation has emerged in China in recent years, with smaller banks and trust companies borrowing from bigger state-run banks and then turning around and re-lending that money at high interest rates to private companies and property developers, usually those that have trouble borrowing.
A huge shadow banking operation has emerged in China in recent years, with smaller banks and trust companies borrowing from bigger state-run banks and relending that money at high interest rates to private companies and property developers, a practice that fuels speculation.
It is a risky strategy for the Chinese government, which is also grappling with a slowing economy. Many of those companies may have a harder time paying back their loans and many analysts fear the losses could ripple through the banking system.
Pressuring speculators is a risky strategy for the Chinese government, which is also grappling with a slowing economy. Many borrowers may have a harder time paying back their loans, and analysts fear the losses could ripple through the banking system.
But analysts say the central bank is willing to hold off on pumping money into the economy — a move that would likely lower short-term interest rates — in the hopes of reducing the role of the state in the economy. “The central bank wants to accelerate reform,” said Zhu Haibin, an economist at JPMorgan. “They want to give the market a lesson: you need to manage your risk and not rely on the central bank.”
“The central bank wants to accelerate reform,” said Zhu Haibin, an economist at JPMorgan Chase. “They want to give the market a lesson: you need to manage your risk and not rely on the central bank.”
The People’s Bank of China is not independent, unlike many other central banks, and reports to the State Council.
Mr. Zhu and other economists say restructuring the economy, which has grown addicted to easy money, could be perilous for another reason. The decision could reduce lending and slow growth too quickly.
Mr. Zhu and other economists say restructuring a slowing economy that has grown addicted to low interest rates and easy money could be perilous; the decision could tighten lending and slow growth too quickly.
The worst case, absent intervention by policy makers, would be defaults at lenders with the most exposure and shakiest balance sheets. The damage could spread to other banks, setting off runs on deposits by ordinary Chinese. In the near term, markets will probably continue to be rattled, especially shares in financial institutions.
In a worst-case scenario, absent intervention by policy makers, defaults at lenders with the most exposure and shakiest balance sheets could lead those institutions to fail. The damage could spread to other banks, setting off runs on deposits by ordinary Chinese. In the near term, markets will probably continue to be rattled, especially shares in financial institutions.
That was certainly the fear on Thursday around the globe. “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.”
“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.”
Stock markets across greater China fell Thursday on news of the liquidity situation and a disappointing survey on manufacturing. The Hang Seng Index in Hong Kong dropped 2.9 percent, and the Shanghai composite index fell 2.8 percent.
The interest rate that Chinese banks must pay to borrow money from one another 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 was up from 7.66 percent Wednesday and less than 4 percent last month.
The combination of slower economic expansion and the liquidity squeeze offers one of the biggest challenges yet to the newly installed leadership in Beijing.
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. In the past when China’s economy has hit a rough patch, the government usually stepped in, forcing state-run banks to pump liquidity into the market, even though there was a risk it could drive up asset prices and lead to overinvestment.
Prime Minister Li Keqiang, who took office in March, has said he plans changes that will promote sustainable growth, as opposed to relying on the easy credit from state-controlled banks that helped the country rebound since the 2008 financial crisis.
“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.”
“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 said in a statement Wednesday after a meeting presided by Mr. Li, according to Xinhua, the state-run news agency.
Ting Lu, China economist at Bank of America Merrill Lynch, said Thursday in a research note 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.”
The interest rate that Chinese banks must pay to borrow money from one another 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 was up from 7.66 percent on Wednesday and less than 4 percent last month.
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 slackened demand both at home and overseas.
China’s policy makers have an arsenal of options at their disposal to inject more money into the financial system, including 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.
In the past, when China’s economy hits a rough patch, the government usually steps in, forcing state-run banks to pump liquidity into the market, even though there was a risk it could drive up asset prices.
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 funds for their investment in higher-yielding bonds, or for off-balance-sheet activities.
Ting Lu, China economist at Bank of America Merrill Lynch, said on Thursday in a research note 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. Economists at HSBC joined counterparts at several other banks on Wednesday in cutting growth forecasts for the Chinese economy this year.
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 in response to slackened 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.
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.
“Beijing prefers to use reforms rather than stimulus to sustain growth,” said Qu Hongbin, HSBC’s chief economist for China, in a statement accompanying the survey results. “While reforms can boost long-term growth, they will have a limited impact in the short term.”
"Beijing prefers to use reforms rather than stimulus to sustain growth," said Qu Hongbin, HSBC’s chief economist for China, in a statement accompanying the survey results. "While reforms can boost long-term growth prospects, they will have a limited impact in the short term.”
The rise in interbank rates began two weeks ago, before China went on a three-day national holiday. Banks typically face higher demand for cash before public holidays, and the initial uptick in rates was not seen as abnormal.
The combination of slower economic expansion and the liquidity squeeze in the financial sector offers one of the biggest challenges yet to the newly installed leadership in Beijing.
But as the situation 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.
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.
Neil
Gough reported from Hong Kong, and David Barboza from Shanghai.
“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 by Mr. Li, according to Xinhua, the state-run news agency.
The rise in interbank rates began 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.
The central bank has been 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.
David Barboza contributed reporting from Shanghai.
