SHANGHAI, June 18: The Chinese central bank’s decision to remain on the sidelines as a nasty liquidity squeeze has roiled interbank funding markets in recent weeks signals the government’s confidence in the economy, despite signs of a growth slowdown, money market traders say.
The stance signals policymakers’ view that monetary easing isn’t necessary and also tips official willingness to accept slower growth in the near term in return for protecting against the medium- and long-term systemic risks of an excessive debt buildup.
A slew of economic and credit indicators released last week showed inflation, money supply, and credit growth all missing expectations, and many analysts have cut their full-year growth forecasts in recent weeks.
As recently as last month, many market watchers expected the People’s Bank of China (PBOC) to ease monetary policy in response to signs of slowing growth in the real economy. Those expectations have now been thoroughly crushed.
Traders said Beijing is particularly sensitive to the way expectations about the economy could become self-fulfilling, amid growing talk that authorities have lost their grip on the economy and that a severe slowdown may be looming.
‘With so many people talking down the economy, there is a real threat that expectations will realise themselves via acts of panic by banks and other institutions, so the PBOC has taken the initiatives to temper market sentiment,’ said a money market trader at an Asian bank in Shanghai.
‘The PBOC’s recent hard-line stance is not a tightening, but aims to force the market to understand that monetary policy remains neutral for now.’
Traders and analysts say money market rates are likely to return gradually to normal after hitting multi-year highs last week, but they say the psychological impact of the recent turmoil will linger.
The central bank’s stance means that even if the PBOC now becomes more generous in offering cash to the market, such adjustments will be interpreted as technical fine-tuning, not as a sign of a genuine shift to looser policy.
‘Through the events over the past week, we think the PBOC has made it clear that overly-rapid credit expansion would not be accommodated,’ Wang Tao, head of China economics at UBS in Hong Kong, wrote in a note to clients on Friday.
‘Behind all these is perhaps the central government’s increased tolerance for slower growth and increased attention to controlling financial risks,’ she added.
ON THE SIDELINES
For much of the year, heavy foreign capital inflows kept interbank liquidity flush, due to a rising currency, low interest rates in developed markets and optimism about a growth recovery in the world’s second-largest economy.
Through early May, the PBOC mainly used its open market operations to sterilise these large inflows by withdrawing excess funds.
But conditions shifted abruptly in May, as inflows began to slow and even reverse amid global concern that the Federal Reserve will soon begin tapering its bond purchase program.
PBOC data released on Friday showed Chinese banks, including the central bank, bought 67 billion yuan worth of foreign exchange in May, down sharply from an average of 378 billion in the first four months of 2013.
But the PBOC declined to use its open market operations to inject additional funds to compensate for the reduced inflows. On the contrary, the central bank re-started the withdrawal of funds through central bank bills, which had been suspended since December 2011.
The PBOC remained on the sidelines even as seasonal factors related to the Dragon Boat Festival holiday last week further exacerbated the cash crunch.
Reflecting the tightness, the Ministry of Finance failed to sell the full 15 billion yuan ($2.5 billion) worth of government bills scheduled to be sold at auction last Friday, the first time that the ministry failed to auction all its debt since July 2011.
On June 8, the weighted-average overnight bond repurchase rate hit 9.81 percent, the highest level in at least 11 years.
On Tuesday, the central bank again declined to inject funds at regularly scheduled open-market operations. Instead, authorities withdrew an additional 2 billion yuan through the sale of central bank bills.
The amount was too small to substantially influence liquidity, but the simple act of issuing bills at all appeared designed to reinforce the PBOC’s hard-line stance against monetary easing.
GRADUAL NORMALISATION
The overnight rate has fallen slightly since, but remained highly elevated at 5.57 percent on Tuesday. Longer-term rates are even farther above normal.
The benchmark short-term liquidity barometer, the weighted-average seven-day repo rate, jumped to its highest since January 2012 on Friday and remained near that level on Tuesday.
Traders expect the PBOC to use open market operations, in particular reverse bond repurchase agreements, to help improve cash supply if the recent money market squeeze persists.
Without help from the central bank, however, and with the quarter-end approaching – when banks traditionally try to boost deposit totals to prettify their financial statements to shareholders and regulators – liquidity could remain tight through end-June or early July.
Such high levels, if they linger for weeks, will eventually feed through to financing costs in the real economy. Small corporates, who are the marginal borrowers in China’s financial system, will be the hardest hit. ($1 = 6.1250 Chinese yuan)
(agencies)
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