China’s central bank indicated that volatility in money-market interest rates will persist and borrowing costs will surge, underscoring the risk of defaults that could weigh on confidence and drag down growth.
“When the valve of liquidity starts to tame and curb excessive credit expansion, money-market rates, or the cost of liquidity, will reflect that,” the People's Bank of China said in February 8 report. “The market needs to tolerate reasonable rate changes so that rates can be effective in allocating resources and developing the behavior of market players.”
The near-default of a shadow banking product last month and two cash crunches last year highlight the challenge for policy makers pursuing twin targets of deregulating interest rates and reining in an unprecedented credit boom. Higher and more volatile interbank borrowing costs may squeeze speculative and wasteful lending even as it leaves some banks and debt providers with funding difficulties.
“Interbank rates are exactly where the PBOC want them to be and higher rates are their way of beginning to deleverage the economy,” said Stephen Green, head of Greater China research at Standard Chartered Plc in Hong Kong. “It’s not a perfect strategy and it certainly carries risks, including more corporate stress as credit costs go up, but it’s going to deliver slower credit growth which everyone agrees is necessary.”
The greater interbank cost for seven-day repurchase contracts at around 4 percent to 5 percent “is meant to squeeze all the activities associated with too-cheap funding,” said Green. “This is about disciplining investment decisions and reducing leverage.”
Funding Struggle
The benchmark seven-day repo rate, a gauge of interbank funding availability, surged to a record 10.77 percent on June 20 as institutions struggled to obtain funds amid a PBOC crackdown on shadow finance and more than doubled in December to 8.84 percent as lenders hoarded cash to meet year-end regulatory requirements. It was fixed at 5.25 percent on February 8.
The rate traded between 3.66 percent and 5.4 percent in November, a range of 174 basis points, according to a daily fixing from the National Interbank Funding Center. That compares with a 62 basis-point range in November 2012, according to data compiled by Bloomberg.
Policy makers are stepping up efforts to rein in financial risks and squeeze speculative lending as concerns increase that a surge in borrowing over the last five years will tip the country into a crisis. At the same time, the PBOC needs to ensure enough credit to sustain economic growth above Premier Li Keqiang’s “bottom line” of 7 percent.
Social Stability
Last month’s eleventh-hour rescue of investors in a 3 billion-yuan ($495 million) high-yield trust product distributed by Industrial & Commercial Bank of China Ltd. underscores the pressure on authorities to maintain financial and social stability even as they seek to slow credit growth and deter excessive risk-taking.
Nomura Holdings Inc. last month predicted defaults across companies, local-government financing vehicles and borrowers in the shadow-banking industry, which involves trust companies and wealth-management products. It estimates 3.5 trillion yuan of trust products will mature this year, with the majority coming due in the second half.
“We see conditions ripe for defaults to occur: slowing credit growth, elevated costs of funding, waning economic momentum and tighter financial regulations,” Yao Wei, China economist at Societe Generale SA in Hong Kong, said in a January 29 report.
Cash Crunch
China’s money markets are playing a greater role in credit allocation and borrowing costs as the central bank has moved to liberalize interest rates and make the economy less reliant on banks for funding. The PBOC abolished controls on bank lending rates in July and the Communist Party said in November it wanted markets to play a “decisive” role in pricing capital.
The central bank alleviated a cash crunch ahead of the week-long Lunar New Year holiday that started January 31, pumping a net 450 billion yuan into the financial system in the last two weeks of the month and expanding short-term lending facilities to small banks. The repo rate spiked to 6.32 percent on January 20 before slipping to 4.98 percent on January 30.
In its February 8 report, the PBOC said it will use tools including the reserve-requirement ratio and short-term lending facilities to ensure “appropriate liquidity.” At the same time, it said it won’t bankroll a growth model that relies on investment and debt.
Increased Risks
“The massive borrowing and construction led by local governments in recent years” increased risks in the Chinese economy, the central bank said. Such a growth model can “easily lead to rising debt and may squeeze credit for other players, especially small businesses,” it said.
To prevent systemic financial risks, the central bank will enhance the monitoring of credit default dangers in local-government financing vehicles, industries facing overcapacity, and the property sector, according to the report. At the same time, the PBOC will continue to strengthen the supervision of wealth-management products and the interbank business, it said.
The scale of China’s credit expansion has evoked comparisons with Japan’s debt surge before its lost decade and with those in Thailand and Malaysia ahead of Asia’s financial crisis.
The combined debt of Chinese households, corporates, financial institutions and the government rose to 226 percent of gross domestic product last year, up from 160 percent in 2007, according to Credit Agricole CIB calculations.
“China’s debt trajectory is unsustainable,” Dariusz Kowalczyk, senior economist and strategist at Credit Agricole in Hong Kong, wrote in a Feb. 5 note. “The debt is putting economic, financial and social stability at risk, and the sooner it is addressed, the smaller and easier to manage the fallout will be.”
