The People's Bank of China has injected some funds and
overnight interest rates on the Chinese interbank markets fell,
but repo rates the most closely watched interbank rates
still show signs that "liquidity conditions remain
uncomfortably tense," according to Societe Generale's China
analyst Wei Yao.
Earlier this month, short-time repo rates jumped up, with
the overnight rate touching an all-time high of 30% intraday on
Shibor, a rate set up six years ago as an alternative to
Libor and as a way for China to get a benchmark interest rate
curve, was 2.2% overnight on May 15, according to data from
Bank of America Merrill Lynch. It rose to 9.6% on June 8 and
moderated to 5.6% on June 27 after both the PBOC and China's
executive pledged to provide liquidity to any banks needing
Bank of America Merrill Lynch analysts Ting Lu and Larry Hu
believe there are two competing theories explaining the
squeeze: the first is that the government was "seriously
concerned about the overly rapid credit growth facilitated by
shadow banking" so it hiked Shibor to slow the growth of
credit; the second, that the PBOC diminished interbank
liquidity "to punish banks that had aggressively used
short-term interbank funding for longer-term investments."
The "surprisingly strong stance" of policymakers supports
Yao's view that the new Chinese leadership is determined to
tackle the economic imbalances "head-on," she said in a market
"The risk of a systemic financial crisis in China is still
manageable in 2013, but will rise steadily going forward," Yao
In her opinion, "there is no other ending to China's massive
credit misallocation than a painful burst. The question is when
will it start unwinding and at what pace."
She believes that even if Chinese policymakers can engineer
a controlled shrinking of the credit bubble, events such as
corporate failures, increases in non-performing loans and
rising bond defaults would follow.
"We think policymakers want to see a meaningful decline in
shadow bank lending, and they will probably get it," Yao
CREDIT SLOWING DOWN
The Societe Generale analyst expects total credit growth to
fall to between 16% and 18% year-on-year by the end of this
year from nearly 25%, and non-bank credit growth to fall to 30%
from over 50% at the moment.
Small and medium size companies, particularly smaller property
developers, are likely to suffer the most as they are one of
the major clients of the shadow banking system, she said.
Higher interest rates will also make local government
financing vehicles which generally invest in local
infrastructure projects more vulnerable, she
Yao also points out that small and medium size banks are
more exposed to the interbank market, because their share of
interbank funding out of total funding has increased rapidly to
12% from between 6% and 8% last year.
Analysts at HSBC note that after the change of leadership
last year, the approach to the economy has changed too and the
focus has been, increasingly, on the "quality" rather than the
"quantity" of growth.
China is more focused on supply-side reforms like
introducing market pricing for food and energy, removing
interest rate ceilings and limiting excessive credit creation,
so it will tolerate slightly lower growth, they said.
But, in the opinion of the HSBC analysts, if growth slows
below 7%, Beijing might decide to do another round of monetary
and fiscal stimulus.
BofA's Ting Lu and Larry Hu believe the worst is over for
China's credit crunch and that interbank rates will gradually
"No policymaker can afford to be blamed for being
responsible for an unnecessary financial meltdown and growth
hard landing," they wrote in their weekly commentary on
"The most likely scenario is that interbank rates will
gradually moderate in the next couple of weeks. A seasonal
decline in liquidity demand in early July will also facilitate
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