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 June 20.
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 it.
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 note.
"The risk of a systemic financial crisis in China is still manageable in 2013, but will rise steadily going forward," Yao said.
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 said.
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 predicted.
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 come down.
"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 Asia.
"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 this process."
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