A liquidity crunch prompting a spike in China's short-term money market rates continues to spook investors. The 7-day repo rate rose to 4.8 percent today while the overnight repo rate jumped to 7.5 percent, its highest level since June. The PBoC has refrained for infusing liquidity - this comes on the back of the 7.8% GDP growth number China reported for the 3rd quarter.
On the contrary, it allowed over the past two weeks about a 100 billion Renminbi to be withdrawn from the banking system, says Andrew Polk, China economist at The Conference Board. He says if rates continue to rise next week, then PBoC will inject liquidity into the system.
Polk says a lot of what is happening now is because companies are demanding cash from banks to pay their corporate tax settlements. He says from the short term perspective this is manageable, but it does kind of underline one of the medium term or long term problems in China that is the banking system is just too cash dependent right now.
The other problem that is plaguing the banking system in China is the rising bad loans. Polk feels going forward, there is going to be more and more non-performing loans throughout the economy as it slows and as the huge credit stimulus that went out in 2009-2010 continues to be rolled over and can't be repaired.
Belos is the verbatim transcript of Andrew Polk's interview on CNBC-TV18
Q: Let me start by asking you about the events of this week. The PBoC refraining from injecting any liquidity in the market that is now seeing overheated short term rates. Why do you think that is?
A: A lot of what is happening right now is down to the fact that we are in the middle of a corporate tax season. So, companies are demanding cash from banks to pay their corporate tax settlements. So, that is one of the things that is driving demand.
As you mentioned the PBoC hasn’t injected money into the bank. Infact it has allowed over the past two weeks about a 100 billion Renminbi to be withdrawn from the banking system. So, these are some of the dynamics that are causing the larger cash demand right now. However the spike in rates I expect it to be temporary. If rates continue to rise next week I think the PBoC will come back in and inject.
So, from the short term perspective this is a manageable issue but it does kind of underline one of the medium term or long term problems in China which is the banking system is just too cash dependent right now.
Q: Does it also in a sense indicate that the PBoC having seen the 7.8 percent growth figure that we saw for the previous quarter is on the directions of the government may be reining in some of the liquidity. We have seen the Chinese government try very hard at managing this economy to come in at a growth rate that is close to 7.5 percent or just a tad below that. 7.8 percent has them a little nervous accompanied with the fact that we have seen a rise in inflation?
A: They are a bit nervous. They realise that most of the ‘rebound’ in the third quarter was policy driven, policy directed or from infrastructure spending that kind of gave a boost to the heavy industries which saw demand from increased construction and infrastructure spending.
I think in the long term they do want to withdraw liquidity but it really highlights the difficult spot that they are in because liquidity demand in the banking system is so high now - these rates have become ultra sensitive to any movements about the PBoC whether injections or withdrawals.
So, I think over the long run they do want to withdraw money from the banking system and wean these banks off their borrowings from each other. However, the problem is that they are not taking fundamental steps to make the banks change behaviour. So, by just pulling back some liquidity what you end up getting is these spikes in rate in shortage of cash within the system.
They do want to do it and I think they are sort of experimenting but really these rates ping ponging all over the place really highlight the difficult spot that the central bank is in.
Q: Let me also highlight one of the other weaknesses of the Chinese banking system and that is the growing proportion of bad loans. Just a few days ago we saw the top five banks in China write off roughly USD 3.6 billion in bad loans – loans that could not be collected in the first six months of this year is what has been reported. What do you make of this, its linkage to the broader economy and where China is in this rebalancing struggle?
A: We all knew that the non-performing loans in the banking system was higher than the actual reported numbers and probably still is. The fact that they have recognized this to some extent is actually positive so that they can get those assets out of the banking system.
We believe that this is going to become a trend. There are going to be more and more non-performing loans throughout the economy as it slows and as the huge credit stimulus that went out in 2009-2010 continues to be rolled over and can't be repaired.
We think this is going to be an ongoing trend and that regulators are going to have to go out and carve out more and more of these bad loans, put them in the asset management companies and try to fundamentally get some of these bad and non-performing or underperforming assets out of the banking system and allow the banks to kind of go back to focusing on challenging credit to people who are going to actually repay.