China cash injection fails to calm lenders

An emergency cash injection by the Chinese central bank failed to calm the country's lenders as money market rates climbed to dangerously high levels.

Analysts cited a variety of technical factors for the tightness in the Chinese financial system, but the sudden run-up in rates was an uncomfortable echo of a cash crunch that rattled global markets earlier this year.

Investors were alarmed at the potential for a repeat of that squeeze. The Shanghai Composite, the country's main equities index, fell 2 per cent. The nine-day decline for Chinese stocks is their worst losing streak in nearly two decades.

Concerns focused on the rates at which Chinese banks lend to each other. The seven-day bond repurchase rate, a key gauge of short-term liquidity, was emblematic of their reluctance to part with cash. It averaged 7.6 per cent in morning trading on Friday, its highest since the crunch that hit China in late June. That was up 100 basis point from Thursday and far above the 4.3 per cent level at which it traded just a week ago.

The sharp increase occurred despite the central bank's highly unusual decision to conduct a "short-term liquidity operation" on Thursday, providing a shot of credit to lenders struggling for cash. In a clear sign of its concern at the stress in financial markets, the People's Bank of China used its account on Weibo, China's version of Twitter, to announce the SLO. According to the central bank's own rules, it is only supposed to confirm SLOs one month after completing them.

The China Business News, a state-owned financial newspaper, reported that the short-term injection was worth Rmb200bn ($33bn), a large amount. But traders blamed the central bank for letting market conditions deteriorate to the point of needing an emergency injection in the first place. The PBoC steadfastly refused to add liquidity to the market in recent weeks despite the banking system's regular year-end scramble for cash.

Lu Ting, an economist with Bank of America Merrill Lynch, said China's financial system was entering a new era and policy makers were struggling to adapt. "The PBoC is faced with some serious challenges . . . and is confused," he said. "The PBoC finds it much more likely than before to make [operational] mistakes."

Mr Lu said he was confident that China would avoid a full-fledged repeat of June's cash crunch because the central bank did not want to see an over-tightening of monetary conditions. Rather, he and other analysts said the PBoC appeared to have misjudged the flow of funds in the economy.

The government is sitting on more than Rmb4tn of deposits at the country's banks, and in past years it has allocated a large amount of that at the very end of the year, something the central bank expected to happen again this year. But with Xi Jinping, China's president, pushing for more frugality, the year-end spending rush appears to have been more muted.

Market-led developments are also making it harder for the central bank to control interest rates. Cash has been streaming out of traditional bank accounts into so-called "wealth management products" and online money market funds, generating more competition for deposits in the financial system.

The pressure on banks to secure deposits is especially intense at the end of the year when they have to satisfy the regulatory requirement that their outstanding loans total no more than 75 per cent of the deposits on their balance sheets.

"While we do not expect the current elevated levels in market rates to last, we do expect volatility to continue in China's money market for at least another couple of weeks," said Wang Tao, an economist with UBS.

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