China’s deleveraging dilemma — how to squeeze excess liquidity out of the financial system without spurring a full-blown cash crunch — is facing its toughest test.
June is traditionally a tight time for banks because of regulatory checks, and this year, lenders are grappling with an official campaign to reduce the level of borrowing as well. Wholesale funding costs and money-market rates are close to the most expensive in two years, and the 30-day Shanghai Interbank Offered Rate has jumped 44 basis points this month, the worst start to a June since an unprecedented cash shortage in 2013.
While China’s deleveraging drive has spurred losses for investors in the nation’s stocks and bonds, policy makers have so far avoided a panic sell-off, and Nomura Holdings Inc. says that the authorities will step in to prevent any crises. Global money managers have a stake in how June plays out as well, with the 2013 funding crunch helping push the S&P 500 Index to its biggest loss in eight months.
“The combination of factors will lead to a more severe situation than in the past couple of years,” said Ji Linghao, a Shanghai-based bond analyst at Huachuang Securities Co. “The central bank should have a bottom line: it mustn’t allow a system-wide crisis because it is trying to mitigate financial risks.”
The debt market has been hit especially hard by the campaign to reduce the level of borrowing, with companies canceling a record 200 billion yuan ($29 billion) of debt sales in the last two months. A potential Federal Reserve interest-rate increase next week is adding to the pressure amid concern the People’s Bank of China may follow suit.
Here are five charts to show the stresses in China’s financial system:
The one-month interbank rate known as Shibor rose to 4.51 percent on Thursday, the highest since April 2015. That surpasses both the one-year cost of 4.41 percent and the Loan Prime Rate — which banks offer to their best borrowers — of 4.30 percent.
Policy makers will maintain a tightening bias — although in a manageable and calibrated manner — and interbank rates could rise by another 40-50 basis points, Morgan Stanley economists led by Robin Xing wrote in a June 4 report.
China’s bond yield curve has inverted for the first time since 2013’s cash crunch, and the second time in data going back 2006. The one-year sovereign yield surged 20 basis points in the last six days to 3.66 percent, one basis point higher than the 10-year yield. The curve probably won’t normalize in the short term, said Qin Han, an analyst at Guotai Junan Securities Co.
Chinese banks’ excess reserve ratio, a gauge of liquidity in the financial system, fell to 1.65 percent at the end of March, according to data from the China Banking Regulatory Commission. The index measures the money that lenders park at the PBOC above and beyond the mandatory reserve requirement, usually to draw risk-free interest.
“Major banks don’t have much extra funds, as is shown by the excess reserve data,” analysts at China Minsheng Banking Corp.’s research institute wrote in a June 5 note. Lenders have become increasingly reliant on wholesale funding and central bank loans this year, they said.
Sales of negotiable certificates of deposit in May lagged maturities by 302 billion yuan, data compiled by Bloomberg show. Refinancing of the short-term wholesale funding tools will be more challenging amid tighter liquidity conditions, according to a Moody’s Investors Service report last month. Recently enhanced regulatory checks potentially affect the demand for bonds and money-market instruments such as NCDs, said Frances Cheung, a Hong Kong-based rates strategist at Societe Generale SA.
Net outbound cross-border payments made by Chinese banks on behalf of corporate and individual clients climbed to 279.1 billion yuan in the first four months of this year, according to the latest available data. A probable Fed rate increase may speed up the departure of capital. The yuan’s 6.5 percent slide in 2016 created a vicious circle of capital outflows and bets on further currency weakness, prompting officials to introduce tighter capital controls.
The PBOC may strengthen capital controls, keep interbank rates relatively high and act against yuan depreciation expectations in case of Fed tightening, Nomura economists Zhao Yang and Wendy Chen wrote in a June 2 report.