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Inflation: China’s January cash shortage signals trouble ahead

A liquidity squeeze in China has observers worrying that there’s trouble in store.

Traders and treasurers in China have been spooked by a liquidity squeeze that has prompted unprecedented rises in interbank rates. While some sources attribute this to the traditional increase in demand for cash ahead of the Chinese New Year, as migrant workers withdraw money to take home to their families, the unusual severity of the squeeze has other sources saying that the Chinese authorities have badly mismanaged the situation.

The People’s Bank of China, the central bank, has been battling aggressively to control inflation in China, its primary weapon being increases in the reserve requirement ratios (RRR) – the amount of cash banks must hold. These increases have the effect of draining liquidity from the system and together with the seasonal extra demand for cash from individuals have contrived to drive up money market rates sharply. On January 25 the benchmark interbank rate jumped a record 242 basis points to 7.69%, a three-year high.

Market criticism of the PBOC’s handling of the situation focuses on a number of issues. First, the timing of the most recent RRR increase on January 20 has been called into question given that cash demands for the New Year were peaking, with the sources that Euromoney spoke to reaching a rough consensus that about Rmb600 billion ($91 billion) is likely to be withdrawn from banks ahead of the celebration.

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