China liquidity crisis: a welcome stress test?
Whether there is a serious liquidity shortage in the Chinese banking sector or just poor liquidity management is missing the broader point: recent outflows provide a necessary stress test for the People's Bank of China (PBoC) to assess the appetite for capital account liberalization, say analysts.
Apparently tight liquidity in China coincides with rising concerns over the country’s growth outlook, amid fears that credit expansion in recent years is unsustainable. However, markets could be ignoring the bigger picture: Chinese banks are enduring a liquidity squeeze, as Beijing tests their strength and assesses the case for capital account liberalization.
|Dr. Jian Chang, China economist
at Barclays in Hong Kong
Last week saw a severe liquidity shortage within the overnight interbank lending market in China, which has seen rates gyrate wildly. The seven-day repurchase agreement rate fell to 6.98% on a weighted-average basis from 9.25% on Friday close after reaching a record 28% in an isolated trade Thursday. On Friday, the overnight night repo rate also fell to 6.11% from 8.70%.
Previously, fears of high capital inflows to China were the main reason the authorities did not want to liberalize during risk-on periods. Now, fears that outflows will outweigh inflows might encourage a slowdown in the capital account liberalization process.
Recent auction failures have also fuelled rumours of a credit crunch in China. Last week, the country's finance ministry sold just Rmb9.53 billion ($1.55 billion) of government bills out of the Rmb15 billion on offer. That comes after a failed auction by the Agricultural Development Bank of China where just Rmb11.51 billion of six-month bills were sold from a Rmb20-billion offering on June 6. This is a sign that Chinese banks are hoarding cash to meet short-term funding requirements, said Chang.
“The current environment provides Beijing with an opportunity to see whether or not they should push for the acceleration of capital account opening,” said Chang. Indeed, if the PBoC is forced to inject liquidity into the market, this would signal that China is not ready to open up its capital account in the current environment, given the prospect that outflows would outweigh inflows, exacerbating the domestic liquidity challenge.
Following an announcement on Wednesday that the Fed will begin scaling back its bond-buying programme come September, Chinese funds saw immediate outflows.
According to Markus Rosgen, chief Asia strategist at Citigroup, Chinese funds saw $558 million of net withdrawals in the week ending June 19. Foreigners sold a net $3.6 billion in the same period.
But according to Qinwei Wang, China economist at Capital Economics: “The Fed’s announcement that it would be scaling back on quantitative easing this year saw capital outflows from emerging markets; compared to others, China was less affected.”
“Nevertheless, this is not the time to push for an open capital account,” he continued. “Despite its relative resilience compared to other emerging markets, China needs a healthier banking market, where risk is managed properly, before it can do this. Regulation is a couple of steps behind economic liberalization; this will mean that the government and the PBoC will refrain from speeding up the liberalization process. Beijing needs to rethink its schedule when it comes to capital account opening.”
China has come under much pressure to reform the shadow banking system and the use of wealth management products (WMP). Tight liquidity conditions would limit the ability of some banks to meet upcoming obligations on maturing WMPs.
“For the last two years, non-traditional channels of lending such as WMPs have been growing while regulations have remained behind. Regulation needs to catch up and Beijing needs to rethink its liberalization schedule,” said Wang.
Although there are stresses within the interbank lending market in China, the PBoC continues to deny that there is an overall liquidity shortage on the mainland.
In a statement dated June 17 published on Monday, the PBoC stated: “At present, the overall liquidity in China’s banking system is at a reasonable level, but due to many changing factors in the financial markets and because of the mid-year point, the requirements for commercial banks in liquidity management have become higher.”