And the markets appear to agree: CDS spreads of Chinese banks soared by an average of 79 basis points in June, during a one-month period.
Meanwhile, China's sovereign CDS spreads soared 55% during the past three days to 140bp on Monday – the highest rate since the Lehman Brothers crisis.
Allan Dwyer, professor of finance at Mount Royal University, Canada, says: “Chinese CDS blew out yesterday, indicating the biggest perceived risk in Chinese sovereign debt since the Lehman meltdown.
“The central bank officials in China are still learning the game, that the policies taken in one sector of the system can have a dramatic – and negative effect – in other areas.
“As the Chinese economy shows signs of struggling, the PBoC [People’s Bank of China] understands that they must keep the China risk premium to a minimum ... and the CDS market yesterday was telling them the exact opposite.”
China’s increased risk perception reflects the central bank’s reluctance to inject more liquidity into China’s banking sector. Tighter liquidity conditions are coinciding with government attempts to moderate credit growth and rebalance the economy to more sustainable levels of economic growth, while reining in the shadow banking sector.
“Chinese finance officials are in a tough spot,” says Dwyer. “They have to rein in the informal banking sector, which is now enormous in size and influence, but they have to do it in a way which does not impact the overall integrity of banking in the Chinese economy.”
However, Hübner reckons liquidity conditions and a more prudent monetary policy could ignite a steeper slowdown in economic growth in the longer-run.
“We might see slower credit growth, especially in the shadow banking sector and all this will weigh negatively on growth, which means we might see a steeper slowdown in growth than we expected even a couple of weeks ago,” he says.
The recent liquidity tightening in China’s interbank market led economists at Goldman Sachs to cut the country’s growth forecasts. Goldman is now forecasting the Chinese economy to grow by 7.4% in 2013, down from a previous estimate of 7.7%.
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