PBOC needs to get ahead of market curve as crunch persists
Delayed and cautious actions by central bank fail to lower borrowing costs and stem outflows
The swap market is telling the People's Bank of China that its two lending rate cuts in three months are not enough to reduce borrowing costs or revive the world's second-largest economy.
Since last weekend's cut to benchmark lending and deposit rates, the cost of locking in borrowing costs for one year has risen to 14 basis points above the five-year contract. That left the swap curve the most inverted since a record cash crunch in June 2013, which Citic Securities says is a signal of both tight money supply and pessimism over economic growth.
"The central bank's actions are delayed and cautious, so the effects aren't obvious and the economic impact is weaker," said Shi Lei, the head of fixed-income research at Ping An Securities, a unit of the mainland's second-biggest insurer. "Its easing policies have always lagged behind market expectations and economic performance."
Premier Li Keqiang faces contradictory objectives as he seeks to defend a 7 per cent expansion target for this year, while containing record debt, currency weakness and capital outflows. He is aiming for 12 per cent money supply growth, down from 13 per cent last year, and a budget deficit of 2.3 per cent of gross domestic product, against 2.1 per cent.
The benchmark seven-day repo rate slipped only four basis points last week even as cash returned to banks after the Lunar New Year holiday, helping set the scene for the February 28 rate cut announcement. Since then, the 10-year government bond yield has climbed three basis points to 3.44 per cent while the Shanghai Composite Index has lost 1.9 per cent. Both the bond and equity markets had their best run in at least five years in 2014.
Monetary conditions have tightened as capital left the country. Following its first annual loss since 2009 last year, the onshore yuan has weakened 1 per cent in 2015 to close at 6.2662 per US dollar on Thursday. The mainland's capital account posted a US$91 billion deficit in the fourth quarter, the widest since at least 1998. Tight cash supply was a sign that monetary easing had not been enough to make up for fund outflows, China International Capital Corp analysts led by Chen Jianheng wrote in a March 2 note.
"The market is in front and monetary policy is behind the curve," Chen said. "Such slow and delayed easing makes capital outflows as hard to deal with as inflows when the yuan was appreciating. This gives funds enough time to build up positions, which will continue to restrain funding conditions in China."
The 7 per cent growth goal would require additional easing, said Shi, who expects large amounts of standing lending facilities to replenish capital at banks this year and a reserve requirement ratio cut of 50 basis points once every two or three months.
"The PBOC can actually completely control funding costs, especially in money markets," Shi said. "So what's happening now is their liquidity management is cautious. I don't think any major economy's liquidity conditions have ever been as volatile as they are in China. People are still very worried."
