Risk of imminent liquidity crisis seen as minimal
Beijing is ready to inject cash into the money market as Fed may end stimulus, economists say
With the Mid-Autumn Festival and National Day holidays approaching, along with a possible tapering of quantitative easing by the United States, concerns that another cash squeeze could hit the mainland's money market this month are gathering steam.
The crux of the credit crunch seen at the end of June remains unsolved - many banks finance their loan-book expansion by heavy short-term borrowing in the interbank market - but economists say the central government has the will and the way to avoid a crisis this time.
At the end of June, interest rates hit record highs in the mainland's interbank market when demand for cash surged during the Chung Yeung Festival and foreign-exchange inflows fell abruptly, depressing money supply.
Banks that usually match short-term liabilities with long-term assets, which limits their ability to repay interbank debts, fretted about mounting default risk. The credit crunch did not ease until the central bank injected cash through major lenders to boost liquidity in the world's second-largest economy.
"Such a liquidity squeeze will come again and each time it will become more and more intense," said Xu Weihong, a researcher at Southwest Securities in Chongqing.
When the central government deleveraged the economy, the whole financial sector was affected, Xu said in the latest issue of Tianjin-based New Champions magazine, and problems in local government financing vehicles, a hotbed for bad loans, would be transmitted from shadow banking to the banking system.
"And the liquidity problem will be exacerbated by the US' gradual exit from quantitative easing," he said.
The Federal Reserve is expected to announce a tapering of quantitative easing - its unconventional monetary stimulus programme - during its policy meeting tomorrow and Wednesday.
Wang Tao, head of China economic research at UBS, said that as quantitative easing was phased out and expectations of yuan appreciation declined, foreign-exchange outflows in the hundreds of billions of US dollars could be seen in the near future.
"But the foreign-exchange flux would have a limited impact on China's liquidity as the country's capital account is not fully opened and the central bank could issue reverse repo or reduce the required reserve ratio to beef up liquidity," Wang said.
The People's Bank of China (PBOC) tolerated soaring interbank rates in the first few days of June's liquidity crunch to signal its displeasure at rampant lending irregularities. But it did not want a "stress test" that could spark a crisis, she said.
Bank of America Merrill Lynch economists Zhi Xiaojia and Lu Ting said in a research note that China's new leadership could not afford to be hit by another unnecessary interbank liquidity squeeze amid turmoil in some emerging markets and in the run-up to an important meeting of the Communist Party's Central Committee in November.
They said the central bank had deep pockets, including about 19 trillion yuan (HK$23.9 trillion) in deposit reserves from commercial banks. The mainland's rosier economic outlook, large trade surplus and rising foreign direct investment also suggested its foreign-exchange purchases might increase despite the tapering of quantitative easing in the US.
"Liquidity demand will surely rise before the Mid-Autumn Festival from September 19 to 21 and the week-long golden week holiday in early October. Such demand also usually rises at quarter-end as banks scramble for deposits to meet their loan-deposit ratio requirement. But there will not be any cash squeeze as in June, given the willingness and capability of the government to deliver a stable interbank market," Lu said.
The PBOC is expected to launch negotiable certificates of deposit in the interbank market as early as this month. Their introduction will help improve lenders' liquidity management as it will allow transactions before interbank deposits mature.