Mainland money rates spiked for a third day yesterday, to their highest since a huge cash crunch in June, despite regulators' efforts to steady the market, raising fears that another liquidity squeeze was under way and driving mainland stocks sharply lower.
The interbank market stresses highlighted the difficulty regulators have in gradually raising the cost of short-term credit to rein in speculative forms of finance without setting off destabilising spikes in adjacent markets.
They also reflected a more fundamental problem within the economy: poor communication by a central bank accustomed to manipulating the cash supply from behind the scenes.
"We believe the PBOC [People's Bank of China] is faced with some serious challenges with rapid unfolding of bottom-up interest rate liberalisation and is confused on whether to target volume or rates [prices] of liquidity," wrote Lu Ting, an economist at Bank of America Merrill Lynch.
"With its limited predictability of flows and its insensitivity to market reactions, the PBOC finds it much more likely than before to make operation mistakes."
The benchmark seven-day bond repurchase contract began rising on Wednesday, and the rise accelerated when the PBOC refrained from injecting cash into the system during regularly scheduled open market operations on Thursday, the fifth straight session it stayed on the sidelines.
The PBOC, as is usual, gave no comment or explanation for its decision, but when money rates leapt up on Thursday in reaction, it attempted to calm sentiment by issuing a statement that it would support the market with short-term liquidity operations (SLOs). In fact, it said it had already done so, and extended trading hours by 30 minutes to give dealers more time to settle transactions.
China Business News, a newspaper owned by the Shanghai municipal government, reported yesterday morning that the bank had injected 200 billion yuan (HK$255 billion) through SLOs with selected banks, quoting an unnamed banking source.
"If it's true what everybody is saying, that the bank injected 200 billion yuan yesterday through a short-term liquidity operation, and this wasn't enough to fill the hole, it must be enormous," said a trader at a bank in Shanghai.
In addition, SLOs on the mainland are conducted with individual banks behind closed doors and the PBOC statement cast little light: it did not say how much money it had injected using the SLO, to whom the cash was given, or even the day on which it was executed.
As a result, dealers shrugged off the message and pushed rates up again yesterday.
The interest-rate swap based on the benchmark seven-day repo, considered the best indicator of liquidity conditions, remained near the record high of 4.99 per cent struck on Thursday. The seven-day repo average rate also rose to close above 8 per cent, the highest level since June 21 and within range of the all-time high of 11.6217 per cent hit on June 20.
The anxiety infected the stock market, where rumours were beginning to swirl of loan defaults by commercial banks. The CSI300 Index, which tracks the largest listed firms in Shanghai and Shenzhen, slid 2.3 per cent on the day and lost 5.3 per cent for the week, its worst weekly performance since late February.