China interest rate surge signals decision to deleverage economy

The liquidity crunch that hit the mainland's money market this week underscores the top leadership's determination to deleverage an economy facing mounting financial risks.

That is likely to benefit long-term economic growth - but at the cost of market volatility and the profits of banks.

The seven-day repurchase rate surged to a record high of 12.45 per cent on Thursday from about 3 per cent in May, roiling the interbank lending market in the world's second-largest economy.

Some calm returned yesterday with talk the central bank had directed the biggest state-owned lenders to extend more short-term funding to small banks.

The credit squeeze came as a surprise because China has the world's largest M2 money supply. An abrupt drop in foreign exchange inflows and central bank measures to restrict wealth management products (WMP) were the immediate causes of the crunch, economists said. They added that the leadership's hawkishness, reflected in its keeping of "prudent" monetary policy, disappointed banks, helping drive rates higher.

"China's macroeconomic policies will involve less intervention in the case of short-term economic and financial fluctuations," Ba Shusong, a researcher at the State Council's Development Research Centre, said on his Sina Weibo microblog yesterday.