Not enough: People's Bank steps back--a little--from the brink, but fears of slowing growth send China into a bear market

06/24/2013 2:20 pm EST


Jim Jubak

Founder and Editor,

The People’s Bank of China has taken a step back from the brink. But it’s a small step and global investors are clearly still worried that actions by China’s central bank will further slow China’s economy. The Shanghai Stock Exchange closed down 5.9% today and Hong Kong’s Hang Seng Index dropped 2.22%. In Tokyo the Nikkei 225 Index fell 1.26%.

Last week China’s central bank let short-term interest rates climb and then climb some more. On Thursday short-term money market rates climbed as high as 28%. The seven-day repo rate, a benchmark for the interbank market in which banks lend to each other for the very short-term, reached a record high of 12% on June 19, the highest level since 2006, according to Bloomberg and then shot up to 25%, intraday, on June 20.

That was enough to bring the People’s Bank into the market. The seven-day repro rate fell to 7.32% today after dropping 2.27 percentage points on Friday. The overnight repurchase rate fell 4.42 percentage points to 8.43% on Friday and has dropped to 6.47% today.

But the central bank hasn’t injected enough liquidity into the markets to end the current cash squeeze at many banks or to take rates down to normal levels. At 6.47% the overnight rate is still more than double the average for 2013 of 3.09%.

And that’s what has financial markets worried.

It looks like the People’s Bank has decided to do just enough to avert a crisis in the banking sector—there were rumors in China Friday and over the weekend of bank failures sparked by regular maintenance at one of the country’s big banks that took ATM machines off line for an hour.

But it also looks like the central bank remains determined to use the current liquidity squeeze to crack down on the shadow-banking sector. Total credit in China grew by a frightening 52% in the first five months of 2013 from the same period in 2012. Much of that—an estimated two-thirds of credit growth—is coming from the shadow banking system of loans from off-balance sheet bank vehicles, financial entities “associated” with local governments, trusts, and other wealth management vehicles. That rate of lending is a problem because when lending grows at that pace the odds are that an increased percentage of loans will go bad. The central bank has minimal control over shadow lending since the lenders in this parallel system aren’t regulated by the central bank. One solution, these moves suggest the central bank has decided, is to shrink liquidity in general so that shadow lenders will have less access to cash.

Of course, less liquidity means less economic growth. Economists are starting to suggest that growth in China could slow to as little as 6% in coming quarters, well below the 7.5% official growth rate.

China isn’t facing a financial crisis since ending the liquidity crunch is pretty much within the central bank’s power. But 6% growth when the world is counting on 7% or 7.5%--and hoping for a higher growth rate—is a big deal for global economies and global stock markets.

Do remember, however, that any change in policy at the People’s Bank will produce a huge snap back rally from what is now a bear market in China’s stock markets.

When? Today the People’s Bank said that liquidity in China’s financial system was “reasonable.” I think that’s a sign that the current policy is likely to stay in effect for this week anyway.
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