Wednesday, June 19, 2013

China's central bank's inaction can have dire consequences - this is not a game

It is remarkable that China's central bank has been unable or unwilling to contain the spike in short-term rates, as the interbank liquidity squeeze continues. This is roughly the equivalent of the Fed not being able to control the fed funds rate. You can certainly have fluctuations, but within a couple of days a major central bank should be able to inject enough liquidity into the system to bring down rates - unless of course the central bank wants the rates higher.

Something is amiss here. China is risking a recession unless the PBoC can bring this under control. Both the repo and the SHIBOR rates have risen to new highs in the past few days.

Source: Reuters

1-week SHIBOR

Some have suggested that the PBoC is in fact trying to tighten liquidity in the financial system in order to put the brakes on the rapidly growing shadow banking sector (see discussion). While an admirable goal, creating a liquidity squeeze in the banking system and sending short term rates to multi-year highs is NOT the way to achieve that. This is especially scary in the face of an already "moderating" economic growth.
Reuters: - China's short-term funding costs surged on Wednesday, with the benchmark money market rate hitting a multi-year high, and authorities postponed the market's close by 30 minutes to give banks extra time to complete their borrowing.

The money market squeeze that began early this month has worsened this week, forcing banks and other financial institutions to trim non-essential businesses, such as wealth management and arbitrage, traders said.

That response may be welcomed by the central bank, which has adopted a hawkish stance towards market liquidity since May, partly to clamp down on an increase in risky shadow banking activities, traders said.
The interbank market decided to extend the trading time to 5 pm as many banks failed to obtain enough short-term money needed for business at the normal closing time of 4:30 pm, traders said.

Such trading extensions have occurred several times recently amid the acute squeeze, traders said. "Everybody is disappointed at the central bank's non-action," said a dealer at an Asian bank in Shanghai.
It's not clear if people fully appreciate the potential impact of this liquidity squeeze - including folks at the PBoC. This is not a game. These tight conditions and high rates over a longer period can easily derail lending activities across the country while potentially putting a number of financial institutions at risk and sending the economy into a tailspin. With the Eurozone still struggling in the aftermath of the crisis, let's see what a recession in China (12% of world's GDP) can do for global growth. Mr. Bernanke and company may need to go back to the drawing board very soon.
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