China’s liquidity crunch, and what it means for everyone; The Chinese central bank has finally broken its silence over the country’s cash crunch, telling banks the onus is on them to better manage their own balance sheets.

China’s liquidity crunch, and what it means for everyone

Kate Mackenzie

| Jun 24 10:43 | 3 comments | Share

Should you panic?

It’s hard to know exactly what degree of control the PBoC has over the events unfolding in China’s interbank markets.

On the one hand, making the smaller banks and shadow finance entities sweat fits with the central bank’s new high-priority goal, introduced late last year, of containing ‘financial risks’, and also with a broader government theme of clamping down on excess.On the other hand, Chinese liquidity is also being affected by external forces (shrinking capital inflows) and the shadow financing calendar (WMP end-of-quarter maturities). Michael Pettis says he suspects the PBoC was “caught flat-footed” by this combination of events, and it certainly isn’t hard to imagine. He also points out that this is a central bank which has almost no experience of any market conditions other than credit creation and expansion.

WMP redemptions could certainly be a problem this week. But WMPs have turned bad before, even affecting mid-sized banks in big cities, and their effect has been contained. That’s the (ahem) beauty of a command economy, in which banks and the media are under state control. Bank runs don’t spread so easily if people don’t hear about them.

Yet could this Chinese ability to conceal and contain financial panic be a double edged sword?

Pettis argues that for many years now, China has been able to use its opacity and control to boost its reputation for financial stability through low volatility. Those days may now be over (our emphasis):

Chinese financial markets often seem less volatile than one would expect for a poor, developing country, largely because of administrative measures that intentionally or unintentionally suppress normal volatility. These kinds of systems, however, are not less volatile. They seem less volatile because small shocks have minimal impact. Larger shocks, however, tend to cause a much greater than expected surge in volatility. Perhaps last week was a case in point.

Going forward we will probably see more of this in China. Volatility will be suppressed for periods of times only to erupt in greater than expected volatility from time to time. This is not only a China problem, of course. One can easily argue that the Fed’s actions under Alan Greenspan seemed to induce a “great moderation”, but only temporarily, and when the great moderation became less moderate, the economy was always likely to be more disorderly than expected. The euro, similarly, sharply reduced volatility in peripheral Europe for many years until it suddenly exacerbated it. Of course no student of Hyman Minsky would be surprised by any of this.

In fact, even suppressing bad news can backfire, he suggests. Pettis points to the panic in China over SARS early last decade as a possible case in point: although news of individual cases was often successfully damped down, rumours only grew and resulted in a panic that was arguably disproportionate to the outbreak. “(T)he attempt to suppress them can actually undermine credibility and so exacerbate the impact of the shock.” He writes that Argentina’s experience in 2001, when the government tried to deny it faced a payments crisis, is another situation where suppression of information may have made the resulting response even worse than if it had been admitted upfront.

Pettis, like StanChart’s Stephen Green, doesn’t think we are seeing a Lehman moment in China. But he does think there are three unanswered questions about this situation: if liquidity is adequate, as the PBoC says, where is it being hoarded?

Secondly, why hasn’t it received more attention from the mainland press (we think Pettis maybe answers his own question by wondering if it was an attempt to prevent depositor panic).

Thirdly, if there are large net redemptions from WMPs, where will that money show up? Writes Pettis:

I can only think of the following: more outflows from China, higher deposits in the banks, stock markets, real estate markets, cash hoarding.

None of which seem like particularly worthy destinations, if the PBoC is hoping its tactics will help improve the quality of credit allocation.

Again, the immediate facts prompt the question about how equipped the PBoC is to handle these situations, and whether the advantages it’s had in the past will continue to work at all, or even backfire.

Central banking is a confidence game. As Anne Stevenson-Yang of J Capital Research writes, the PBoC has to maintain the confidence of not just domestic financial participants; it also has to persuade speculative overseas capital that the country, and its currency, are still stable enough to invest in.

At the moment, the most likely end game of all of this is more realisation of misdirected investments that have resulted from the vast wave of credit growth over the past few years (which has in turn taken the place of export growth as China’s primary key of growth).

Recognising the misallocation — or being forced to recognise it — would in turn imply a steeper growth slowdown. Just look at how the sub-8 per cent growth has shaken global confidence. Nomura are now putting a 30 per cent chance of sub-7 per cent growth in H2.

Here’s another thought. Stevenson-Yang, who closely watches the amazingly rapid innovations in China’s shadow finance world, sees a risk that China’s feted huge foreign capital reserves could dry up.

That would be a shock.

June 24, 2013 6:03 am

PBoC breaks silence over China cash crunch

By Simon Rabinovitch in Shanghai

The Chinese central bank has finally broken its silence over the country’s cash crunch, telling banks the onus is on them to better manage their own balance sheets.

The People’s Bank of China said liquidity was at a “reasonable level” and called on big lenders to do more to help restore calm to the country’s anxious markets.

Interbank rates spiked to double digits last week, even momentarily hitting 28 per cent, before easing. The sudden cash squeeze raised the spectre of a credit crisis in the world’s second-biggest economy and rattled global investors.

“Commercials banks must pay close attention to the liquidity situation in the market and must strengthen their analysis and forecasts of factors affecting liquidity,” the central bank said.

“Financial institutions, especially large commercial banks, must at the same time as strengthening themselves, play an active role in using their advantages to support the central bank in stabilising the market,” it added.

The PBoC’s statement was dated June 17 but was only published on Monday, its first public comment since the start of the turmoil. Both Chinese and foreign investors had criticised the central bank week, saying its silence at a time of obvious market stress was unbefitting of a central bank in such an important economy.

After the central bank ordered banks to resume lending to each other late last week, the interbank market came unfrozen and rates began to decline, a process that continued on Monday.

The seven-day bond repurchase rate, a key measure of liquidity, tumbled to 7.32 per cent – more than 100 basis points lower than its close on Friday, though still high by normal standards. With investors worried about the consequences for the broader economy, the Shanghai Composite Index, the country’s main stock index, fell 3 per cent on Monday, bringing its loss over the past two weeks to more than 10 per cent.

The central bank said that technical factors at the end of the year’s first half, including tax settlement and the meeting of cash reserve requirements, had placed clear pressure on banks. Analysts have forecast that after these factors fade in early July, interbank rates will fall back further.

But the PBoC also signalled that the problem was more than just technical. Banks must “be prudent in managing the liquidity risks that may arise from an overly fast expansion of loans and other assets,” it said. “Amid volatility in market liquidity, banks should make timely adjustments to their asset structures.”

The central bank played a critical role in driving money market rates higher by refusing to inject extra cash into the economy over the past two weeks, as it had consistently done before whenever there was a squeeze.

Higher money rates have been seen as a tool for reining in banks that have extended too many loans or that have funnelled too much cash into off-balance-sheet “shadow banking” vehicles.

With China on track for a second straight quarterly slowdown, analysts say the tightening could lead to an even sharper deterioration in growth prospects.

“While the intention is good, monetary tightening creates a harsh environment for economic growth, and the economy is already in a slowdown,” said Shen Jianguang of Mizuho Securities. “In addition, transparency is critical to a central bank’s policy direction in order to avoid excessive fluctuation in the market.”

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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