China’s Funding Woes Deepen; Bond Yields and Money Market Rates Hit Four-Month Highs

China’s Funding Woes Deepen

Bond Yields and Money Market Rates Hit Four-Month Highs

SHEN HONG

Updated Oct. 30, 2013 11:22 a.m. ET

SHANGHAI—Bond yields in China rose to four-month highs as poor demand for newly issued government debt triggered selling in a market where a shortage of funds had already pushed borrowing costs higher. But with investors betting that Communist Party leaders will unveil measures that could support stock prices after a meeting scheduled for Nov. 9-12, share prices shrugged off the rise in borrowing costs. Analysts say the increase is likely to be short-lived.Earlier this week, China’s central bank signaled its intention to ease a weeklong cash crunch, and demand for funds is expected to fall when the corporate tax-payment season ends Thursday.

A benchmark of the cost of loans among Chinese banks, the weighted average of rates on seven-day repurchase agreements, rose to 6.00% Wednesday from 5.04% Tuesday, the highest since it hit 6.75% June 27. The benchmark averaged as high as nearly 12% when China suffered a cash squeeze in June, with the rate on one loan hitting 30% on June 20.

The latest surge came after demand for a one-year government bond, issued by China’s Ministry of Finance, turned out to be disappointing at a routine auction Wednesday. The bond fetched a coupon of 4.01%, the highest since 1996, when a similar offering yielded 12%.

Although the Chinese government has the capacity to absorb the high borrowing cost, especially given the bond’s short tenor, the result could hinder China’s efforts to foster a vibrant corporate bond market to reduce reliance on bank loans. Prices for government bonds serve as a benchmark for corporate bonds, so increases in Beijing’s borrowing costs can flow through to companies.

Offers to buy the bonds totaled 1.01 times the amount of debt for sale, well below the usual ratio of 1.5-2.0 times for such new issues, said Wang Ming, a partner at Shanghai Yaozhi Asset Management, which has about 2 billion yuan ($657 million) in assets under management.

The poor demand for the new bond triggered selling in the secondary market, where the yield on one-year government paper rose to 3.79% from 3.73% Tuesday, its highest level since June 26’s 4.05%. Yields rise when prices fall.

“The auction result led to some panic in the market, although it didn’t come as a huge surprise in an already bearish market,” said Mr. Wang

China’s bond market has been in the doldrums this year, pressured by competition for capital from higher-yielding wealth management products and an improving economy that has encouraged investment in riskier assets, such as stocks, in recent months. Funding conditions have been tight, pushing up investors’ borrowing costs and forcing them to demand higher yields on debt they purchase.

More than a week ago, the People’s Bank of China stopped offering so-called reverse repurchase agreements, a form of short-term loan, draining a net 58 billion yuan from the banking system last week. Tuesday, it resumed providing the funding, offering 13 billion yuan of seven-day reverse repos.

“The PBOC is likely to offer reverse repos again tomorrow but the scale is expected to remain small,” said Chen Long, an analyst at Bank of Dongguan. The central bank typically adjusts funding conditions in the money market every Tuesday and Thursday.

Even if the central bank doesn’t offer any fresh money, funding costs are widely expected to fall because corporate demand for cash will likely decline after Thursday, the deadline for companies to pay their taxes, analysts said.

“Money market rates could start coming down as soon as Thursday afternoon,” said Mr. Wang.

Tangyue Yanglin, a senior investment adviser at Everbright Securities, 601788.SH -0.32%said “the mini cash crunch is already past tense.”

“Stock investors are all adopting a forward-looking view and paying more attention to the [Communist Party’s] big meeting and the new reforms.”

China is expected to unveil overhauls ranging from greater access to the economy for private and foreign investors, to moves to allow increased mobility of the population, to further financial deregulation when the nation’s ruling elite meet next month.

The benchmark Shanghai Composite Index ended a six-day losing streak to close 1.5% higher at 2160.46 Wednesday.