Stocks Fall as Central Bank Defends Liquidity Position

The Wall Street Journal reports that Chinese stocks “were in free fall on Monday” after Beijing scrambled over the weekend to assure investors that its financial system had ample liquidity. After the People’s Bank of China allowed interbank borrowing costs to surge at the back-end of last week, a Xinhua News commentary argued that China was not suffering from a cash shortage. From The Financial Times:

“Is China really experiencing a ‘cash crunch’ where liquidity is being squeezed?” asked Xinhua, and added that many large enterprises continued to spend heavily on wealth management products, capital was still in search of speculative investment opportunities and private lending continued to be strong.

“This contrast clearly shows that this seemingly ferocious ‘cash crunch’ is in fact structural funding constraints caused by a misallocation of funds. It is not that there is no money, but that the money has not reached the right places,” the commentary said. [Source]

One issue of concern, according to Reuters, is shadow lending – Chinese companies with easy access to credit are borrowing funds and on-lending them to smaller firms at much higher interest rates. And while the growth in China’s shadow lending system may have slowed thus far in 2013, as David Keohane of the Financial Times points out, one concern is the more than 1.5 trillion RMB in Wealth Management Products that mature and will need to be redeemed in the last ten days of June. On Monday, China’s central bank sent an official note to lenders urging them to strengthen liquidity management. Forbes’ Agustino Fontevecchia thinks that last week’s spike in interbank rates “is a self-inflicted wound,” a move by the Chinese government to clamp down on the shadow banking system:

Credit growth is out of control in China, where it’s currently twice as big as GDP and growing twice as fast.  As I previously reported, overall credit has grown from $9 trillion to $23 trillion in the five years since the implosion of Lehman Brothers, with credit-to-GDP going from 75% to about 200%.  About $5.6 trillion of that represented non-loan credit, with nearly $2 trillion extended by opaque non-bank financial institutions.  According to Fitch, more than $2 trillion in credit is connected to informal securitization of bank assets in so-called wealth management products (WMP).

“China is displaying the same three symptoms that Japan, the U.S., and parts of Europe all showed before suffering financial crises,” Nomura’s research team noted, “a rapid build-up of leverage, elevated property prices, and a decline in potential growth.”

Indeed, the current administration has acknowledged this, and is therefore clamping down on the shadow banking system, understanding the trade-off between short- and longer-term objectives.  In terms of the liquidity crunch, it was in great part a consequence of the People’s Bank of China (PBoC) refusing to inject liquidity in the system, which, according to Nomura, is a calculated bet. [Source]

Fontevecchia adds in a separate piece that while “the move by China’s authorities is the right one, the real question is, will they be able to manage such a complex and leveraged system without screwing up.” Kate MacKenzie of the Financial Times writes that “the immediate facts prompt the question about how equipped the PBOC is” to prevent financial panic:

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). [Source]


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