China’s central bank (CB) auctioned no new bills or bond repurchase agreements this week, a sign that it remains sensitive to the liquidity squeeze still roiling the interbank market, despite the cut in the required reserve ratio (RRR) announced last weekend.
The move highlights the unfamiliar situation facing the People’s Bank of China (PBOC) this year as it tries to support bank lending in the face of slowing growth.
For most of the last decade, the main challenge was how to absorb the massive excess liquidity created by large foreign exchange inflows.
Now, with China’s trade surplus narrowing, such inflows are slowing.
“Going forward, we really need to rely more on RRR cuts to provide liquidity. Otherwise, I would expect money market rates to remain relatively high,” said Frances Cheung of Credit Agricole.
The People’s Bank of China, which is the central bank of the People’s Republic of China with the power to control monetary policy and regulate financial institutions in mainland China.
PBOC has announced a required reserve ratio cut on Saturday night. Chinese equities and global commodities have rallied this week in response to the move, but interbank rates have stayed stubbornly high this week.
The required reserve ratio cut does not take effect until on Friday, so it is too early to judge the impact.
Still, the seven-day bond repurchase rate - a benchmark indicator of Chinese banks’ willingness to lend to each other - was at 5.5004 per cent at mid-afternoon on Thursday, down only 19.26 basis points since its last close before the required reserve ratio announcement.
A seven-day rate below 3.5 per cent indicates easy conditions. The high seven-day rate on Thursday comes despite the fact that a seven-day repo loan extended on Thursday would fall mostly into the period after the required reserve ratio cut takes effect. The People’s Bank of China will be watching the market closely next week.
If money market rates stay high, it could affect banks’ ability to support the economy through lending. New loans in January were far below market expectations.
Though the Lunar New Year was a contributing factor, some analysts have blamed tight liquidity, which may have prompted banks to offer higher lending rates than potential borrowers were willing to accept.
Cheung expects that rates may fall between 50 to 100 basis points. But some dealers say they expect the seven-day rate to remain above 5 per cent.
In another indication of the funding squeeze affecting some banks, an auction for six-month finance ministry deposits on Thursday morning yielded an interest rate of 6.8 per cent, nearly twice as high as the benchmark one-year deposit rate of 3.5 per cent for corporate and household deposits.
“The pressure on banks to attract deposits is pretty heavy because of the loan-to-deposit ratio,” said a dealer at a foreign bank in Shanghai.
The halt in bill and repo sales means that maturing bills will add a net 2 billion yuan ($317.66 million) into the banking system this week.
Last week, the People’s Bank of China conducted a net drain of 9 billion yuan from the market through publicly announced open market operations.