CHINA EASES IMMEDIATE CASH CRUNCH BUT POLICY STILL TIGHTENING / THE TELEGRAPH

China eases immediate cash crunch but policy still tightening

One-week borrowing costs tumble as China calms nerves but fears grow that small scale tweaks will not contain credit crunch

By Ambrose Evans-Pritchard

12:25PM GMT 24 Dec 2013
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China's central bank acted after attempts to inject cash into the system last week failed to stem a deepening cash crunch as liquidity dried up and struggling lenders hoarded funds. Photo: AP

Short-term rates plummeted in China after the central bank injected fresh liquidity to alleviate extreme stress in the money markets, but key borrowing costs remain worryingly high as the authorities try to rein in the world's biggest credit bubble.

Seven-day 'Shibor' rates in Shanghai fell 265 basis points to 6.20pc, reversing the sharp spike over recent days caused as banks hoarded funds and built up buffers against potential defaults and counter-party losses.

The closely-watched 7-day repurchase rate fell by the most in almost three years to 5.55pc after the central bank added $4.8bn in liquidity early on Tuesday through open market operations.

While the move has for now calmed nerves, it remains unclear whether calibrated tweaking on such a small scale will be enough to ease fears of a credit crunch for long.

The year-end jitters have been the worst since the cash squeeze in June, an episode that briefly span out of control and left lingering doubts about the ability of the Communist authorities to manage the credit system.

The Shanghai Composite index of stocks has recovered slightly this week but is still reeling from the worst slide in 19 years in the prior nine trading sessions. Chinese equities have fallen by three quarters in real terms since their peak in 2007, once of the worst bear markets in any major economy in recent history.

Foreign investors are now scooping up Chinese stocks at bargain prices, betting that the Communist Party's Third Plenum in November will lead to a major free-market shake up -- a hotly disputed issue given the intense resistance from vested interests within the Party. Patrick Chovanec from Silvercrest Asset Management said foreign investors may be jumping the gun. "Looks cheap is not the same as is cheap," he said.

Tuesday's central bank action had no impact on the crucial three-month rates used to price contracts across much of the shadow banking system. The rate has risen 80 basis points since the start of the month, tightening the screw on wealth management products that rely on the wholesale capital markets to raise money.

Fitch Ratings says half of the $2 trillion in outstanding liabilities in wealth products must be rolled over every three months, and a further 25pc every six months. There have been widespread reports in the Chinese press that many of these funds -- a hidden second balance sheet of the banks - will face losses if they have to refinance at current rates.

Credit has spiralled up from 125pc to over 200pc of GDP since the Lehman crisis, when the government launched a lending blitz to keep uber-growth alive in the face of a eroding competitiveness and sputtering global demand.

A report this week by the Chinese Academy of Social Sciences (CASS) said the total may have reached 215pc of GDP, warning that local government debt had surpassed $3 trillion by the end of 2012 - double the level two years earlier.

A task-force audit by the government found that private debt has reached 139pc of GDP. This exceeds the OECD's safe speed limit of 90pc for wealthy countries, and is far above credit levels in other BRICS states and developing economies.

CASS said the picture is worrying but still under control. The central bank can slash the reserve requirement ratio to support banks at any time if need be.

Qinwei Wang and Mark Williams from Capital Economics said detailed work by officials at the Economic Work Conference suggests the authorities are determined to curb credit come what may. "Tighter conditions are here to stay," they wrote.

The pace of credit growth eclipses excesses seen in Japan before its property bubble burst in 1990, or in Korea before its crisis in 1998, or in the US before the subprime bubble burst in 2007.

The sheer scale of outstanding loans - now $24 trillion, as much as the US and Japanese banking systems combined - leave the financial system highly vulnerable to higher borrowing costs.

The central bank faces a delicate task trying to wean the economy off such extreme levels of credit, and may have left it too late to avert a stormy landing.

The US crisis in 1929 and the Japanese crisis after 1990 were both triggered by central bank tightening intended to halt speculation, harder to achieve in practice than in theory. However, any crisis in China would be sui generis since the core of the Chinese banking system is state-owned.

There is little to be gained from pushing China's debt ratios any higher at this point. The economic return on each extra yuan of credit has fallen from 0.85 as recently as 2007 to barely 0.20 today, a classic sign of credit exhaustion.

The calculus of risk and reward has turned hostile. The great question is whether the Party can deliver on the Third Plenum reforms soon enough to trigger a fresh surge of economic growth, this time driven by productivity gains rather than debt.