China’s benchmark money market interest rates tumbled Friday, amid the People’s Bank of China applying pressure on banks to release more cash to ease the country’s worsening liquidity crunch.

Interest Rate

The money market rates saw the biggest drop since 2007, when the one-day repurchase rate tumbled 384 basis points, or 3.84 percentage points, to 7.90 percent earlier Friday. The seven-day rate tumbled 351 basis points to 8.11 percent. Both rates posted record highs yesterday at 13.91 and 12.45 percent respectively.

Citibank Analysts’ Views

Citigroup Inc (NYSE:C) released a report today titled ‘China Macro Flash’ cautioning that the weak economy coupled with skyrocketing money market rates could potentially take the Chinese economy into a crisis. However, Minggao Shen and team feel with inflation remaining low, Chinese authorities have sufficient ammunition to calm the financial convulsions.

Citigroup Inc (NYSE:C) analysts feel the recent liquidity crunch will likely increase the risk premium in the financial sector, contain the pace of expansion in the shadow banking sector, besides adding downside risks to an already weak economy. The analysts feel RRR cuts are likely in the coming week to re-set expectations in money markets.

China’s central bank, People’s Bank of China, infused over 50 billion yuan ($8.2 billion) into the economy on Thursday, as China’s benchmark rate Shanghai Interbank Offered Rate (SHIBOR) spiked overnight to a record high yesterday from Wednesday’s 7.66 percent.

Banks Face Persistent Cash Squeeze

Apart from the quarter-end obligations towards reserve-requirement ratios, some banks are confronted with inability to pay back in full the maturing wealth-management products. Fitch Ratings estimates about 1.5 trillion yuan ($245 billion) would be due before this month end.

Besides, the central bank has stopped infusing cash through its regular open-market operations this week in the world’s second largest economy.

Drop in One-Year Interest Rate Swap

According to Bloomberg data, the one-year interest-rate swap, the fixed cost needed to receive the floating seven-day repo rate, dropped 19 basis points to 4.51 percent in Shanghai. The interest rate swap reached an all-time high of 5.06 percent yesterday.

The central bank, People’s Bank of China, sold 2 billion yuan of three-month bills yesterday at a yield of 2.91 percent. The central bank also sold a similar sized sale at the same rate two days earlier. However, the monetary authority has refrained from conducting reverse-repurchase agreements, which inject funds, since February.

Some analysts feel if the central bank continues to sell short-term bills to absorb liquidity from the financial system, the cash squeeze would only persist.

Chinese banks’ asset quality also posed concern in recent years, in the aftermath of government-engineered lending binge in 2009 to extend loans to low-yielding or mammoth infrastructure projects.

According to Bank of America Merrill Lynch economists, China’s policy makers could be taking advantage of tight liquidity to punish some small banks, which previously used low interbank rates to finance purchases of higher-yielding bonds. The economists anticipate the tight liquidity situation will persist until early July.

Chen Qi, a Shanghai-based strategist at UBS Securities Co, feels the worst might be over with the country’s central bank likely to serve as a last resort and intervene to calm the markets and avoid huge volatility. However, the strategist ruled out PBOC announcing reduction in interest or reserve ratio.