China’s Liquidity Crunch: An Inside Look

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It’s been a couple of weeks since China’s cash crunch reached record levels, raising concerns among investors. Lingling Wei and Bob Davis of the Wall Street Journal reviewed internal documents that show Chinese leadership fell short in redirecting Chinese economy. China also failed miserably to communicate its intentions to markets.

The People’s Bank of China set the background for cash shortages that pushed interbank lending rates to record highs. The Chinese central bank said the credit growth was out of control, so it had no alternatives. But the PBOC failed to make that clear to the markets, contributing to an increase in global market anxiety.

China Interbank

China’s Top leaders Were Unsure

After the chaos and rumors of a bank defaulted on a payment, even top leaders in the country began to blame market speculations and “overly aggressive” media coverage. However, critics said that the fault lies with the poor maneuvering by the central bank and its officials.

A behind the scenes look at the events underscores that Chinese leaders were unsure of how to tackle the credit spike. China’s Vice Premier Ma Kai has ordered an investigation into the rumors surrounding the default of Bank of China. The Wall Street Journal says it indicates that Chinese leaders are still looking for a clue.

PBOS Twisted Arms Of Banks

Since the beginning of June, the People’s Bank of China has forced Chinese banks to shift their lending away from shadow bankers. To achieve its objective, the central bank twisted the arms of traditional banks by withholding money from the interbank market. On June 20, leaders feared the cash squeeze getting out of hand as Shibor rate spiked to 30 percent on that day. At the same time popped up the rumors of the Bank of China default.

Vice Premier Ma Kai immediately ordered an investigation into the default with a focus on how the rumor got started. Moreover, the Central Propaganda Department instructed Chinese media to avoid terms like “inadequate liquidity” and “cash crunch” in their coverage.

In its June 19 internal meeting, PBOC expressed concerns that Chinese banks increased lending by as much as 1 trillion yuan ($163 billion) in the first 10 days of June. That’s a figure never seen in the history of the world’s second largest economy. About 70 percent of that lending was in the form of short-term notes that mostly doesn’t appear on the banks’ balance sheets. Banks used it as a method to get around regulatory restrictions and keep lending to shadow bankers.

China Borrowing

PBOC And State Council Calm Concerns

Later, PBOC’s monetary policy chief Zhang Xiaohui said that banks shouldn’t expect the central bank to help every time they ran into trouble. He said that PBOC will not ease its monetary policy. The State Council approved PBOC’s decision the same day. The State Council asked banks to lend to favored borrowers instead of shadow bankers.

Believing that the banks wouldn’t get its message, PBOC called in banks, gave them more funds and asked them to use it wisely. Meanwhile, economists began to criticize PBOC for letting the situation go out of control. To ease fears, the central bank added cash into the financial system and said it will continue to do so if required. It took days to pacify markets. On June 26, the State Council also said that authorities should stabilize market expectations.

Their moves helped bring down the Shibor rates from 11.62 percent on June 20 to 5.45 percent on Monday. But that’s still higher than its 3 percent-4 percent range before June.

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