A dearth of central bank notes maturing in the next six months, as well as the possibility that the US Federal Reserve (Fed) could begin tapering its quantitative easing programme by the first quarter of 2014, could present liquidity problems for China.
And depending on the severity of the country’s cash crunch, the People’s Bank of China (PBoC) may be forced to cut banks’ reserve requirement ratio (RRR) – a dilemma for the country’s leadership which is opposed to greater monetary easing.
“We don’t think that China is out of the woods yet,” said a senior rates strategist. “China’s monetary environment could change [heading into the New Year] and the one thing the market is relying on is the PBoC’s reverse repo programme.”
The problem is partially attributable to the low volume of central bank bills maturing in the next six months. The PBoC will have Rmb22 billion of notes maturing in October, and just Rmb11 billion coming due in November. There are no bills maturing in the following five months.
Historically, though, the PBoC has had Rmb200 billion- Rmb500 billion (US$32.7 billion-US$81.71 billion) of bank bills come up for maturity per month.
In the absence of PBoC maturing bills, the financial system will become almost entirely dependent on the central bank’s reverse repo programme for liquidity.
However, while the PBoC has conducted these weekly reverse repurchases on Tuesdays and Thursdays since July 30, the central has failed to keep up regular repurchases in the past, much to the concern of markets.
Furthermore, China sought to teach commercial banks a lesson in responsible cash management in June by orchestrating an onshore liquidity crunch. While the PBoC’s stunt helped to shrink the shadow banking industry, the event caused jitters among global market participants and led to the shutdown of the offshore renminbi bond market.
China’s monetary situation has since stabilised with the reintroduction of regular reverse repos, yet the memory of June’s crunch is not far away.
“As long as the PBoC is willing to inject liquidity in the repo market, investors should have confidence that the liquidity squeeze will not repeat itself,” said Frances Cheung, a senior strategist at Crédit Agricole. “Aside from RRR cuts – which the PBoC is hesitant to introduce because there are fears the money won’t flow into the right places in the economy – open market operation is the main liquidity tool the central bank has. It has to continue with it.”
Ramping up repos
In addition, the limited amount of bank bonds up for maturity has meant that the PBoC has to increase the size of its reverse repos to compensate for the lack of liquidity.
On Tuesday, October 8, the PBoC injected Rmb65 billion into the market via a seven-dayrepo, and injected Rmb48 billion of 14-day reposon Thursday, October 10.
These amounts are several times larger than the sizes of the PBoC’s reverse repos earlier this year, typically closer to Rmb8 billion-Rmb20 billion. And analysts expect that the size of repos to rise heading into 2014.
“For the next three months the liquidity situation should be stable, but the situation will change around the first half of the year,” said Eliza Liu, an economist at China Construction Bank International. “Usually, the liquidity supply is relatively tighter due to strong loan and credit demand at the beginning of the year.”
In addition, the market faces tighter liquidity conditions going into the Chinese New Year holiday - which next year takes place at the end of January - as depositors across the country withdraw money for holiday spending. This means that the PBoC must inject even more cash into the system.
Ahead of the Lunar New Year in 2013, the PBoC had injected the record amount of Rmb450 billion into the financial system. The central bank faces a payment of several times that amount in 2014.
“In the past we have had central bank bills maturing to supplement onshore liquidity, but that won’t be the case this upcoming New Year season,” said the rates strategist. “It’s possible the PBoC will inject up to Rmb1 trillion to keep liquidity conditions stable.”
The Fed’s tapering is also expected to exacerbate China’s situation.
Even before the US central bank scales back it bond-buying programme, 10-year US Treasury yields reached 3.01% on September 5, the highest since July 2011. If the Fed begins tapering by 2014, it is likely that investors will pull their cash out of China and other emerging markets in search of higher-yielding products.
Analysts believe that, depending on the severity of these outflows, the PBoC could be forced to cut China’s RRR level for the first time since May 18, 2012, when the PBoC cut the RRR by 50 basis points.
“It’s a very slim chance there will be RRR cuts in the next three months, but if you’re looking at maybe six months or nine months ahead then it will depend on the liquidity situation,” said Liu. “In the first quarter, should domestic liquidity turn to be tighter due to the reversal in forex inflows, plus some middle-sized banks’ loan-to-deposit ratios have been very high approaching 75%. At that time, there will be increasing need for a cut.”
However, China’s leadership is hesitant to introduce such monetary easing due to concerns that the additional cash in the system will increase inflation, fuel housing prices and lead to a bubble. This is also why regulators have embraced China’s slower gross domestic product (GDP) growth, which will also slow money supply growth.
China’s GDP dropped from 10.4% for the full year of 2010, to 9.3% in 2011, to 7.8% in 2012. Analysts predict 2013 growth to drop to 7%-7.5%.
China Construction Bank expects China’s money supply to grow 12%-13% next year, slightly lower than 14% in 2013.
Given the conflicting views of China’s regulators and its financial market liquidity needs, the country may need to brace for tighter conditions.
“Right now there’s nothing much to worry about regarding the country’s outflows – it isn’t an issue, until the US does start to get its house in order and QE tapering reverses flows for China,” said the rates strategist. “The country’s standard lending facility, which provides shorter-term liquidity, is not as effective as RRR cuts… The administration is hesitant to engage in this aggressive monetary policy, but it will have to consider this if liquidity conditions become poor enough.”