China interbank liquidity crunch eases, but relief may be fleeting

[SHANGHAI] Rising short-term funding stress in the interbank market, which has complicated Beijing's efforts to support the stock market, appears to have eased after Tuesday's aggressive policy easing.

The central bank cut interest rates and bank reserve ratios late on Tuesday to shore up the economy.

Cheaper borrowing could help buttress Chinese stocks, which fell around 20 per cent in the last 10 days. For most of 2015, short-term borrowing rates and China's margin-fuelled equity markets have proven highly correlated. From March to July, benchmark money rates and weekly equity movements had a near perfect inverse correlation of -0.77.

But traders and analysts cautioned that any support from lower rates could prove transient unless the central bank arrests capital outflows as investors brace for the prospect of more yuan depreciation and slowing growth. "Interest rates will go down in the next few days," said a trader at a Chinese bank in Beijing. "But because of the downward pressure on the currency in the foreign exchange market, the central bank may slow down this process. I think it will benefit some long-term bonds but the ultimate effect on short rates remains to be seen." The weighted average of the benchmark seven-day repurchase agreement (repo) rate was down 18 basis points as of late afternoon on Wednesday to 2.37 per cent. The one-day yield was down 13 points at 1.73 per cent.

Particularly welcome for now is lower overnight borrowing costs, which had crept up by nearly 70 basis points (bps) following the initial stock rescue in early July.

The rapid rise in overnight rates against the one week benchmark is indicative of short-term funding stress and may have been a factor in the recent equity sell-off.

The elephant in the room remains the surprise devaluation of the yuan in early August, which seems to have intensified capital outflows.

From mid-August until the rate cut on Tuesday, benchmark repo rates ignored central bank open market injections netting over 150 billion yuan and instead marched higher. "It is clear to us that regardless of what China does with the renminbi, capital outflows will accelerate in the short-term," said Oliver Barron of NSBO Beijing, the macro consultancy. "No matter what PBOC says about the level of RMB, the market believes it should be weaker." Tuesday's 50-basis-point cut to large banks' reserve ratio requirements will release much more liquidity, and therefore may be enough to keep short rates down.

However the central bank also injected 140 billion yuan into banks through short-term liquidity operations (SLO) on Wednesday in a sign it would like to see short-term rates fall even further.

REUTERS