China sees signs of liquidity stress as PBOC faces maturity test

TWO key indicators of Chinese interbank borrowing costs have hit a three-month high, as the nation’s central bank faces a crucial decision on what to do with a massive amount of policy loans due next week.

China’s one-year interest-rate swaps, a popular hedging tool sensitive to rate expectations, are now at 2.05 per cent, a level unseen since Jul 28, Bloomberg-compiled data show. The cost of issuing one-year negotiable certificate of deposits, a key form of banks’ short-term debt, also has jumped to a three-month peak of 2.12 per cent.

The signs of funding stress underscore the pressure on the People’s Bank of China (PBOC) to keep liquidity ample when 1 trillion yuan (S$193 billion) of medium-term lending facility matures on Nov 15, either by extending such loans to financial institutions or lowering banks’ reserve requirements to free up cash. The central bank’s decision will carry added importance now that fresh evidence has emerged of withering demand in the world’s No 2 economy.

“Uncertainties over how PBOC will fill the gap is keeping traders on edge as they pushed up borrowing costs preemptively,” said Ming Ming, an economist at Citic Securities. “Liquidity conditions have been more fragile after tax payment in October, and banks may need to replenish funding to boost lending.”

While there’s speculation about whether the PBOC may cut banks’ reserve requirements again to meet the needs, a full rollover of the MLF would be a more practical option as monetary stimulus may not be the best cure for China’s weak demand, Ming added.

Expectations for Beijing to step up policy support for an ailing economy have grown further after data showed Wednesday that the country suffered its first producer-price deflation in nearly two years. The last time China reduced banks’ reserve requirement ratio was in April, with the last round of policy rate cuts delivered in August.

But despite the calls for loosening monetary conditions even more, Beijing’s choices may be limited given the risk of causing further currency depreciation and capital outflows. The Federal Reserve’s aggressive rate hikes and a surging US dollar have kept the PBOC from adding long-term liquidity into markets in the past few months.

“We expect the PBOC to tolerate some rise in funding costs within the year, as low rates lasting for too long will threaten to trigger more capital outflows,” said Zhaopeng Xing, a senior strategist with Australia & New Zealand Banking Group. “Liquidity will be ample but expensive.” BLOOMBERG