Caixin Calls for Caution While Deleveraging in Order to Avert Liquidity Crunch

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The editor of one of China’s most influential economics publications has called for financial regulators to exercise heightened caution during their deleveraging efforts in order to avoid a credit crunch.

Caixin chief editor Hu Shuli notes that the deleveraging drive launched by Chinese regulators in the second half of last year has led to a rise in money market rates, as well as recently caused the one-year Shanghai Interbank Offered Rate (SHIBOR) to rise briefly above the one-year loan prime rate that banks charge their best customers.

This meant that the cost of wholesale borrowing potentially exceeded what banks charge some of their lending clients for capital.

China’s central bank appears intent upon using interbank rates to prevent risky loans and tamp down on asset bubbles, as well as maintain currency stability amidst potentially destabilising events such as the US Federal Reserve’s recent decision to push through with a rate hike.

Hu notes, however that raising borrowing costs could potentially “derail China’s fragile economic recovery,” with many companies posting flagging profits as well as struggling to obtain capital.

“Although the People’s Bank of China has in its first quarter policy report stated that the rise of money market rates is not comparable to a domestic interest rate hike, it will affect the economy by pushing up rates of bank bills and bonds,” writes Hu.

China’s private enterprise remains significantly dependent upon banks bills and bonds to raise capital, and rising money market rates could dampen their activity. Hu notes that the annual growth rate of private investment had already fallen to 5.3% in April compared to the figure of 8.6% in the previous month.

PBOC has pushed through with painful money market rate hikes in the recent past in order to address problems with the financial system, with the 2013 Chinese liquidity crunch briefly causing interbank overnight rate to shoot to 30% in June.

Hu points, however, to research produced by Caixin subsidiary CEBM group which show that Chinese banks shoulder a heavier debt burden now than they did several years ago, and that hikes in money market rates are likely to trigger a more pronounced domino effect within the economy.

While Hu says regulator’s should not shy away from inflicting short-term pain in order achieve long-term reform goals, she notes that the current leverage clampdown has shaken up Chinese markets and wiped away billions of dollars in stock and bond value, which in turn threatens to cause a liquidity crunch.

In order to address this issue, Hu advocates that policymakers resort to monetary policy tools in order to “cushion the impact” of deleveraging particularly given the breathing space afforded by stabilisation of the Chinese yuan in the wake of the Fed’s March rate hike, as well as easing of capital outflows.

She also reiterates the core refrain of reformers in transitional socialist economies, pointing to the need to the role of the private sector at the expense of state-owned enterprise.

“The urgent task at hand is to improve market access to allow more private players into lucrative areas that have been dominated by state-owned enterprises,” wrote Hu. “Meanwhile, poor performing state giants should be allowed to fold and their assets and resources channeled to more productive parts of the economy.”

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