Credit Tightens in China as Central Bank Takes a Hard Line

China’s interbank and money market rates have soared over the last two weeks, and banks and other financial institutions are afraid of lending to one another. Without that lending, an economy can quickly stultify. Those in need of short-term cash, or liquidity, must pay dearly or risk default.

China’s central bank, the People’s Bank of China, has refused to provide large amounts of additional cash to the credit market. Analysts say the government is holding off for a reason: it is trying to reshape the economy while reducing its future role. The bank is not independent, unlike many other central banks, and reports to the State Council.

A huge shadow banking operation has emerged in China in recent years, with smaller banks and trust companies borrowing from bigger state-run banks and relending that money at high interest rates to private companies and property developers, a practice that fuels speculation.

Pressuring speculators is a risky strategy for the Chinese government, which is also grappling with a slowing economy. Many borrowers may have a harder time paying back their loans, and analysts fear the losses could ripple through the banking system.

“The central bank wants to accelerate reform,” said Zhu Haibin, an economist at JPMorgan Chase. “They want to give the market a lesson: you need to manage your risk and not rely on the central bank.”

Mr. Zhu and other economists say restructuring the economy, which has grown addicted to easy money, could be perilous for another reason. The decision could reduce lending and slow growth too quickly.

The worst case, absent intervention by policy makers, would be defaults at lenders with the most exposure and shakiest balance sheets. The damage could spread to other banks, setting off runs on deposits by ordinary Chinese. In the near term, markets will probably continue to be rattled, especially shares in financial institutions.

That was certainly the fear on Thursday around the globe. “China’s interbank market is basically frozen — much like credit markets froze in the United States right after Lehman failed,” said Patrick Chovanec, managing director and chief strategist at Silvercrest Asset Management. “Rates are being quoted, but no transactions are taking place.”

Stock markets across greater China fell Thursday on news of the liquidity situation and a disappointing survey on manufacturing. The Hang Seng Index in Hong Kong dropped 2.9 percent, and the Shanghai composite index fell 2.8 percent.

The combination of slower economic expansion and the liquidity squeeze offers one of the biggest challenges yet to the newly installed leadership in Beijing.

Prime Minister Li Keqiang, who took office in March, has said he plans changes that will promote sustainable growth, as opposed to relying on the easy credit from state-controlled banks that helped the country rebound since the 2008 financial crisis.

“While the economy faces up to many difficulties and challenges, we must promote financial reform in an orderly way to better serve economic restructuring,” China’s State Council said in a statement Wednesday after a meeting presided by Mr. Li, according to Xinhua, the state-run news agency.

The interest rate that Chinese banks must pay to borrow money from one another surged overnight to a record high of 13.44 percent Thursday, according to official daily rates set by the National Interbank Funding Center in Shanghai. That was up from 7.66 percent on Wednesday and less than 4 percent last month.

China’s policy makers have an arsenal of options at their disposal to inject more money into the financial system, including open market operations — trading in securities to control interest rates or liquidity — or, more drastically, freeing up some of the trillions of renminbi that banks are required to keep on reserve with the central bank.

Neil Gough reported from Hong Kong, and David Barboza from Shanghai.

Article source: http://www.nytimes.com/2013/06/21/business/global/china-manufacturing-contracts-to-lowest-level-in-9-months.html?partner=rss&emc=rss