Is China's push to deleverage its financial system over?
That is the question following last night's dramatic reversal in recent PBOC liquidity moves, when after weeks of mostly draining liquidity, the central bank injected a whopping 170 billion yuan (net of maturities), or $24.7 billion, the biggest one-day cash injection into the country’s financial markets (and contracting shadow banking system as first reported here last week, when we showed the first drop in China Entrusted Loans in a decade) in four months. The surprising move was "a fresh sign that Beijing is trying to mitigate the damage to investor confidence inflicted by its recent campaign to tamp down speculation fueled by excessive borrowing" according to the WSJ.
Today's injection was the the largest since just before the Lunar New Year holiday in January, when Chinese banks traditionally stock up on liquidity.
Why the sudden shift?
On one hand it is possible that the PBOC is simple concerned about the sharp decline, and in fact contraction, in China's shadow banking system, where as we showed last week Entrusted Loans posted their first decline since 2007 even as China's M2 continued to decline.
The huge cash injection followed comments from Chinese officials in recent days which hinted they are getting concerned that recent moves to tighten market regulation have caused too much disruption. As a reminder, in recent weeks money market rates and yields on corporate bonds had all shot up to multi-year highs.
The real reason may be simpler: with a major leadership shuffle due later this year, the central bank is not taking even the smallest chances of turmoil in the banking sector. and as such admitted that - once again like in 2013 - its posturing to delever the world's most leveraged financial system was just that. The WSJ has more:
President Xi Jinping’s call for financial stability ahead of a major leadership shuffle later this year led regulators to unleash a blitz of new rules. The banking regulator under new chief Guo Shuqing has cracked down on speculative investment practices that relied on borrowed money and has also imposed sharply higher fines for irregularities.
But the new regulations, alongside tighter monetary conditions in China, have proven hard for investors to absorb. China’s main stock market has dropped 5.4% in just over a month, while yields on Chinese government bonds have risen to more-than two-year highs. Bond yields rise as their prices fall.
Predictably, China throwing in the towel on deleveraging immediately raised animal spirits: the Shanghai stock market rose 0.7% on Tuesday, having earlier fallen by nearly 1%. The yield on China’s benchmark 10-year government bond, meanwhile, fell back to 3.62% from 3.64%.
Ultimately, what the PBOC did is just what every other developed central bank when faced with declining markets: it capitulated.
“The timing of PBOC’s move does point to an intention to appease investors,” said Ding Shuang, an economist at Standard Chartered Bank.
As Goldman noted over the weekend, the first sign of Beijing’s desire to soften its tone emerged last Friday, when the PBOC said in its latest monetary-policy report that regulators should carefully handle the timing and pace of introducing their policies and solve financial risks in an orderly manner. The central bank also pledged to provide necessary liquidity to ensure “reasonable” credit growth. It waited just 2 days to do just that.
Also Friday, China’s banking regulator said in a briefing it was trying to “avoid creating new risks in the process of resolving existing risks” and that it would give banks time to adapt, applying tougher standards only on new investment products while allowing existing ones to expire intact.
Then on Sunday, an editorial from the official Xinhua News Agency urged financial regulators to refrain from turning the recent campaign of risk prevention into a fresh risk itself. The same day, Chinese Premier Li Keqiang stressed at a cabinet meeting the importance of “striking a balance” between maintaining financial stability, “gradual deleveraging” and stabilizing economic growth.
“There were indeed worries that if the market volatility induced by the regulatory crackdown worsened, it could lead to systemic risk and hurt the real economy further,” said Liu Dongliang, senior analyst at China Merchants Bank. And with a critical for Xi Jinping Congress later this year, the risk of overshooting the tightening was just too high.
The Chinese central bank’s cash injection came a day after data showed the world’s second-largest economy weakened more than expected last month on flagging consumer demand and slowing investment levels. Borrowing costs for businesses, including bond yields, have risen sharply since China’s central bank raised a suite of key short-term interest rates twice since early February.
As a result, new corporate bond issuance in China has plunged in recent months, making life difficult for struggling private firms that have limited access to a banking sector designed to favor inefficient but politically influential state-run enterprises. Chinese companies have raised a total of 674 billion yuan via bond issuance since this year, down from 1.8 trillion yuan during the same period a year ago.
But the single biggest catalyst may have been an all too familiar one: China's stocks had failed to keep up with the rest of the world, prompting analysts and traders to ask just how bad is the true situation behind the scenes.
Losses in China’s stock markets have also worried securities regulators, prompting them to issue secret and usually verbal instructions, known as window guidance to market participants, to avoid large amounts of selling in recent weeks.
The punchline: "such covert market intervention reached a climax on Friday, when brokerages and fund managers received fresh warnings from securities officials against placing large sell orders ahead of an important international summit in Beijing."
And just like that, China confirmed that when facing a declining market, and rising worries that China's fading credit impulse will drain the global punchbowl, it will do everything in its power to restore the status quo.