One of China’s most widely used interbank borrowing rates surged to its highest level since late 2014 earlier this week, stoking worries that a painful credit crunch could be looming as the country’s central bank moves to tighten monetary conditions, according to a research note from Goldman Sachs.
China’s seven-day repurchase (repo) rate shot to 5.5% on Tuesday from 3.85% on Monday, before settling at 5% on Wednesday.
For anyone who follows Chinese politics, the sudden jump in interest rates is hardly surprising: At an annual meeting of China’s parliament that concluded a week ago, the country’s leaders said that tackling risks related to the country’s growing pile of risky debt would become a priority.
The Goldman team, led by MK Tang, the investment bank’s senior China economist, said it expects interbank rates to remain fairly volatile in the coming days as the People’s Bank of China (PBOC) prepares for its quarterly macroprudential assessment, which will take place at the end of March.
Persistently higher rates could create problems for Chinese companies and financial institutions that are heavily reliant on short-term credit to finance their operations, as the chart below illustrates.
Economists have widely cited China’s growing pile of bad debt as a potential risk to the global financial system. China has overtaken the eurozone to become the world’s largest banking system by the aggregate value of loans outstanding, as the Financial Times reported earlier this month. China’s economy has relied heavily on debt to drive growth since the global financial crisis.
Last week, the PBOC decided to raise short-term policy rates for the third time in three months, mirroring a similar move undertaken by the Federal Reserve just a day earlier.
China’s complex monetary policy framework consists of a ticket of “interbank” and “policy” rates. Beginning in mid-2015, the central bank endeavored to keep interbank rates, which are determined by market conditions, relatively steady. But it has recently changed tack, signaling its intention to dissociate the policy rate, which governs interest on loans and deposits generated by banks, from the interbank rate, which also applies to repo transactions undertaken by nonbank financial institutions.
Much of the increase in the interbank rate has been driven by nonbank financial institutions, which are generating a rising share of the country’s loans. As of the end of February, interbank repo borrowing by various funds was over 30% — high by historical standards, according to Goldman Sachs.
Like many global central banks, the PBOC resorted to a series of stimulus measures to help bolster its sagging economy in the wake of the financial crisis. It loosened restrictions on how much capital banks needed to hold in reserve and slashed interest rates, among other measures.
Lenders in need of short-term liquidity often turn to the repo market, where they can find funding by pledging debt securities as collateral.
China’s seven-day repo rate is based on transactions in the country’s interbank repo market that occur between 9 a.m. and 11:30 a.m. local time. It is important to note that nonbank financial institutions, which account for an increasing share of loans originated in the world’s second-largest economy, also participate in this market.
Most interest-rate swaps that originate in the country reference the 7-day repo rate as a baseline.
By Joseph Adinolfi