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2013-07-01 11:21:38
China s leadership shows a welcome toughness but also an alarming clumsiness
SINCE assuming power in March, China s new rulers have prided themselves on
their no-frills approach. Xi Jinping, China s president, inveighs against pomp
and protocol. His prime minister, Li Keqiang, who oversees the economy, favours
masochistic metaphors. In March he said that the state should remove its hand
from many parts of the economy, even if doing so felt like cutting its own
wrists.
This doggedness, along with a new economic team (see article), has raised hopes
for reform, which will require grim resolve. Interest-rate liberalisation, for
example, faces resistance from state-owned lenders which do not want rivals to
poach depositors by offering better rates. Liberalising product markets faces
even stiffer opposition. Mr Li says he wants to help private entrepreneurs
compete with state-owned enterprises (SOEs). But that upsets SOE bosses, who
enjoy the comforts of incumbency, and leftist party members, who still enjoy
the comforts of socialist ideology.
The tough talk was therefore welcomed. But many still wondered if it was only
talk. Were China s new leaders really prepared to change China s growth model,
stopping the same share of resources flowing through the same banking channels
to the same state-owned purposes? Were they prepared to inflict the necessary
pain? Last week the sceptics got an unexpected answer. Yes, the leadership is
willing to inflict pain, even when it is unnecessary.
The pain in question arose in China s fledgling interbank markets, where banks
borrow from each other to meet temporary shortfalls in funding. Banks often
find themselves running low on cash at this time of year, thanks to corporate
tax payments, holiday withdrawals, and their need to keep cash on their
balance-sheets to pass mid-year regulatory inspections. However, they can
typically count on China s central bank, the People s Bank of China (PBOC), to
inject more money into the market if liquidity gets too tight.
Last week it stunned everyone by refusing to do so. Interest rates spiked. One
benchmark, the Shanghai Interbank Offered Rate or SHIBOR, peaked on June 20th
at 13.4% for overnight loans (see chart). Another rate hit 25% during trading.
How much of this stress was necessary? How much was intentional? The central
bank s governor, Zhou Xiaochuan, is no doubt worried about excessive lending,
having led a big bank clean-up earlier in his career. The stock of outstanding
credit, broadly defined, has been rising faster than GDP, suggesting that much
lending is not helping the real economy, as China s leaders call it, but is
financing the purchase of existing assets, bidding up their price.
No doubt the PBOC is also frustrated by the banks balance-sheet shenanigans.
Many banks sell wealth-management products (WMPs) to investors that mature just
before the end of the quarter. The repayments are paid into the bank s deposits
in time for regulatory inspections, only to disappear into a new product
immediately afterwards. Meanwhile, the bank needs to borrow the funds it repays
to the products buyers. Some smaller banks would not need the central bank s
money if they had not ignored lending limits in the first place, points out
Mike Werner of Sanford C. Bernstein, a research firm. The central bank is
understandably reluctant to help them.
Both Mr Werner and Ting Lu of Merrill Lynch wonder if the central bank also had
a more specific concern. It may be worried that bank balance-sheets are
mismatched as well as oversized. Many smaller banks, Mr Lu explains, have taken
advantage of stable interbank funding to borrow short-term from other banks and
lend long. If interbank rates remain stable, they can simply roll over their
borrowings. If not, such mismatches are cruelly exposed.
Whatever the aim, the consequences will hurt smaller banks disproportionately.
Lacking the deposit base enjoyed by China s big state-owned lenders, they rely
more on borrowing from other banks or selling WMPs to investors. Some are also
less disciplined in their lending, helping to finance the grand ambitions of
local officials. Perhaps Mr Li wants to consolidate financial firepower in the
big banks that do what they are told. But that would leave local governments in
need of other revenue sources. To squeeze the pimple of over-leverage, we need
an overhaul of the current fiscal system, one government researcher told
Xinhua, the official news agency.
However, such theories attribute more cunning to the financial authorities than
they displayed last week. If some pain and trepidation was part of the plan,
the degree of pain was probably unintentional. Trying to calm the markets on
June 25th, the PBOC attributed the extreme rates of the previous week to
emotional factors , among other things. Since even the PBOC does not target
emotion, these factors were presumably not a part of its design.
Many central banks were set up to help banks survive financial panics, by
providing a lender of last resort. The origins of China s central bank are
different. Until 1979 it was just about the only lender of any sort, collecting
the nation s funds and allocating them as the state saw fit. Some traces of
these origins survive. The PBOC is probably more sensitive to deviations from
its targets than to turbulence in the markets. If so, this month s market
distress will have re-educated the central bank as much as the banks it sought
to punish.