SHANGHAI/SINGAPORE- China’s attempts to keep the yuan from falling contributed to last week’s chaos in money markets, sources involved say, pointing to the pressure behind the scenes as Beijing tries to guide its economy and markets through a major slowdown.
Routine month-end demand for cash in China’s banking system snowballed into a scramble on Oct. 31 that pushed short-term funding rates as high as 50 percent in some cases, an incident that authorities are now investigating.
Six participants in the market say a confluence of factors drove fear and confusion across trading rooms in Shanghai and Beijing by late afternoon on that day.
Eventually, the People’s Bank of China (PBOC), its affiliated China Foreign Exchange Trade System (CFETS) and bond clearing houses stepped in, directing lenders, extending trading hours and holding meetings with institutions to calm markets.
The contributing factors were the usual month-end demand for liquidity, cash hoarding in the lead up to a big government bond sale and a market where the biggest banks were already reticent to lend because of a mandate to counter pressure on the yuan.
“It was an accident,” said Xia Chun, chief economist at wealth manager Yintech Investment Holdings, calling it an unforeseen consequence of the government’s heavy hand in financial markets.
“Banks were grudging in lending, leaving non-banks asking each other for money in afternoon trade,” he said. “Borrowing rates surged as a result, with some willing to take any price.”
The reasons for the spike in interest rates and the ensuing market chaos are detailed here for the first time. Participants say that the vulnerability exposed will stay as long as capital outflows keep the system under pressure.
Most of them requested anonymity as they were not authorized to discuss a sensitive topic publicly.
The PBOC told Reuters that CFETS was probing “abnormal” trades on Oct. 31 involving some accounts repeatedly borrowing and lending money at “extremely high interest rates” near the end of trading hours.
Short-term financing markets, such as overnight repurchase agreements, or repos, are crucial to the daily business of banks, insurers and other financial institutions.
They affect foreign exchange movements since the markets are the major avenue for the supply of money.
Funds and non-banks borrow and roll over loans that finance their investments and trades in the repo market. The month-end is also when banks and other finance-sector participants have to square their books and comply with rules on capital buffers.
Disruptions, therefore, can threaten financial stability.
Seeds of trouble were sown in October when China approved one trillion yuan ($137.32 billion) in sovereign debt sales, to be rolled out – according to sources familiar with the plans – by sticking to the issuance schedule for the fourth quarter but increasing the size of each tranche.
Typically, said one fund manager in Shanghai, in such situations the PBOC would offset the cash drain from the extra bond issuance with extra funding support – for example by relaxing bank reserve requirements.
But putting extra cash into the system would risk adding downward pressure on the yuan – which has lost over 5 percent against the dollar this year – and undercut months of efforts to stabilize the currency.
“The inaction by the central bank is mainly due to its concern over yuan depreciation,” said the fund manager, who declined to be identified as he was not authorized to talk to media.
On trading floors that Tuesday, the scramble for short-term funds became a stampede.
Even repo rates between banks, normally stable and the main gauge of short-term funding costs, flew from an overnight rate of 2 percent a day earlier to as high as 8 percent on Oct. 31. – Reuters