China may be ready to curb some of the excess liquidity sloshing in the banking system as it turns its focus to mitigating risks in the financial industry.
The first sign of that could come at Monday’s medium-term lending facility operation. Eight out of 12 economists and analysts polled by Bloomberg are forecasting that the People’s Bank of China (PBoC) will withdraw cash through MLF for the first time this year by offering less cash than the 600bn yuan ($89bn) maturing this month. The median estimate is for a 400bn yuan injection, and all of those polled expect the rate to be kept unchanged.
The shift in the central bank’s operations indicates that Beijing is now prioritising limiting financial risks over relying on ultra-loose liquidity to support growth.
While ample cash conditions have pushed interbank rates to multi-year lows, the excess funds aren’t being funnelled into the real economy. Instead of boosting loans to corporates and households, banks have ramped up purchases of government bonds and highly-rated credit by increasing leverage.
The PBoC “should be preventing leveraged positions in the bond market from building up,” which calls for draining liquidity, said Adam Wolfe, emerging markets economist at Absolute Strategy Research Ltd in London.
But the need to support growth means the central bank is likely to roll over most of the MLF funds to avoid sending a wrong signal that it’s withdrawing liquidity support, he said.
While excess cash has highlighted the limits of monetary policy in stimulating growth, expectations are that the PBoC will remain accommodative - in contrast with global central banks including the Federal Reserve that are hiking rates to tame inflation. That’s because data on Monday are expected to show a mixed economic picture of China. While industrial output and retail sales are expected to have improved last month, property investment probably slowed.
The PBoC may have hinted at its impending decision in a quarterly monetary policy survey released this week. It pledged to “not over-issue money” and to avoid massive stimulus amid inflation threats. It sees consumer inflation exceeding 3% in some months this year after the price barometer accelerated to a two-year high of 2.7% in July.
The central bank has been regulating liquidity via daily open market operations. It reduced the daily injection amount via seven-day reverse repo to 2bn yuan from 10bn yuan in July, citing weaker demand from primary dealers.
Still, the seven-day interbank borrowing cost remains near the lowest in over two years, indicating the magnitude of surplus cash. The PBoC injected 2bn yuan yesterday at 2.1%, matching maturities.
A significant drainage of cash via MLF could stoke concerns over policy tightening and trigger a selloff in stocks and bonds. However, market reaction would be muted in case of a mild withdrawal or full rollover. A net injection of cash could spur a rally in risk assets on bets of further PBoC easing.
Demand for the MLF may decline in tandem with market rates, according to China Merchants Securities Co and Australia & New Zealand Banking Group.
Banks may not be inclined to borrow from the PBoC at 2.85% when they can raise funds via one-year debt at below 2%.
The gap between broad credit and money supply growth suggests that additional cash injection from the central bank is not critical at this stage to fan recovery, with the economy still facing turmoil in the property sector and recurring Covid outbreaks. JPMorgan Chase & Co sees corporates saving funds rather than investing amid growth uncertainty.
At a Politburo meeting last month, Chinese authorities downplayed their growth target of 5.5% this year - which economist think is out of reach - while saying country should strive for “the best outcome” possible for economic expansion.
That’s also likely to keep the cash withdrawal moderate, according to Ding Shuang, chief economist for Greater China and North Asia at Standard Chartered Plc. “The PBoC may not want to be seen as shifting to a tighter policy stance.”