MNI CHINA MONEY WEEK: PBOC Liquidity Remains Market Driver

     LONDON (MNI) - Liquidity, so often the driver of China's financial markets,

continues to stand front and centre, while the latest U.S.-China trade truce has

been quickly downplayed by many market participants. Policymakers filled the

liquidity gap in the wake of the state takeover of Baoshang Bank back in May.

The PBOC has started to ween some of the liquidity it provided out of the

market, opting not to conduct reverse repo operations for 10 consecutive days,

resulting in a net drain of CNY340bn over that period (all of which came this

week).

     The recent run of liquidity withdrawals hasn't prevented the overnight repo

rate from plumbing fresh all-time lows this week (based on Bloomberg records),

before they stabilised just above levels not seen since 2008.

     Several analysts have suggested that the low interest rate environment in

Chinese money markets will be difficult to sustain, expecting the ample levels

of liquidity to moderate in the near term. Some disagree though, with both

Huatai Securities and Tianfeng Securities noting that liquidity levels are

unlikely to be significantly tightened given that the PBoC still needs enough

liquidity to manage risks, stabilise economic growth and lower interest rates

for small companies.

     At face value, it would seem that the PBOC is comfortable with the current

liquidity backdrop and it has noted that "liquidity is at a relatively high

level in order to absorb maturing reverse repos and government bond issuance."

     However, smaller lenders and non-financials have been subjected to

increased borrowing costs in the wake of the Baoshang debacle.

     Two of the country's major brokerages have received permission to issue a

combined CNY10bn worth of financial bonds. Caixin suggest that "the approvals

are just the latest sign that policymakers remain concerned about distress in

the interbank market after May's takeover of Baoshang Bank. The interbank market

oils the daily wheels of the country's financial system and provides much of the

short-term funding for banks and nonbank financial institutions, at least one of

which has failed after the Baoshang seizure because it was unable to get

financing."

     Looking at the purpose of the financial bond issuance, GF Securities, one

of the issuers, has noted that it will use the proceeds from the issuance to

lend to small and medium non-bank financial institutions on the interbank

market. This would be in line with the continued push for targeted lending,

likely with the aim of lowering borrowing costs for the sector, in addition to

boosting liquidity.

     The move comes hot on the heels of the PBOC lifting short-term debt quotas

at brokerages, which also had the aim of boosting liquidity for non-bank

institutions.

     Premier Li hammered the message home in an address Tuesday, noting

policymakers have the tools to facilitate easier lending to small and private

firms, identifying targeted RRR cuts and "other tools". Li quantified the aims

of policymakers, noting that China will lower small firms' cost of borrowing by

1.0% this year, after he highlighted the downward pressures that SMEs are

facing. Li was quick to add that any adjustments to monetary policy will of

course be "prudent" and won't result in a flood of liquidity.

     Looking ahead to next week, another CNY220bn worth of reverse repos are set

to roll off, which will result in a net drain, while an CNY188.5bn MLF is set to

mature. There is a high likelihood that this will be rolled over, with the

potential for some add-ons.

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

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