REPEAT:MNI China Liquidity Survey: Autumn Cheer Turns to Gloom

Repeats Story Initially Transmitted at 07:50 GMT Nov 30/02:50 EST Nov 30

--Survey Shows Surge in Traders Reporting Deteriorating Liquidity Conditions 

--More Traders Expect Bond Yields to Rise 

     BEIJING (MNI) - September and October saw the People's Bank of China (PBOC)

smother the interbank market with money to ensure stability ahead of, during and

after the 19th Communist Party Congress.

     Many traders were predicting a shift back to the central bank's "neither

tight nor loose" liquidity stance in November. But the deepening bond rout,

which saw yields on 10-year government bonds break the key psychological level

of 4% for the first time in three years, left the PBOC with little choice but to

pour more cash into the market to steady a dangerously listing ship.

     The PBOC injected a net CNY810 billion via open-market operations in the

week ending Nov. 17, the largest amount since the week of Jan. 14-20 this year.

It dialed back support last week but still added a net CNY150 billion, and in

the first four days of this week there has been no net injection or drain.

     The central bank also injected a net CNY8 billion via its Medium-term

Lending Facility (MLF) this month. It means the PBOC injected a net CNY508

billion via monetary instruments in November, the second-largest net injection

this year after CNY888.5 billion in October. 

     In spite of the central bank's actions, traders are beset by gloom over the

crackdown on financial leverage that has exacerbated the drop in bond prices and

cut the amount of spare cash sloshing around the interbank market looking for a

home.

     Almost 74% of traders polled in the latest Market News International

monthly interbank survey reported liquidity conditions were worse than the

previous month, surging from zero in October. Although the reading is only the

highest since August, it's the biggest monthly swing since the survey started in

May 2014. Respondents who thought liquidity conditions were better slumped to

5.3%, down from a record 89.5% in October.

     The MNI survey gauged the opinions of 19 traders with financial

institutions operating in the interbank market, the country's main platform for

trading money-market, bond and currency instruments, and the main funding source

for financial institutions. Interviews were conducted from Nov. 20-24.

     "Demand for liquidity has been comparatively stable -- if you look at the

daily trading volume it's stable," said a trader with a big state-owned bank in

Guangdong province. "The problem has been on the supply side. We're approaching

the year end and banks have to deal with all kinds of things like preparing for

their Macro-Prudential Assessment and dressing up their balance sheets to meet

regulatory requirements and for their annual results for shareholders.

     "So the willingness of big banks to lend money is declining; they have just

not been positive about lending these days."

     The trader also pointed out that many banks have been shifting their money

out of the interbank market to boost loans to small and medium-size enterprises

and other targets of the government's "inclusive finance" campaign to qualify

for the PBOC's reserve requirement ratio cut in January.

     A trader with a city commercial bank in eastern China pointed out that

seasonal factors such as big tax payments and declining fiscal spending have

also affected liquidity in the banking system. But even accounting for these

considerations, traders are not optimistic about the liquidity outlook.

     "The market is pessimistic and traders are pretty miserable," he said. The

PBOC isn't helping the liquidity situation by trying to push institutions to

borrow longer-term funds by issuing more-expensive 63-day reverse repos at

open-market operations rather than cheaper shorter-term money, he said. The PBOC

has been pricing 63-day reverse repos to yield 2.90%, compared with 2.45% for

seven-day reverse repos and 2.60% for 14-day contracts, raising the average cost

of borrowing for financial institutions.

     The central bank launched 63-day reverse repos on Oct. 27 with the aim of

guarding against any sudden liquidity squeezes caused by its deleveraging

campaign in the run-up to the end of the year and through early January.

Previously, the longest maturity of reverse repos was 28 days. So far, it has

issued CNY630 billion of 63-day reverse repos.

     In its third-quarter monetary policy report on Nov. 17, the PBOC said the

aim of using longer maturity reverse repos was to stabilize liquidity and supply

funding that would stretch across the traditionally tight year and quarter-end

periods. The new tool will increase the willingness of financial institutions to

lend longer-term money, which can help optimize the duration structure of money

market rates, it argued. 

     Even so, traders aren't happy with the new 63-day maturity.

     "The problem is that when these reverse repos mature, it's going to cause a

stampede from institutions who will all be rushing at the same time to roll over

the debt," the trader said. "So the PBOC should really think about the risk when

it conducts the 63-day reverse repo and not sell too much of it."

     The deteriorating liquidity conditions have kept money-market rates

elevated. The benchmark volume-weighted seven-day deposit repo rate, which

reflects the cost of borrowing for banks, has crept up from 2.3% at the

beginning of the year, and was 3.0225% on Thursday. In November, it rose as high

as 3.1431% in the middle of the month from the low of 2.8344% early in the

month, compared with a volatility range of 2.8360% to 3.1873% in October. 

     Over the same period, the seven-day repo rate, which reflects the cost of

borrowing for all financial institutions and is much more volatile, traded at a

low of 2.4% and was last at around 3.5%, although it has jumped above 4% several

times during the year.

     There has been no improvement in the short-term outlook for repo rates

among traders. The latest MNI interbank survey shows 73.7% of respondents expect

the seven-day repo rate to move higher over the next two weeks, the same

proportion as in October, as the financial deleveraging campaign, tighter

regulation of wealth management products, and year-end regulatory requirements

all combine to put pressure on liquidity.

     The bond rout of the past month has sent yields soaring to multi-year

highs, with the yield on the benchmark 10-year China government bond (CGB)

breaking 4% several times. The yield on the most-actively traded 10-year CGB

closed at 3.9000% on Wednesday, the lowest closing yield since Nov. 9, when it

broke the 3.9000% level for the first time during the month. The yield jumped as

high as 4.0200% in interday trading this month, the highest in three years.  

     Nevertheless, a growing number of traders expect the 10-year CGB yield to

move even higher over the next three months -- 58% of respondents in the

November MNI survey compared with 47.4% in the October poll. That's the highest

percentage since April and the first time the response rate has topped 50% since

May. Only 15.8% of traders see yields falling, down from 26.3% in October and

the second-lowest percentage since March.

     Although the consensus in the market is that economic growth will slow,

which should be good news for bonds, many traders and analysts are becoming

increasingly concerned about accelerating consumer price inflation. Although the

CPI has remained well below the government's 2017 ceiling of around 3%, it rose

to 1.9% year-on-year in October, the highest so far in 2017, and price pressures

are building in the non-food sector. Core inflation, excluding food and energy,

stood at 2.3% year-on-year in October, while services inflation was at 3.2%.

     "What I'm worrying about is inflation," said a trader with a small

commercial bank in Fujian province in eastern China. "The CPI could go over 3%

in February as food prices rise [around Chinese New Year] and then expectations

for higher interest rates will increase, even if they don't actually

materialize, which is bad for the bond market." He estimates the yield on the

10-year CGB could rise as high as 4.3% early next year.

     The brief optimism about the economy that accompanied the upbeat

third-quarter GDP growth numbers released in mid-October has also ebbed, with

almost half of the traders in the survey saying current economic conditions have

deteriorated. The proportion who said conditions have improved slumped to 21%

from 68.4% in October's survey.

     Economic data for October was disappointing, showing more evident signs of

a slowdown as industrial activity was hurt by the government's campaign to curb

pollution and fixed-asset investment for the first 10 months grew by 7.3% year

on year, the slowest pace since 1999.

     "Weakness has started to appear in the economy," said a trader with a

state-owned bank in Shanghai. "Investment growth in the property sector has

started to fall and if it keeps falling it's bound to have an effect on the

economy. Yes, corporate lending is increasing, which should be good for growth,

but how much those loans can really contribute to economic growth is hard to

say. And with market interest rates increasing, that's eventually going to pass

through into higher funding costs for the real economy."

--MNI Beijing Bureau; +86 (10) 8532 5998; email: marissa.wang@marketnews.com

--MNI Beijing Bureau; +44 203-586-2244; email: nerys.avery@marketnews.com

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

--MNI Beijing Bureau; +86 (10) 8532-5998; email: vince.morkri@marketnews.com