China Injects Cash in Bid to Improve Liquidity

The People’s Bank of China decided to inject 17 billion Yuan ($2.7 billion) into money markets today despite having let everyone believe that they didn’t give two hoots about the way things were going, just as long as the bad credit stopped getting granted and the shadow bankers fell off the Great Wall never to be seen again. Now, it looks as if with market volatility and growing fears that the liquidity in China is in fact worse than they are letting on and that the economy is growing at under half of what they have been leading us to believe (closer to 3-4% rather than 7.5% according to some analysts), the People’s Bank of China has decided to step in and allay some of the fears at least. This is the first time that there has been a cash injection into the Chinese economy since February.

PBOC - Cash Injection

PBOC - Cash Injection

The PBOC is obviously aiming at reducing fears and avoiding liquidity problems in the banking system that were revealed in June 2013. But, the small amount that has been injected is perhaps a tell-tale sign that the PBOC is there to provide some assistance, but that ultra-loose Bernanke-style injection is not going to happen.  Some analysts are predicting however that the PBOC will continue injecting money into the markets right through August now. But the small amount of money means that the markets are being made aware that the PBOC wishes to provide just the right amount of liquidity but at the same time being able to still reign in risky lending practices in the banking sector. Short-term lending rates have been on the up over the past few weeks and the banks in China have had to keep a tight hold on their liquidity for fear of not having enough to make dividend payments and to sort their accounts out by the end of the month. The PBOC has played it very cool hinting at the fact that they would step in only if necessary to provide assistance in the event of cash levels dropping, but there were relatively few statements being made. Liquidity is there it might seem, but it has a price for the banks and will not be dished out by being thrown at the people from a helicopter like elsewhere in the world.

The result was that Chinese shares reversed the downward trend of the past three weeks, rebounding on the Shanghai Composite and also on the Hong Kong market. The Hong Kong Hang Seng Index stood at +0.48% (up 103.81 points to 21, 9853.96) and the Shanghai Composite reached 1, 990.06 (up 13.76 points or 0.70%).

The Bank of China (which is the 2nd largest bank in China and the 5th largest in the world in terms of market capitalization) rose by 0.62% (up 0.020 HKD to 3.260 HKD). At the end of June the Bank of China had to cut lending almost immediately and brought the lending limit down. It is up today as the cash injection takes effect. The Industrial and Commercial Bank, which also had trouble with liquidity (customers were unable to withdraw cash from ATMs at the end of June), was up today also by 0.59% (+0.030 HKD to 5.090 HKD). The Industrial and Commercial Bank is the largest bank in the world in terms of profit and market capitalization. Lending has stood at 70 billion Yuan on average since 2010 and that means that it lent to more companies and private individuals than any other bank in the world.

Some are saying that China has relied too heavily on exports in the past and also investment that is driven by credit. The economy has over-invested in property markets and industries that are no longer as profitable as they once were (car industry and electronics or textiles) due primarily to rising demands of increased wages. Yield on investments is thus dropping off. The objective is to try to avoid redundancies and bankruptcies with the credit-crises looming. But, is it going to be possible to steer clear of that?

Chinese Cash Injection

Chinese Cash Injection

Some are seeing dangerously worrying similarities between Japan of the 1980s and the 1990s and China’s situation today. Both countries primarily allowed investment to take place through the banking sector. But the banking sector only provided loans and credit to the least-risky enterprises (which were multinationals or state-owned). The solution for both countries was to free the financial sector allowing for non-bank lending. Thus, non-bank lending and bank lending increased and a property bubble ensued. Credit in China increased from 105% of Gross Domestic Product in 2000 to 187% in 2012.

But, some of the problem also stems from the fact that banks that are already experiencing tight cash flows are being encouraged to keep those that my otherwise default on repayment of loans afloat. That is stopping the cash-strapped banks from investing in new projects and viable ones that may exist. This is causing a spiraling downward effect as the banking sector enters the vicious circle of the Chinese economy’s contraction. Although there are the migrant workers that could help pull China out of that, but it must be remembered that the median age of rural people is now 40 years old in China and hardly the age at which those people are going to move into urban areas. In addition, half of the Chinese population already lives in an urban area today. The one-child policy has seen the drastic effect of a shrinking working population, which all put together means that there is lower consumption and also a decline in growth rates that will take place.

The cash injection of 17 billion Yuan today had the effect of boosting the banking system for at least a while. But, for how long that will last is another matter. Without structural reforms to the Chinese economy and the country in general, the road ahead will only be one of injections and more injections until the banking system is fully intravenously on a drip. Intravenous cash therapy!

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