Why China remains a risk for dry bulks as bank interest rate stays above average

Market Realist

The impact of China’s financial industry

The financial industry is an essential part of any economy. Without a stable financial system—one that supplies liquidity to businesses and individuals and bridges the gap between savers and borrowers—an economy can’t function as efficiently and productively as it could. So a collapse in China’s financial industry would grind its economy to a halt. Because China is an important importer of key raw materials such as iron ore, importing 745 million tonnes (70% of total global shipments) in 2012, changes to China’s economic outlook have a significant impact on shipping demand, which in turn affects the shipping rates of dry bulk shipping companies.

Interbank repo rate

Through July 9 to July 12, China’s interbank three months repo rate stood at 4.8%. The rate, expressed in annual terms, reflects the interest that banks charge each other to borrow cash for three months in exchange for securities such as government bonds. High interest rates are generally negative, as they reflect a cash squeeze or cash crunch—a condition of high demand or low supply of cash available in the financial system—just like when people in the United States weren’t able to find money to pay off record interest on their mortgage debt when the housing bubble began collapsing in the late 2000s.

High repo rates also present a risk for the economy because they often mean not enough money is available to flow through the financial system. Without the flow of money, nothing can be done. Companies that rely on banks to run their daily operations—such as paying suppliers and workers as well as purchasing new equipment—will not be able to use banks’ services as usual. As these bills go unpaid and purchases are postponed, the economy will fall into a recession or weaker growth. This happened back in 2008 once.

Good and bad news

The good news is that the rate has fallen from a record 13% on June 20, as China expressed openness to fine-tune its monetary policy on June 21 and injected capital into some banks. This move has been positive for dry bulk shipping firms such as Diana Shipping Inc. (DSX), Eagle Bulk Shipping (EGLE), Navios Maritime Partners LP (NMM), Safe Bulkers Inc. (SB), and Knightsbridge Tankers Ltd. (VLCCF) over the past few days.

The bad news is that while the rate fell to 4.3% on June 8, close to the average of the first half of this year, it jumped to 5.9% on the next day, which means volatility has yet to show signs of stability and risk remains. For further explanation, continue to History shows high repo rates follow high repo rates, negative for dry bulk stocks.

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