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China’s Borrowing Cost Slump Shows Limits of PBOC Policy Easing

·4 min read

(Bloomberg) -- There is so much cash sloshing around China’s banking system and so little appetite for loans that a key rate has dropped to a level unseen since January 2021.

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The cost to borrow in the overnight repo market fell below 1% on Wednesday, down 93 basis points this month, in another sign that much of the liquidity the People’s Bank of China is providing is sitting in banks.

This underscores the difficulty Beijing faces with boosting growth -- ample liquidity is failing to stimulate demand, which remains weak due to the nation’s Covid-Zero strategy and growing housing crisis. To make matters worse, there are signs that banks are taking advantage of the low funding costs to boost leverage and invest in government and policy bank bonds.

“Excess cash is piling up in the financial system instead of being funneled to the real economy,” said Ming Ming, chief economist at Citic Securities. The risk of a liquidity trap -- a situation where monetary easing is unable to boost demand -- is rising, he said, adding that the demand for loans likely slowed in July from June amid scattered Covid outbreaks.

Demand for credit has been weak for much of this year, with a key indicator for new mortgages falling in February and April as property sales continued to drop. Overall loan demand tumbled in the second quarter to the lowest since 2016, according to a PBOC survey, while gross bond sales by China’s non-financial firms fell this year even as the cost of raising debt dropped to the lowest since 2020.

However, even as demand to borrow has been low, the PBOC has increased the amount of money in the system. Even though it hasn’t cut rates since early in the year, it added liquidity by transferring 900 billion yuan ($133 billion) of profits to the central government in the first half, reduced the amount of cash banks must keep in reserve in April, and also injected 400 billion yuan of medium-term lending facility in the first seven months.

The overnight repo rate fell as much as four basis points to 0.98%, before paring the decline to 1%.

Repo Volumes

The trading volume of repo contracts soared to a record 6.1 trillion yuan this month. The willingness of banks to lend more and more to each other even as their returns fall is a sign that they can’t get enough long-term demand from corporates or individuals.

Fiscal spending that followed record local government bond issuance in the first half of the year has also contributed to easier liquidity this month, according to Zhou Guannan, analyst at Huachuang Securities Co.

In the first half of the year, the sale of bonds by the government mopped up some of that liquidity, but with almost all 2022 local government bonds already sold, there is little new debt coming onto the market now to drain cash from the system. Local government bond issuance this month dropped to a 10th of the record 1.6 trillion yuan sold in June, according to data compiled by Bloomberg.

Covid Zero

A central bank official hinted recently that there may not be much the PBOC can do to improve credit demand due to the uncertainties surrounding Covid controls and lockdowns. Corporate and household balance sheets may improve as the Covid situation comes under control and the economy recovers, Zou Lan, head of the monetary policy department at the PBOC, said earlier this month.

And there’s no indication that the central bank will change that cautious stance, with Premier Li Keqiang saying last week that “China won’t roll out massive stimulus, issue an excessive amount of money or overdraw the future for an overly high growth target.”

However with the virus still spreading it’s likely the country will have to deal with the economic hit from new lockdowns. If that does happen, the weak credit demand and excess money in the banking system mean that the central bank might struggle to have much of an effect if it did change course and start adding stimulus.

(Updates with repo moves in 2nd and 7th paragraphs)

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