Continued from Part 1
China’s repo rates and dry bulk
Although China’s interbank repo rates have fallen from their peak, questions remain over whether interbank repo rates will continue to stabilize and stay low in the short to medium term. What, then, would the repo rates’ implication be on China’s economy and demand for dry bulk shipments, which depend heavily on China’s industrial output?
Historical analysis of repo rates
Interbank repo rates have fallen recently, as China expressed openness to fine-tuning its monetary policy and injected some money into banks. But history says that a volatile increase in interbank repo rates precedes persistent or volatile rates. In late 2007, for example, the interbank three months repo rate spiked from ~3.0% to 6.0%. Although it came down to 3% for a few days, it went right back above 6.0% a few days later. This zig-zag action continued until the first quarter of 2008. Even as volatility fell, the repo rate continued to stay above 4.0%, which was negative.
Shipping rates for dry bulk shipments, for example, eventually collapsed.
The popular iShares FTSE/Xinhua China 25 ETF (FXI), which invests in several financial companies, topped out earlier, in late 2007.
The central bank
Often, the central bank will intervene by purchasing securities from banks, which increases the cash reserve and liquidity of banks while lowering the repo rate. However, central banks will sometimes let rates stay high to punish banks that irresponsibly issue loans that may be uncollectible in the future, as well as companies that over-invest, anticipating that the central bank will bail them out in the end and create a bubble along the way. This is what we’re seeing now. As China prepares itself for an economy led more by private enterprises and consumer spending, it’s trying to discover and expose excessive lending so that it can correct this practice.
Many financial companies in China predict that rates will stay high, as Governor Zhou Xiaochuan (People’s Bank of China) calls for a correction to excessive lending. In addition, a high rate would increase the opportunity cost for these financial firms to move money back into the real estate sector, thereby reducing investments in the short term. This move may be negative for the economy in the short to possibly medium term, because construction growth could remain restricted.
Learn more about a possible slowdown in China’s economic growth
For further signs of a potential slowdown in China’s economic growth, continue to China’s bear case economic growth will hurt dry bulk stocks (Part 3), which will follow later today.
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