By Simon Rabinovitch in Beijing
China?s most important gauge of short-term funding costs has risen to a three-year high, illustrating the severity of the government?s monetary tightening and the stress it is placing on businesses.
The country?s seven-day government bond repurchase rate is notoriously volatile and is expected to fall after a month-end cash shortage eases. But in jumping to its highest level since late 2007, this barometer of interbank liquidity has raised fresh questions about the extent to which China?s fight against inflation could undermine economic growth.
The seven-day repurchase, or repo rate, hit 8.9 per cent on Wednesday, up more than 500 basis points from its average in May. Analysts said regional and municipal banks were being hit hard, because they are net borrowers in the interbank market.
That in turn threatens to make life more difficult for small- and medium-sized enterprises, which are already strapped for cash and rely heavily on smaller banks for their borrowing needs.
The All-China Federation of Industry and Commerce, a state-backed chamber of commerce, warned this month that Chinese SMEs were facing a worse cash squeeze than during the global financial crisis in 2008.
With these companies accounting for about 60 per cent of China?s gross domestic product, their troubles could lead to wider fallout for the economy.
The immediate cause of the rise in repo rates was the central bank?s decision last week to increase required reserves for the sixth time this year.
That move, which went into effect on Monday, drained an estimated Rmb380bn ($59bn) from the finan-cial system and came as something of a surprise.
?Interbank liquidity was already quite tight,? said Ting Lu, an economist with Bank of America Merrill Lynch.
?The People?s Bank of China wanted to show the market that there is no easing of monetary policy.?
The central bank acted after Chinese inflation hit 5.5 per cent in the year to May, just shy of a three-year peak.
There had been speculation that signs of a soft patch in economic growth would stay the bank?s hand despite high inflation.
Repo rates are likely to edge down soon. With banks forced to meet loan-to-deposit requirements at the end of the month, many are now hoarding cash but are expected to loosen their grip at the start of July.
Nevertheless, the central bank gave an indication of its concern about the current squeeze by quietly conducting reverse repos this week, injecting at least Rmb50bn into the economy, according to the official China Securities Journal.
Mr Lu said that it could take longer than usual for the seven-day repo rate to fall back to a normal level because of the sustained tightening.
But he also said that its direct impact on credit conditions should not be exaggerated.
The government uses administrative quotas to control lending by banks and it has been steady in targeting roughly the same volume of new credit issuance as last year.
? The Financial Times Limited 2011