Excess Cash Piles Up in China Havens Instead of Flowing Into Real Economy

● China’s top leadership is committing to ample liquidity as the nation contends with a slowdown. So far, a lot of that cash is sitting in the financial system instead of being transmitted to the real economy.

Cash-rich lenders and funds have been using the money to buy policy bank bonds and high-grade corporate debt, as well as the dollar as the growing interest-rate differential between China and the US boosts the currency’s appeal, according to data compiled by Bloomberg.

The cost to borrow overnight in the pledged repo market slid to the lowest since early 2021 this week, and the Politburo on Thursday pledged to maintain liquidity at “reasonably ample” levels to support the economy. The challenge for Beijing is to get the cash out to companies and individuals to bolster spending and investment as it has signaled that it won’t deploy more stimulus.

“Interbank liquidity condition is ample but money flow fails to reach corporate and support real economic activities,” Ken Cheung, chief Asian foreign-exchange strategist at Mizuho Bank Ltd., wrote in a note on Wednesday. “Considering the pretty low real interest rates in China, perhaps China’s economy is falling into a liquidity trap and more fiscal policy and property market easing will be needed to support growth.”

Here are four charts showing how banks and investors are dealing with the excess liquidity in China’s banking system:

Investors are snapping up policy bank bonds, which are among the most liquid instruments in onshore markets. These securities are luring in funds as they offer higher yields than sovereign debt and carry a minimal risk of default. An example is the 10-year debt issued by China Development Bank, where the yield premium over government securities has shrunk to the narrowest since 2007.

Non-bank financial institutions such as securities firms and mutual funds are likely to be the main buyers of policy bank bonds as they add leverage to their positions, said Zhaopeng Xing, a senior strategist at Australia & New Zealand Banking Group Ltd.

The US currency is another beneficiary of the surplus liquidity as the dollar-yuan pair is supported by the Chinese currency’s deteriorating carry. The growing policy divergence between the world’s two biggest economies is boosting the dollar’s appeal as the Federal Reserve raises interest rates, while Chinese authorities maintain an accommodative stance.

In the offshore forward market, the cost of yuan funding versus the greenback has fallen for the third month. Twelve-month forward points on the offshore yuan dropped to minus 574 pips in July, the lowest level since 2011, reflecting higher demand for the dollar. The forward points are now at around minus 482 pips after the Fed delivered another 75 basis-point rate hike on Wednesday.

The excess cash is also finding a home in relatively liquid shorter-maturity bonds. Yields on a range of one-year onshore debt with low default risks, including government securities and high-grade corporate notes, have all fallen to the lowest since 2020. Consequently, China’s sovereign yield curve became the steepest in two years earlier this month.

The rally in front-end bonds may also indicate a preference for shorter-duration debt as investors position for a potential tightening of liquidity and a recovery in growth. Mary Xia, a rate analyst at UBS Securities Co. Ltd., recommends investors buy bonds with maturities of between one and five years, with a view that the 10-year benchmark yield may rise to 3% by year-end.

Banks are refraining from raising extra funds as they are awash with cash that’s not taken up by corporate and household loans. As a result, the monthly net issuance of negotiable certificates of deposit sold by top-rated lenders fell to the lowest since 2020 in July, according to data compiled by Bloomberg.

Source: Bloomberg News, Thu, July 28, 2022