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

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

(Bloomberg) -- There is so much cash sloshing around inside China’s banking system and so little demand for loans that banks are lending each other record amounts of money even as returns shrink, suggesting it will be hard for more monetary stimulus to boost an economy facing a lack of demand, not a lack of cash.

The amount of money being lent in the overnight repo market hit a record 6.1 trillion yuan ($902 billion) last Friday and continued near that level this week, while the cost to borrow in that market has fallen 91 basis points this month to just above 1%, the lowest since January 2021. The willingness of banks to lend more and more to each other even as their returns fall signals that they can’t find any more profitable ways to use their money.

“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.

The People’s Bank of China has continued its accommodative policy this year but refrained from substantially increasing stimulus, arguing that there is already sufficient liquidity and it’s unnecessary to flood the economy, despite the property slump and covid lockdowns. However those factors are weighing on credit demand, which is weak despite calls from the government and PBOC for banks to boost lending.

Demand for credit from households and companies has been weak for much of this year, with a key indicator for new mortgages actually 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.

The property and manufacturing industries that traditionally are more reliant on external funding don’t have the appetite to borrow much at the moment, according to Yang Hao, a fixed-income analyst at Nanjing Securities Co.

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 of profits to the central government in the first six months, reduced the amount of cash banks must keep in reserve in April, and also injected 400 billion yuan of liquidity through the medium-term lending facility in the first seven months of 2022.

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 remove money 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.

The increase in liquidity and low loan demand caused money supply to grow faster than total credit in the past three months for the first time since at least 2017 and has also boosted deposits held by non-financial enterprises by the most since March 2020 in June.

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.

©2022 Bloomberg L.P.