Goldman On China: 'Sufficient' Liquidity But Tightening Bias To Stay

The People's Bank of China (PBOC) released an official statement addressing directly the latest liquidity conditions in the banking system and indicating that the central bank intends to maintain sufficient liquidity conditions in the interbank market. As Goldman notes, this clear communication of policy intentions is highly important to guide market expectations, avoid liquidity hoarding, and contain excessive volatility of market. While they hope this calms markets in coming days, Goldman notes that theinterbank rates are likely to settle back to a level higher than before to rein in leverage growth. However, in a helpful prompt for more jawboning, the squid notes, continued communications on policy intentions and actions will be helpful to further ease market uncertainties, given the extreme volatility in recent weeks; though we note the tightening bias will remain as the new leadership appears to prefer to take their pain early (and blame previous parties) than wait.

Via Goldman Sachs:

The key messages from the PBOC:

1. Plenty of system-wide liquidity. The PBOC revealed that as of end of May, the excess reserves ratio was 1.7% (which implies around Rmb1.7 trillion in terms of the absolute amount. There can be some imprecisions as not all deposits are subject to required reserve). As of June 21, there was still Rmb1.5 trillion in excess reserves (the PBOC didn't give an excess reserve ratio. Using the deposit data at the end of May this would imply a ratio of around 1.5%). Therefore, commercial banks as a whole have sufficient funds to lend to the non-banking sector. While the excess reserves are often unevenly distributed among different banks (thus individual banks can still feel tight even with system wide excess reserves), this is welcoming news as this suggests that there is no major shortage of fund supply as a whole.

2. The high interbank rate reflects demand and seasonal factors: Such factors include the high loan demand, seasonal factors such as tax payment and the Duanwu holiday, liquidity needs from reserve submission, and a reduction in FX inflows. Thus according to the central bank, the very high interest rates recently have been partly driven by temporary factors (i.e. they are unusual). We review below the recent development in more details.

3. The central bank is still the lender of the last resort: According to the statement the PBOC has been providing liquidity support to institutions that are deemed to have managed liquidity prudently. The quantity and price of such support remains unknown. Together with regular interbank borrowing, the interbank rate has become more stable, according to the PBOC. The central bank will continue to use a combination of different liquidity tools including open market operations (OMO), relending, SLO and SLF to maintain stability in the money market.

4. Commercial banks should be prudent on liquidity management: Commercial banks should improve liquidity forecast and reduce maturity mismatch. Large banks need to play a role in stabilizing the market.