Can China Prevent One Crisis Without Causing Another? Spoiler Alert: “No”

On Wednesday, we brought you “‘Some Folks Missed Payments’: There’s A Storm Brewing In China.”

You should maybe read it. Or not. Whatever.

What we would say is that it’s easily the best and most comprehensive assessment you’ll find anywhere (we checked) of the dilemma the Politburo faces with regard to preserving the credit impulse that not only makes the NBR’s “GDP growth is 6.5%” charade possible, but also keeps the global economy from careening into the deflationary doldrums.

The problem, you’ll recall, is that Beijing needs to releverage and deleverage simultaneously. Here’s how we explained things in the context of last week’s OMO hike (the second in as many months):

Ok so look, all of that probably sounds like Greek … err.. Chinese… to you, and that’s fine because the bottom line here is simple: in late November, China embarked on a concerted push to tighten through repo rates versus policy rates. As we noted last week, “Beijing has essentially shelved policy rates in favor of repo rates when it comes to tightening.”

But then, in comments that accompanied this month’s OMO hike, they kind of tried to downplay the extent to which they’re transitioning to repo rates versus policy rates as a means of managing liquidity and financial conditions more generally.

Say whatever you want about that, but at the end of the day that’s a reflection of Beijing trying to walk a tightrope between keeping conditions loose enough to support growth (not to mention the global credit impulse which depends almost entirely on China) and tightening enough to discourage the rampant proliferation of leverage and speculative excess.

Again, there’s much, much more in the post linked above, but we thought some commentary out Thursday from Deutsche Bank would help flesh things out a bit in terms of illustrating how this all works.

With that in mind, consider the following (and do note the extent that it mirrors precisely what we said yesterday):

Via Deutsche Bank

China’s monetary policy has been shifting gradually towards a tightening stance since 2H16. Targeting the liabilities side of the banking sector, the PBOC hiked rates of monetary tools, such as MLF, SLF and OMO (Figure 1), and withdrew liquidity on a net basis after the Chinese New Year (Figure 2). At the same time, it targeted the asset side of the banking sector when it rolled out stricter MPA rules by including off-BS WMP credit in broader credit assessment and imposing stricter-than-expected penalties on banks that fail to comply.

DB1

As a result, the key indicators in the money market, including repo and CD rates, all suggest stretched domestic liquidity. For example, the 7-day repo rate, which is the most representative liquidity indicator, has exceeded the interest rate corridor ceiling of 3.45% several times this year (Figure 3). Moreover, the interbank CD rate spiked to 4.6% on 20 Mar 2017, up c.180bps from last year’s low (Figure 4).

DB2

We summarize in the below diagram recent financial deleveraging efforts by regulators.

DB3

So that’s all fine and good from a kind of “let’s curtail systemic risk” perspective, but the problem is, China’s labyrinthine shadow banking complex has grown so large that the very act of unwinding it in the interest of financial stability creates its own systemic risk.

To see what we mean, just have a look at the following chart and imagine all the red drying up

China

(Citi)

 

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