There’s still a lot of confusion out there surrounding exactly what’s going on in China.
And understandably so.
After all, the country has embedded so much risk in its financial system via what SocGen correctly describes as a “mind-boggling” array of shadow credit channels that untangling who’s responsible for what and where all that credit ends up is “nearly impossible.”
That said, it’s pretty easy to understand why everyone is suddenly concerned about the situation. See China is looking to squeeze those credit back channels and that effort is being undertaken via “stealth” tightening. Basically, Beijing is tightening the screws on the interbank market. Well, because the credit extended via those back channels very often ends up as speculation in various assets, it’s hardly surprising that when those channels are squeezed, you see asset bubbles pop.
If this spills over into EM more generally, China’s problem becomes everyone’s problem.
That’s the gist of it.
Well, in an effort to help you visualize what everyone is talking about in terms of stress in the interbank market (where the above-mentioned screw tightening is evident), we present the following brief excerpts and visuals from Goldman which should help you get a better handle on Beijing’s efforts to rein in leverage…
We select three variables for the interbank market: 1) the spread between 3-month Shibor and the yield on 3-month government bonds (Exhibit 5), to capture counterparty risk among banks, similar to the TED spread (the difference between 3-month LIBOR and 3-month T-bill interest rate); 2) volatility of the 7-day repo rate (Exhibit 6); and 3) the gap between R007 and DR007 (Exhibit 7). The third variable can potentially capture some of the risk for non-bank financial institutions, reflected in the liquidity pressure of them, due to either maturity mismatch issues related to shadow banking activities, or intentional correction of over-leveraging by policy makers. But the problem of this variable is that the data history is relative short (starting from end 2014). As shown in Exhibit 8, the peak for the financial stress in the interbank market was actually achieved in end October 2007. The macro backdrop was, as the economy was over-heating and liquidity was excessive, the PBOC had kept increasing the RRR and benchmark interest rates since late 2006, and increased the RRR on Oct 25 (the tightening cycle continued until late 2008). Another idiosyncratic shock was Petrochina’s A share IPO in October 2007, with a large amount of liquidity frozen in the market until Oct 31 (during this time planned bond issuance by CDB was also delayed). In recent months, we also see a sharp increase in financial stress in the interbank market, especially when the gap between R007 and DR007 is included in the index.