China To Prioritise Reform Over Growth

June 28, 2013Chinaby EW News Desk Team

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China’s central bank chief on Friday said it stands ready to preemptively “adjust” liquidity in the market to ensure stability, a policy that would prioritise the need for reform in China’s economy while keeping the lid on speculative lending in the country’s booming shadow banking sector.

Speaking at a financial forum in Shanghai, head of the People’s Bank of China Zhou Xiaochuan said investors can no longer depend on cheap cash to fund riskier operations, cautioning that the central bank will conduct pre-emptive adjustments to liquidity in the banking system to keep financial markets stable.

Without marking specific reference to China’s recent cash crunch, Zhou remained confident about China's growth, though he acknowledged the economy had slowed.

"China's economic growth has slowed but is still within a reasonable range," Zhou said. "China's current economic and financial operations and consumer prices are generally stable, all of which show prudent monetary policy is appropriate and producing good results."

Related: Chinese Economy Needs “Renewed Reform Momentum”, Says OECD

For almost three weeks, funds have been in short supply on China's interbank market and at one point the rates at which banks lend to one another shot as high as 28 percent after the central bank allowed the supply of cash in the money market to tighten significantly.

The shortage of interbank credit also spilled over to the stock market, unnerving investors and sending share prices tumbling as much as 5.8 percent on China’s so-called Black Monday.

The hard-line approach contributed to the biggest drop in Chinese stocks in almost four years though prices have since recovered.

In a dramatic reversal, the PBOC on Tuesday complained it was “not the stock market’s ‘wet nurse’” but confirmed it had provided extraordinary support to individual banks that were short of cash.

The cash crunch appears to have limited impact on the real economy, given the disconnect between interbank borrowing conditions and the flow of loans to main street businesses.

However, economists warn that a wider crackdown on the so-called shadow banking sector, whose assets have nearly doubled since 2010 to equal 69 percent of China’s GDP, and the PBOC’s commitment to preventing a debt blowout, will raise borrowing costs and reduce the flow of credit to the already slowing Chinese economy.

“Allowing liquidity to dry up to communicate your message strikes us as a dangerous game,” said Andrew Elofson, senior research analyst at D.A. Davidson.

Related: IMF Lowers China Growth Forecast to 7.75%, Issues Warning on Debt

Related: Will China Succeed In Its Self-Imposed Revolution?: Michael Pettis

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