FUNDING SQUEEZE NARROWS BEIJING´S POLICY OPTIONS / THE WALL STREET JOURNAL

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Updated June 19, 2013, 3:54 a.m. ET

Funding Squeeze Narrows Beijing's Policy Options

By TOM ORLIK

China's cash crunch also leaves Beijing in a policy jam.

 

Money-market rates remain near record highs. The benchmark seven-day repurchase rate increased to 8.2% in Wednesday trading, up from 6.8% on Tuesday.

 

In the short term, a cut in the reserve requirement to ease conditions for the banks is a possibility. That would certainly bring money-market rates down. But it wouldn't solve the underlying problems of overstretched banks and unpredictable cross-border capital flows.

 

More interesting is what the funding squeeze means for Beijing's policy options on the exchange rate and interest rates.

 

A key reason for tight conditions in money markets is a sharp slowdown in capital inflows. China's banks purchased just 66 billion yuan ($10.8 billion) in foreign exchange in May, down from an average of 377 billion yuan in the first four months of the year.

 

Expectations on the yuan have swung from appreciation to depreciation, with the freely traded offshore yuan now priced cheaper than its onshore cousin. People's Bank of China Deputy Gov. Yi Gang said in April the central bank would soon move to widen the yuan's trading band against the dollar. But in the current environment that could trigger capital outflows, exacerbating the cash crunch.

 

A continued slowdown in growth, combined with subdued inflation and high costs for servicing corporate debt, has raised the possibility that China's central bank might cut interest rates.

 

But there were already arguments against doing so—notably the risk of adding to an already weighty load of credit—and the crunch in money markets makes it even less likely. The expectation that the U.S. will exit from quantitative easing already has investors considering an exit from emerging markets. If interest rates in China fall that would further reduce the appeal, which again could trigger an exodus of funds—adding to the funding squeeze for banks.

 

Money-market rates have already stayed elevated for more than two weeks. The impact on monetary-policy decisions could be even longer-lived.