People's Bank of China: Between a rock and a hard place

China's spiralling credit to GDP ratio is a talking point much beyond its shores. This is an economy that lures investors from around the world with the promise of high returns but credit to GDP ratio beyond 200 percent for a middle-income country does not augur well for its future, atleast that's what economists from around the world will have you believe. People's Bank of China agrees with that assessment. In keeping with this, it has been trying to discipline its banking system against credit expansion that overlooks due-diligence before lending.

In the year 2013, this is the second time that China's banking system is experiencing a cash crunch, the earlier episode having played out in June.

The problem

The short-term inter-bank lending rate in China has seen a sudden spurt and has now moved beyond 8 percent. Similar highs were scaled in June as well. This essentially means that the central bank is not that active in the open market and banks are unwilling to lend to each other given that the credit uptake is high in December and withdrawals by organizations are substantially higher. Also, as avenues for investment grow in the form of varied financial instruments, banks find it increasingly difficult to attract depositors with their products. The interest rates for lending beyond the three month period still remain stable.

PBoC is caught between its efforts to ensure that the banking system remains stable - which essentially implies that high credit uptake should not lead to unmanageable bad debt levels which can significantly harm the banking system as it grows - and the need to keep the short term rates in check lest it squeeze the liquidity out of the system.

Action taken

PBoC announced that it had intervened via short term liquidity operations (SLOs) to lend nearly $50 billion to banks for the short-term. In a first, an announcement was made on Weibo about the impending move.

Long term impact

 There is a unanimous agreement on the fact that China needs to regulate its banks in order to effectively manage growth in credit uptake that is continuously seeing an annual growth of more than 20 percent for the last few years. The high reserve ratio requirement of 20 percent which requires banks to deposit nearly $3 trillion with PBoC does not hide the fact that China has an active shadow banking system. This cash crunch is not being seen as a major threat for now as long term interest rates are stable and the situation is expected to improve at the beginning of February next year which marks the beginning of a Chinese lunar new year.

China is unique in many ways. The more you try to learn about China, the more it intrigues you with its peculiarities.