China markets stabilize, but mood still fragile

An investor looks at computer screens showing stock information at a brokerage house in Shanghai June 25, 2013.

SHANGHAI (Reuters) - Chinese stocks searched for a footing on Thursday as investors hoped the worst of the cash crunch had passed, but concerns the recent market turmoil is ushering in a period of tougher funding conditions and weaker economic growth contained any optimism.

Chinese authorities are alarmed that even as the world's second-largest economy shifts down from double-digit growth of the past decades, debt keeps rising and much of it contributes to a build-up of risks and financial imbalances with little benefit for productivity and economic growth.

As such, analysts think Beijing is even prepared to risk missing its growth target of 7.5 percent -- a two-decade low -- to drive home the message that banks can no longer rely on cheap cash to fund riskier operations.

"The worst of the liquidity squeeze, especially the confusion and panic among many market participants, is perhaps over," UBS economists said in a report.

"However, an improvement in market sentiment and drop in interbank rates do not mean a reversal of macro and monetary policies. Over the coming months, we expect credit growth to slow and financing costs in the economy to rise."

Last week, the People's Bank of China (PBOC) allowed money market conditions to tighten and rates to soar, sparking fears of a credit crunch that roiled local and international markets.

It later moved to quell fears the squeeze could spin out of control into a full-blown financial crisis, but made it clear that cash conditions were being tightened and lenders should improve money management and lending practices.

On Thursday, the central bank opted not to drain cash from the money market, helping rates dip for a fifth day, while mainland shares, including battered financial stocks, opened higher for the first time this week.

Still, cash rates held well above long-term averages.

The weighted average for the benchmark seven-day repo rate dropped more than half a percentage point to 6.74 percent, while the overnight rate was inched down slightly to 5.53 percent.

The average seven-day rate, which used to hover in a 3-4 percent range, shot to a record 11.62 percent a week ago, though some trades were seen as high as 28 percent.

The gradual improvement in cash conditions initially boosted the stock market, but it could not be sustained. The index of the largest Shanghai and Shenzhen stocks .CSI300 ended down 0.4 percent, taking losses to about 9 percent over the past week.

However, financial stocks .SSEFN on the Shanghai bourse closed up 0.5 percent.

"We expect interbank rates will come down, but not to the same level as seen before the stress episode," Haibin Zhu, JP Morgan China Chief Economist, wrote in a note.

"The higher funding cost for banks could be ultimately passed through to borrowers. If lending rates are higher, it will put downward pressure on the already weak corporate sector and economic activity."

Several Chinese media outlets reported some branches of leading banks were either suspending lending to businesses and individuals or tightening and extending credit procedures.

It was not immediately clear, though, to what extent banks were already feeling the funding pinch and how much was a typical slowdown by banks that had already reached their end-of-quarter lending ceilings.

Responding to the reports, the nation's second-largest lender said it has not stopped offering new loans or lending to other banks.

"Currently, the short-term panic of the credit crunch has eased," China Construction Bank Corp (601939.SS) (0939.HK) President Zhang Jianguo said at the opening of the bank's first Taiwan branch in Taipei.

"CCB is operating smoothly. We are still capable of giving funds to other banks via interbank (loans)," he added. "We are not stopping giving out any new loans."

(Additional reporting by Yimou Lee in HONG KONG and Faith Hung in TAIPEI; Writing by Tomasz Janowski; Editing by John Mair)