CHINA MONEY-Tax man attack on shadow banking startles markets
* Finance ministry abandoned active fiscal policy
* Reversal of "active" fiscal policy in place since 2008
* Traders believe fiscal policy now factually neutral
* Supports c.bank efforts to tighten liquidity
By Lu Jianxin and Pete Sweeney
SHANGHAI, Jan 24 (Reuters) - China made an unusual about-turn on tax policy last year to tighten its grip over sloppy lending that Beijing fears facilitates unhealthy growth in high-risk shadow banking.
The Ministry of Finance (MOF) reversed its "active" fiscal policy, in which tax revenues are redeployed into the monetary system to support growth, central bank data shows.
It vacuumed up cash instead, complementing similar efforts by the People's Bank of China (PBOC), as regulators clamped down on runaway shadow banking activity.
The tax authorities did not announce the change, however, which sparked volatility in China's financial markets in 2013.
The finance ministry drained a net 576.8 billion yuan ($95.4 billion) from money supply through corresponding increases in "fiscal deposits" held by Chinese banks in 2013, effectively the biggest annual drain it has conducted since 2007, data published by the PBOC in mid-January showed.
That enormous drain stands in sharp contrast to the 179.7 billion yuan net injection the ministry conducted in 2012, when it was still implementing a stimulative fiscal policy in the aftermath of the global financial crisis.
"It appears active fiscal policy has been quietly withdrawn by the new government which took office last March," said a trader at a major Chinese state-owned bank in Shanghai.
"The new leadership has apparently shifted economic priority to structural improvements, and the Finance Ministry thus appears to have also tightened its stance."
CASH CRUNCH PANICK
Despite the drain, the Chinese government verbally reiterated its commitment to an active fiscal policy in 2013 -- and this mixed message may have contributed to a series of dramatic cash crunches in the interbank market.
Money markets panicked in June 2013, with rates climbing as high as 30 percent for some short-tenor contracts, then again to a lesser extent in December.
At the time, the PBOC protested that there was plenty of net liquidity in the system, pointing to 1.5 trillion yuan in excess reserves outstanding at commercial banks, and advised those banks to do a better job of cash management instead of begging for funds.
FISCAL REVENUE IMPACT
In restrospect, the shortage of fiscal revenues flowing into the system may have contributed to the market's impression that a squeeze was under way.
Chinese companies and other institutions must deposit tax payments into accounts at designated commercial banks in the form of fiscal deposits.
Three times per month, the commercial banks hand these deposits over to the PBOC, and they become part of the PBOC's monetary base. This base money can be either retained in times of excess liquidity, or pushed back into the system.
A decline in fiscal deposits implies an injection into the money supply, and a rise implies the opposite; when the MOF injects funds by converting fiscal deposits, the PBOC has less need to pump its own money into the system through open market operations.
However, whereas information about open market operations is relatively transparent and immediately available to the market, information about tax revenue inflows is not made public in a timely fashion; bankers must obtain real-time data surrepticiously through contacts in the ministries, or guess.
December, in particular, sees massive inflows from fiscal revenues, and banks factor in such flows when allocating cash.
The finance ministry did in fact inject funds in December -- a record 1.45 trillion yuan, up from 1.17 trillion yuan the previous December and higher than the historical record of 1.21 trillion yuan set in December 2011.
But many traders and analysts complained that the money actually entered the system later than expected, and the mismatch -- given year-end cash demand -- created a squeeze.
The squeeze was aggravated by the central bank, which held back from injecting cash through open market operations, letting maturing instruments drain 84 billion yuan in December.
"There is clear correlation between the PBOC'S market operations and changes in the MOF's fiscal deposits," said a senior trader at an Asian bank in Shanghai.
"While the central bank is now sticking to tight liquidity stance, we see another year of neutral, even slightly tighter fiscal policy in 2014, no matter what the government says."
($1= 6.05 Chinese yuan) (Editing by Jacqueline Wong)
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