June 7, 2013 / 6:56 AM / 5 years ago

China money rates jump, partly on default talk; conditions tight

* Pre-holiday liquidity squeeze affects interbank market
    * Rates up on rumour a mid-sized bank defaulted on interbank
    * Some banks desperate to borrow at any price - dealers
    * Reduced forex inflows remove major source of liquidity
    * C.bank liquidity injection fails to aid market

    By Gabriel Wildau and Chen Yixin
    SHANGHAI, June 7 (Reuters) - China's money rates skyrocketed
on Friday from already-high levels the previous day, pushed up
partly on rumours that a mid-sized bank had failed to repay an
interbank loan.
    Dealers said that virtually the entire market was short of
cash, with few or no banks willing to lend.
    The benchmark weighted-average seven-day bond repurchase
rate soared to 6.68 percent, up from 5.32 percent
on Thursday and the highest since January 2012, just before that
year's Spring Festival holiday.
    Traders said the rumours of a loan default, which could not
be substantiated, began during late trading on Thursday, during
which rates increased as a holiday neared.
    Chinese interbank lending rates often rise sharply in the
days before national holidays. Mainland markets will be closed
from Monday through Wednesday for the Dragon Boat Festival.
    Earlier this year, the People's Bank of China (PBOC)
launched short-term liquidity operations as a supplement to
twice-weekly bill and repo auctions, partly in an effort to
reduce volatility in the interbank market.
    But the PBOC has not employed this tool on a significant
scale to bring down rates in recent days. 
    A dealer at a city commercial bank in Shanghai said the
current situation is "quite similar" to a spiking of rates ahead
of the Spring Festival in 2011.
    "But at that time, we all knew why the market was tight,"
the dealer said. "Now it's kind of inexplicable."
    "The market has been very tight, (but) the central bank
continues to drain funds," he said, referring to the issuance of
new central bank bills and repos this week in open market
    Individual trades for seven-day loan repos went as high as
12 percent. That price was paid by a mid-sized bank, a dealer at
an interbroker dealer in Shanghai said.
    The one-day repo rate jumped to 8.45 percent
on Friday from 6.15 percent on Thursday, the highest since
October 2007. 
    It's extremely unusual for the one-day rate to move higher
than the seven-day rate, though the holiday market closure means
that one-day loans extended on Friday will not mature until next
    "They have no guidance price today. In other words, if
there's cash available, they'll take it. So it seems like a bit
of price gouging," said the dealer, referring to banks' normal
practice of issuing guidance on the price at which their traders
are permitted to borrow money.
    Traders have said in recent days that the central bank
appeared to be using open market operations to tighten interbank
liquidity somewhat, amid concerns that loose liquidity
conditions in recent months have fueled speculative activity
while failing to spur growth in the real economy. 
    The PBOC injected 160 billion yuan ($26.07 billion) into the
interbank market on a net basis this week, but the injection was
the result of the maturity of previously-issued bills and repos.
The bank still withdrew some funds through new bills and repo
    Apart from seasonal factors, a slowdown in capital inflows
is also likely responsible for the rise in rates. 
    Foreign exchange purchases by Chinese banks - which analysts
view as a rough proxy for capital inflows - surged in early
2013, reaching a record high in January and remaining elevated
over the next three months. 
    Forex purchases by the central bank, which are included in
the data, add to the base money supply, increasing interbank
    But a front-page analysis in the official Shanghai
Securities Journal on Tuesday predicted that forex purchases had
fallen back markedly in May.
    "We think the core cause of lower liquidity is related to
slowing FX inflows," Igor Arsenin, head of emerging Asia
interest rates strategy at Barclays in Singapore, wrote in a
note to clients on Friday.
    A slowdown in base money creation via forex purchases could
explain why the relatively sizable fund injection via open
market operations this week failed to calm funding markets. 

                                 Current  Prev close  Change
                                       (pct)           (bps)  
7-day repo         6.6530     5.3205     +133.25
7-day SHIBOR           6.6570     5.1370     +152.00
 Note: Repo rate is weighted average.

    - China opens new front in war as yuan speculation distorts
export data 
    - China seeks to curb speculative flows without monetary
    - Markets spin on liquidity switches 
    - Non-bank financing to rise in 2013 
    - External liquidity tracker: FX purchases are main source
if liquidity injection in recent months GRAPHIC: r.reuters.com/das95t
    - Impact of maturing central bank bills and repos GRAPHIC: r.reuters.com/kas95t
    - Long-term Chinese govt bond yields slumped amid doubts on
growth GRAPHIC: r.reuters.com/jas95t
    - China's interest-rate swap curve has flattened GRAPHIC: r.reuters.com/has95t
    - China corporate bond spreads have narrowed slightly 
GRAPHIC: r.reuters.com/mas95t
    - Hot money tracker: Hot money inflows have returned in
2013, boosting liquidity GRAPHIC: r.reuters.com/was95t
($1 = 6.1362 Chinese yuan)

 (Editing by Richard Borsuk)
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