February 21, 2013 / 6:56 AM / in 5 years

China record fund drain rattles shares, but tightening risk low

* China stocks tumble on monetary tightening concerns
    * Record-high c.bank fund drain via open market operations
    * But money market conditions remain comfortably loose
    * IRS market shows little expectation of tightening

 (Recasts, adds IRS quote)
    By Gabriel Wildau
    SHANGHAI, Feb 21 (Reuters) - China and Hong Kong shares
tumbled on Thursday on worries that a record-high liquidity
drain by the central bank this week portends monetary tightening
in the months ahead, but traders say aggressive tightening is
    Conditions remain comfortably loose and the central bank's
action is mainly an effort to offset big liquidity inflows from
other sources rather than a signal of a hawkish stance, traders
    A statement by the outgoing Premier Wen Jiabao expressing
renewed concern about housing prices has also fuelled concerns
that monetary policy may soon tighten. 
    But traders point out that monetary policy isn't the
government's primary tool for influencing the property market,
and there is still scant evidence of inflationary pressure in
the broader economy. 
    "With CPI still well below three percent, you can't really
say that inflation is a big threat," said an interest-rate swaps
trader at a joint-stock bank in Shanghai.
    China's January CPI was 2 percent, though the
impact of the Lunar New Year holiday may have distorted the
    With the economy recovery still somewhat uncertain, the PBOC
will refrain from aggressive tightening measures unless basic
material prices begin to rise, the trader said.
    China's CSI300 index, which tracks the country's
largest listed firms, was down more than 3 percent on Thursday
on concerns about the launch of a tightening cycle.
    But the impact of open market operations cannot be viewed in
isolation from other factors affecting liquidity in China's
interbank market.
    In particular, cash that flowed out of the banking system
ahead of the Lunar New Year is now returning in droves, traders
    Another source of liquidity is purchases of foreign exchange
by the central bank, which expand the base money supply. FX
purchase data for January is not yet available, but traders say
strong export growth in recent weeks as well as yuan
appreciation pressure boosted such purchases.
    Thursday's one-year interest-rate swap fixing
, which reflects expectations for liquidity
conditions over the next three to six months, edged up by less
than two bps to a modest 3.15 percent on Thursday, well shy of a
recent peak of 3.40 percent on Jan. 4
    Even the central bank's open market operations themselves
are less dramatic than they appear. The record-high fund drain
this week is mainly the result of the record-high injection that
the central bank conducted prior to the holidays. 
    Some 860 billion yuan in 14-day reverse repos issued early
this month matured this week, draining funds. Standard repos
issued this week added only 50 billion yuan to the total drain. 
    Prior to this week, the People's Bank of China had not
issued any standard repos since June last year. The
re-introduction of this instrument, and especially the 10
billion yuan in longer-term 91-day repos issued on Thursday,
caused some analysts to conclude that the PBOC had turned
    "Re-introduction of a longer-dated, (3-month) draining
operation suggests a hawkish bias as it means removing liquidity
for a more extended time," said Dariusz Kowalczyk, senior Asia
economist at Credit Agricole in Hong Kong.
    Interest rates on the PBOC's repo operations also suggests
that authorities are not actively guiding rates higher. 
    The 28-day day repos issued on Thursday carried a rate of
only 2.75 percent, compared to the current
one-month interbank repo rate of 3.23 percent. The
PBOC issued its 91-day repos at 3.05 percent,
below the market rate of 3.55 percent.       

 (Editing by Jacqueline Wong)
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