Monday, June 24, 2013

When it comes to the latest PBoC policy, Mr. Mobius knows best

The PBoC acted to calm China's interbank markets this morning, somewhat stabilizing liquidity and short-term rates.

The PBoC made a vague statement over the weekend regarding its monetary policy.
PBoC (translation/paraphrasing): - The PBoC meeting stressed the need to conscientiously implement the Party's recent economic directives, to pay close attention to the latest international and domestic economic and financial developments and changes in international capital flows, to continue to implement prudent monetary policy, and make efforts to enhance policy to be more proactive with targeted, flexible, appropriate and timely fine-tuning. The meeting stressed sound macro-prudential policy framework, the integrated use of various monetary policy tools to strengthen and improve liquidity management, guidance on monetary credit, and steady growth of social financing. These goals should be achieved by maintaining the stability and continuity of macroeconomic policies, while optimizing allocation of financial resources,... and effectively supporting the restructuring, transformation and upgrading of the economy. This will ultimately help serve the real economy, job growth, and financial risk mitigation.
What does this mean? It seems the PBoC has been trying to avoid adding incremental liquidity in order to help facilitate the "restructuring" of the economy, while fine-tuning liquidity when needed. Most central bank watchers would agree that creating a liquidity crunch however is a bizarre way of implementing economic restructuring.

Raising short term rates may serve two purposes and China is unlikely to be interested in either. One would be to slow economic growth, which China clearly doesn't need. And even if it did, it would want to target a gradual increase, not the mad volatility shown in the chart above. The second reason to raise short-term rates is to defend the currency (something Brazil may end up doing). But China's massive foreign reserves would make that task fairly simple without having to take liquidity out of the market.

The central bank is trying to reduce growth in shadow banking and "speculation" using this blunt monetary tool. That will end up tightening credit conditions for regular bank lending as well (see discussion). A far more efficient way of achieving this goal is by increasing bank capital requirements for "wealth management products" as well as  on- and off-balance sheet undesirable risk taking. A simple way to implement such policy would be through stress testing requirements, forcing banks to have higher capital ratios. That would reduce unwanted risk taking without killing general lending. But that's not what the PBoC is doing.

What this tells us is that China doesn't have a good handle on risk-based capital needs for the nation's banks and resorts to liquidity "starvation" to stem growth in shadow banking. Somewhat surprisingly, Mark Mobius believes the PBoC is doing the right thing. His view is that since the banking system is state-owned, it can be recapitalized (bailed out) at any time. Let the PBoC shock the system and see how things ultimately shake out.
CNBC: - While China's housing market problems are similar in scale to those faced during the U.S. subprime mortgage bubble and its banks are rife with bad loans, it won't lead to another Lehman-style crash, Franklin Templeton's Mark Mobius told CNBC on Monday.

Mobius said the similarities could not be denied but since Chinese banks are owned by the government, they will not be allowed to fail.
Sounds like a dangerous strategy. But clearly Mr. Mobius knows best and it is all going to work out in the end. Is that why China's stock market tanked 5% overnight?

Shanghai SE Composite Index (source: CNNMoney)

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