Reasons for the Sharp Rise in China's Base Interest Rate... Liquidity Misjudgment

On the 26th, citizens passed in front of a currency exchange booth in Myeongdong, Seoul. On the same day, the People's Bank of China, the central bank of China, announced the exchange rate of the Chinese yuan at 7.1293 yuan per US dollar. This is the highest level in more than 12 years since February 27, 2008, during the global financial crisis. Photo by Moon Honam munonam@

[Asia Economy Reporter Hwang Junho] China's Shibor interest rates surged for three consecutive days from the 26th to the 28th of last month. On the 29th, they sharply rose to 3.28% (1.6 0.62%, overnight rate basis), reaching levels last seen in 2015. This was a different pattern compared to the usual increase in liquidity supply ahead of the Lunar New Year. The possibility of a China-originated financial crisis was highlighted, and it was pointed out as one of the causes for the stock market adjustment in South Korea. KTB Investment & Securities cited reasons for this liquidity recovery in China in its weekly bond analysis on the 6th, including confirmation of economic recovery, a focus on financial stability, and misjudgment of liquidity conditions.

The People's Bank of China creates the financial market environment through three main policy rates (reverse repo, MLF, LPR). Among these, the reverse repo rate refers to the ultra-short-term interest rate. A reverse repo involves receiving collateral bonds from commercial banks and supplying liquidity in return, while repo refers to liquidity withdrawal. This time, an unexpected withdrawal of funds caused the interest rates to surge.

"Confirmation of economic recovery" can be a reason for the sudden withdrawal of funds. Most forecasting institutions predict around 8% growth for China this year. Having overcome COVID-19 the fastest in the world, and with the recovery of external demand (due to the US economic stimulus) and policies to strengthen domestic demand, an 8% GDP growth is considered achievable. As a result, monetary authorities appear to have shifted the policy focus to financial stability and withdrawn liquidity accordingly.

The more decisive trigger for liquidity withdrawal was likely a "misjudgment of liquidity." In response to the health crisis, the expansion of MLF (medium-term liquidity support policy) supply led to a record high balance of 5.3 trillion yuan. This caused a decline in interbank funding demand, and interbank rates consistently fell below the People's Bank of China's target, diluting the effectiveness of monetary policy. In fact, the reverse repo rate, which the People's Bank of China decides (through policy meetings), should serve as the lower bound for money market rates, but as it was continuously undercut, it is likely they judged that liquidity was oversupplied.

Heo Jeong-in, a bond researcher at KTB Securities, stated, "The Chinese government is expected to maintain the current easing policy stance following this interest rate surge." He explained that the money market's lack of stability was directly experienced, making it difficult to endure tightening, and that under the current circumstances, the side effects (credit deterioration due to increased interest costs, additional yuan appreciation caused by funding rate differentials, and concerns over increased foreign capital inflows) outweigh the benefits (macroprudential strengthening through deleveraging) of tightening.

This content was produced with the assistance of AI translation services.