The People's Bank of China withdrew 109 billion yuan ($14.9 billion) from the financial system on Wednesday through seven-day reverse repurchase agreements, causing the overnight repo rate to slip 15 basis points to 1.71 percent.
This move came as Chinese businesses faced liquidity stress, with overnight borrowing costs soaring on Tuesday, despite the sharp tightening of funding conditions in recent days due to month-end demand from tax payments and large government bond sales.
The PBOC typically drains cash from the financial system at the beginning of each month as demand for financing decreases and liquidity eases. In contrast, it injects cash at the end of each month as banks increase their liquid assets to meet regulatory requirements.
By draining cash from money markets, it suggests that the PBOC sees the spike in short-term borrowing costs as a temporary disruption.
Interbank borrowing costs eased on Wednesday, with the weighted average rate of overnight repurchase agreements falling as much as 15 basis points after a spike of 18 basis points on Tuesday, the biggest since Sept. 28. This indicates that liquidity stress has declined.
Repo rates review
The highest overnight repo rate reached as high as 50 percent on Tuesday, as reported by China Central Depository & Clearing Ltd. Two-day repo rates spiked to 30 percent and seven-day repo rates peaked at 12 percent. The average rate stood at approximately 3.6 percent, while the average seven-day repo rate remained at 2.0675 percent.
In the later afternoon trading, some traders from small lenders were still looking to borrow money. Some of them voiced concerns about potential defaults in the market without providing specific details.
"The liquidity tightness caught me off guard. The price suddenly shot up," said a trader, as reported by Reuters.
The surge in repo rates reminded traders of the June 2013 cash crunch, when the overnight repo rate hit a record high of 30 percent and sent shockwaves through global markets. China's crackdown on shadow banking sparked this crisis.
This time, brokerages believe the cash shortage was due to record issuance of government bonds, limited channels for banks to expand their liability, and seasonal factors. Traders also cited fears of default by cash-strapped institutions.
"The PBOC likely viewed the incident yesterday as a temporary mismatch, not a structural issue," said Bruce Pang, chief economist for Greater China at Jones Lang LaSalle Inc.
According to two traders who refuse to be named, liquidity remained tight on Wednesday morning as large banks restricted funding. Banks borrowed overnight funds at the weighted average rate, while non-banking institutions paid higher borrowing costs of around 2.5 percent.
Citic Securities chief economist Ming Ming expects repo rates to drop in November, as the central bank is likely to maintain loose monetary policy, possibly with a cut to banks' required reserve ratio (RRR).
Struggling economy
China's financial system has been stressed lately as the government used debt-fueled stimulus to prop up the economy, intensifying scrutiny of its money market operations.
Liquidity is expected to tighten after Beijing announced last week that it will increase the fiscal deficit ratio and authorize the sale of 1 trillion yuan in sovereign bonds in the remaining months of the year.
As banks are already facing challenges due to a surge in debt sales, this could lead to an RRR cut as the next policy action, alongside short-term cash injections and one-year policy loans.
The central bank had slashed the RRR by 25 basis points in March and September to support the slowing economy. It also trimmed the medium-term lending facility rate in June and August and pumped more cash into the financial system in October as borrowing costs soared.