Wildau SHANGHAI, Apr 18 (Reuters): China's short-term funding costs slumped this week amid an abundance of money market liquidity, driven partly by weaker demand for funds as economic growth slows, traders said.
Liquidity was likely to be comfortable in the medium-term as banks appear to have reduced shadow banking activity that had become a large source of short-term funding demand prior to an official crackdown on off-balance activities last year.
Loose liquidity in the interbank market suggests there is no need for the People's Bank of China (PBOC) to reduce banks' reserve requirement ratio (RRR), at least during the second quarter, let alone cut official interest rates, traders said.
A string of weak first-quarter economic data has led many economists to predict Beijing will loosen monetary policy to keep growth on track, specifically by cutting the RRR, but dealers in China's money market aren't betting on it yet.
"I would say the market is really flooded with money for now. Banks find that if they offer even slightly elevated rates, it becomes quite difficult to lend," said a dealer at a major Chinese state-owned bank in Shanghai.
"Perhaps the central bank does not want to tighten liquidity conditions, but it also does not need to inject large amounts of fresh money into the markets to fan supply."
The weighted average of the benchmark seven-day bond repurchase agreement rate stood at 2.76 percent at midday on Friday, tumbling nearly a full percentage point from last week's close.
The overnight repo rate dropped 73 basis points to 2 percent, while the 14-day repo tumbled 97 basis points to 2.72 percent.
A typical RRR cut by the PBOC is usually 50 basis points, and a single cut, based on China's total bank savings at present, would thus pump about 550 billion yuan ($89 billion) of base money into China's monetary base.
If one applies a usual four-time money multiplier effect in China to that injection, it would add 2.2 trillion yuan in fresh cash in circulation in the banking system.
But enduring weak demand within China, together with the huge 116 trillion yuan M2 money supply already outstanding, means that a further injection would likely push funds into sectors that the government does not want to support.
These include industries struggling with overcapacity such as steel and cement, as well as the frothy property market.
"Companies complaining they are short of money are either cash-intensive companies, such as property firms, or those which rely on borrowing new money to roll over old debt," the Financial News, a newspaper run by the PBOC, said in a commentary in late March.
"If the PBOC releases money via an RRR cut now, liquidity will flow to such companies. As a result, property prices will continue rising and overcapacity in sunset sectors will worsen."
Traders also noted that similar predictions about RRR cuts circulated in the markets in 2013 after an uninspiring first quarter, but those never materialised. Instead, the PBOC dramatically tightened money in June.
