Fed taper comes at 'delicate moment' for China

An employee counts yuan bills at a bank in Xuchang, Henan province. The value of the yuan retreated on Thursday, along with other emerging market currencies. Provided to China Daily

The United States Federal Reserve Board's announcement that it will scale back its bond-buying program could crimp liquidity in China at a delicate moment, analysts warned.

China's interbank lending rate is at its highest since June, when the central bank pushed up rates to discourage borrowing, a move engineered partially to prevent further shadow banking activity, said Patrick Chovanec, managing director of Silvercrest Asset Management Group and former economics professor at Tsinghua University.

"Part of the liquidity that's been provided has been US dollar borrowing, both licit and illicit," Chovanec told China Daily on Wednesday after the Fed's announcement.

"Dollars flowing into China add to the credit supply, and that has been based on the assumption that quantitative easing would continue."

The Fed's pullback from monthly bond purchases, which were aimed at stimulating US economic growth, could have implications for interest rates and currencies around the world.

Chovanec said that although China has relatively lower exposure to macroeconomic risks from the Fed's action, the move could "undercut liquidity at a delicate moment".

The Fed acted after months of speculation that it would begin slowing its controversial stimulus to the economy, known as quantitative easing. Citing progress in lowering the US unemployment rate and in improving economic conditions, the agency said it will "modestly" scale back its pace of purchases by $10 billion now.

It also said it will buy $75 billion worth of Treasury and mortgage-backed bonds each month, starting in January. The move signaled the beginning of an end to five years of unprecedented US government intervention in financial markets.

Tan Xiaosu, an international finance professor at the Central University of Finance and Economics, said that although the market had already factored in some of the impact before the Fed's announcement, there will still be a reaction when tapering actually occurs, including foreign capital outflows and yuan depreciation.

The value of the yuan retreated on Thursday, along with other emerging market currencies, but analysts said that the Chinese currency's decline will be limited as its increasing international usage means demand is still there.

Yukon Huang, a senior associate at the Carnegie Endowment for International Peace, said tighter liquidity might be a good thing, as it sends a warning to small banks in China about the risks of excessive reliance on the interbank market.

Positive aspect

Much of the tension in the interbank market can be attributed to small banks' excessive borrowing from large banks, as the former have a weak household deposit base.

"Liquidity in China actually is not the problem. The problem is lack of efficiency in the money markets," he said.

Huang said now is also an opportune time for China to reduce its monetary expansion, which dates back to the aftermath of the 2008 global financial crisis.

Bank of America Merrill Lynch's Ting Lu said in a note to clients on Sept 2: "China will surely be affected by the coming QE tapering, but we believe the QE tapering will have little material impact on China's growth, currency valuation and financial stability."

He added that "with the rising uncertainty over emerging markets due to the coming QE tapering, the Chinese government most likely will put a special emphasis on financial and economic stability".

In Hong Kong, Acting Chief Executive of the Hong Kong Monetary Authority Eddie Yue said Thursday that the Fed's decision to begin tapering monetary stimulus starting next month will cause short-term volatility in the market.

In a statement to the media, Yue said that local banks had been advised to monitor interest rates closely and not lend out too much.

Although the decision to reduce the stimulus of QE reflects a brighter view of the US economy, which is expected to have a positive impact on the global economy, Yue warned that market volatility may occur as the pace and scale of the Fed's measures are not clear.

Hong Kong Financial Secretary John Tsang said volatility will continue for some time. He advised investors and companies to be careful about volatility and take a long-term view in terms of investment.

"We haven't seen any outflow of liquidity as yet, so we have to monitor the situation closely," Tsang said.