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PBOC Q3 monetary policy report released on 26 November reinforces our view that liquidity will be going tighter and deleveraging may be getting more prominent in the months ahead.
The report, echoing the need to stabilize leverage, direct financing and control financial risk suggested by PBOC governor Yi Gang in a research paper published on 17 Nov, indicates second-phase deleveraging is kicking in, though it, in terms of magnitude, may be more gentle than the first-phase in 2017 (chart 1).
While deleveraging is kicking in and the problem of credit default is worsening (chart 2), we are increasingly concerned about the liquidity issue. Data suggests that bank reserves currently amounts to some CNY21tn in total (consisting of around CNY18tn required reserves and CNY3tn excess reserves), representing nearly 7% of total bank assets (chart 3). Given such a huge amount of reserves, China's banking system should be able to manage any further significant increase in credit defaults. Assume 50% of the CNY4tn corporate bonds currently held by banks get defaulted, around 66% of the excess reserves will be wiped out. That's not trivial, but may spark a liquidity crunch in certain scale. Despite that, it should not be detrimental to the stability of the banking system.
As a conclusion, we reckon that liquidity, heading into 2021, will be going much tighter. 7-day repo rate (currently at 2.30%) and 1-month repo rate (currently at 2.90%) will have reseen to 2.90% and 3.70% respectively by the end of H1 2021.
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