China Money Markets Face $411 Billion Crunch as Congress Nears

China's money markets are grappling with a significant liquidity crunch, with the seven-day interbank pledged repo index surging to its highest level in over a year. The funding squeeze, which has been exacerbated by seasonal factors such as the Lunar New Year and tax payments, has prompted the People's Bank of China (PBOC) to take action to maintain market liquidity.

The PBOC has injected a substantial amount of liquidity into the market through open market operations, with net CNY954 billion injected in January 2025. Additionally, the central bank has been utilizing structural monetary policy instruments to support specific sectors, such as lowering the required reserve ratio (RRR) twice for financial institutions by a total of 0.5 percentage points, injecting medium and long-term (MLT) funds exceeding RMB1 trillion, and lowering the policy rate twice to bring down market interest rates on a continuous basis.

However, the PBOC's interventions have not been enough to alleviate the cash squeeze, and market participants are closely monitoring how far the central bank will stomach a spike in borrowing costs. The rise in borrowing costs is putting pressure on corporate debt issuers and banks, making it difficult for them to sustain China's delicate economic growth.

The PBOC has recognized the importance of maintaining liquidity in the system while keeping the currency stable, indicating a more proactive approach to managing liquidity. However, the central bank must also be mindful of the potential consequences of its interventions, such as fueling investment into a hot bond market and creating bubbles, as well as the potential impact on the yuan's exchange rate.

As the Lunar New Year holiday approaches, the demand for cash tends to increase, leading to a tightening of liquidity conditions. Additionally, maturities from a PBOC lending facility and tax payments also cause cash outflows from the banking system, exacerbating the liquidity crunch. To manage these seasonal factors and mitigate the liquidity crunch in the future, the PBOC can take several steps, such as increasing liquidity injections, adjusting monetary policy tools, strengthening communication, and closely monitoring and managing risks associated with seasonal factors.

In conclusion, China's money markets are facing a significant liquidity crunch, with the seven-day interbank pledged repo index surging to its highest level in over a year. The PBOC has taken action to maintain market liquidity, but the interventions have not been enough to alleviate the cash squeeze. The central bank must be mindful of the potential consequences of its interventions and take proactive measures to manage seasonal factors and mitigate the liquidity crunch in the future.