Liquidity crunch to plague China?

The recent interest rate increases in China's inter-bank market have raised concerns over a liquidity crunch, but experts have viewed it in the context of weak economic recovery and argued that liquidity is abundant.

The overnight rate of China's Shanghai Interbank Offered Rate has soared since the beginning of this month amid dwindling foreign capital inflows. It rallied 206.40 basis points to 7.66 percent on Wednesday.

Higher rates have led market expectations for lowering banks' reserve requirement ratios to free up liquidity, but some experts said that such a move is not necessary as the current monetary supply is ample enough to support the real economy.

Zuo Xiaolei, chief economist at China Galaxy Securities, said the problem with the Chinese financial market is that much of the funding stayed "circulating" in the financial system instead of translating into real economic growth.

Since the beginning of this year, China has demonstrated a mixed picture of a booming financial market versus sluggish economic growth, with the broad measure of money supply (M2) growing at around 16 percent year on year while industrial production has stayed at only around nine percent.

Liu Yuhui, a financial researcher with the Chinese Academy of Social Sciences, said some money was used to repay debts. Many projects invested with funding from the country's four-trillion-yuan (about 650 billion U.S. dollars) stimulus package launched in 2008 have been finished, but are not yet yielding returns. So the investing parties have to borrow money to repay the loans.

Xu Hongcai, deputy head of the Department of Information under the China Center for International Economic Exchanges, said some money has gone to inefficient state-owned companies, sectors with excess production capacity, or have turned into products that can not be sold due to weak domestic demand.

Therefore, the financial market seems booming, but the economic growth is moderate, according to Zuo Xiaolei.

The recent soaring inter-bank interest rates were pushed up by easing capital inflows due to tight regulatory oversight, instead of real demand from the economy, Zuo said.

According to Wednesday's State Council meeting chaired by Premier Li Keqiang, China will continue a prudent monetary policy while keeping a reasonable scale of monetary supply.

Zeng Gang, a banking expert with the Chinese Academy of Social Sciences, said the key to addressing problems with China's financial sector lies outside the sector as banking is just a supporting for the economy.

Reforms should be taken in the real economy to unleash new growth points to direct the movement of money supply, said Zeng. In this way, the financial risks will gradually be tackled.