China's central bank said that it will use tools to safeguard stability in money markets and that tight liquidity is set to ease, giving the first official signs of relief for a cash squeeze in the world's second-largest economy.

The People's Bank of China (PBOC) has provided liquidity to some financial institutions to stabilize money-market rates and will use short-term liquidity operations and standing lending-facility tools to ensure steady markets, according to a statement posted to its website yesterday. It also called on commercial banks to improve their liquidity management.

The statement is the first public confirmation of central bank action to ease a crunch that sent China's overnight repurchase rate to a record last week and came hours after Ling Tao, deputy head of the PBOC's Shanghai branch, said liquidity risks were controllable. Premier Li Keqiang is seeking to wring speculative lending out of the nation's banking system after credit expansion outpaced economic growth.

“The message is clear: The central bank doesn't want to see a tsunami in China's financial markets, and market rates will drop further,” said Xu Gao, Everbright Securities Co.'s Beijing-based chief economist, who previously worked at the World Bank. The PBOC is giving the market “a pill to soothe the nerves,” he said.

Policy makers' reluctance to add liquidity contributed to tipping the CSI 300 Index of Chinese equities into a bear market on June 24. Yesterday, the nation's stocks posted the biggest swings in 22 months. The Shanghai Composite Index fell 0.2 percent at the close after declining as much as 5.8 percent.

“With the elimination of seasonal and emotional factors, interest-rate fluctuations and the tight liquidity situation will gradually ease,” said the central bank, which attributed the increase in borrowing costs to a rapid increase in lending, cash demand during a holiday earlier this month, and changes in foreign-exchange markets.

The overnight repurchase rate dropped 47 basis points to 6 percent in Shanghai yesterday, according to a daily fixing compiled by the National Interbank Funding Center. It hit a record 12.85 percent on June 20 and has averaged 3.12 percent this year.

Financial institutions' cash reserves stood at about 1.5 trillion yuan ($244 billion) as of June 21, compared with the 600 billion yuan or 700 billion yuan sufficient “under normal circumstances” to cover payment and clearing needs, the central bank said in the statement. “The present liquidity is not insufficient.”

Closely Monitor

“We'll closely monitor the change of liquidity within the banking system going forward, flexibly adjust liquidity management based on international payments and the liquidity demand-and-supply situation,” Ling said at a briefing in Shanghai yesterday. The PBOC will “strengthen communications with market institutions, stabilize expectations and guide market interest rates within reasonable ranges.”

Ling's remarks preceded the city's annual Lujiazui Forum financial conference starting tomorrow.

While “liquidity conditions may become less volatile” the PBOC's policy stance will probably “remain tight,” Zhang Zhiwei, chief China economist at Nomura Holdings Inc. in Hong Kong, said in a note. He sees a 30 percent chance that the economy will grow less than 7 percent in the third or fourth quarter.

China's central bank lacks the degree of autonomy enjoyed by its counterparts in the U.S., Europe, and Japan, with the State Council, or Cabinet, playing a leading role in setting policy. The nation in March completed a once-in-a-decade leadership transition, with Li becoming premier.

“An increased level of transparency from the central bank side is helpful,” said Sun Junwei, a Beijing-based economist at HSBC Holdings Plc. “At the same time, the decision-making process at the People's Bank of China is very different from other central banks like the Fed, so what the People's Bank of China can do in communicating with the market may be limited.”

PBOC Governor Zhou Xiaochuan, 65, reappointed in March after a record 10 years in office, has been silent on the cash squeeze. Ling, 58, previously worked as a deputy director at the central bank's finance research institute in Beijing. The Shanghai branch, located in China's financial center, is the most important local outpost and the only one called a “head office.”

The central bank told banks to handle fluctuations in liquidity “calmly” and avoid “irrational behavior,” according to the statement. The PBOC said it will provide liquidity support to those banks with temporary needs if they are lending to help the economy. For banks with liquidity- management problems, the PBOC will “take corresponding measures according to circumstances” to ensure broader market stability, it said.

Growth Target

China's cash squeeze is increasing the chance that Li will be the first premier to miss an annual growth target since the Asian financial crisis in 1998. Goldman Sachs Group Inc. and China International Capital Corp. this week pared their growth projections this year to 7.4 percent, below the government's 7.5 percent goal.

Lu Ting, head of Greater China economics at Bank of America Corp. in Hong Kong, said in a note yesterday that while officials are unlikely to cut benchmark interest rates or banks' reserve requirements, the government “will have to end the credit squeeze soon.”

“The current growth rate is quite close to the floor” that new leaders have indicated they will tolerate, Lu said.

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