BEIJING – China’s strategy of defending its currency by choking local liquidity is sending ripples throughout the financial system, squeezing banks and fuelling losses at bond funds.
The People’s Bank of China (PBOC) has drained cash through open market operations most days in February, supporting the renminbi by making it more scarce.
But that has had unintended consequences: Banks have hoarded cash rather than lend it to rivals, while debt funds have suffered losses as investors sell bonds to raise money.
China’s 10-year bond yield hit its highest level since December on Feb 24.
The latest sign of a cash crunch at Chinese banks is a sharp drop in their lending through repurchase contracts, or repo.
The country’s biggest banks cut their lending in the repo market by around two-thirds in mid-February compared with the daily average in 2024, according to people familiar with the matter.
“If banks’ cash-borrowing pressure keeps building and the costs further climb, it may limit their ability to issue loans and support the economy,” analyst Yang Yewei, from local brokerage Guosheng Securities, wrote in a note. “We doubt tightness in funding can be sustained for a long period.”
The PBOC did not immediately reply to a fax seeking comment.
The cash crunch has come at a bad time for Chinese banks.
Their deposits from other non-bank financial institutions declined about a quarter from November’s level in just two months, after regulators moved in late 2024 to limit the rates they can pay on interbank deposits.
Slumping savings rates have also put pressure on deposits.
Meanwhile, more than half of the Chinese funds that invest in the bond market were sitting on year-to-date losses by mid-February, according to the China Securities Journal, a state-owned publication.
These funds have been hit hard by the liquidity squeeze, which has weighed on debt prices as investors sell bonds to free up cash.
Their woes have been exacerbated by a resurgence of interest in the stock market, fuelled by optimism over Chinese AI start-up DeepSeek and signs of Beijing’s renewed support for the private sector.
“The poor performance in fixed income fund products made them vulnerable to potential outflows when sentiment on equities is improving,” Topsperity Securities analyst Lv Pin wrote in a note. “This may exacerbate the selling pressure in the bond market and pose a risk of negative feedback loop,” he added.
A Bloomberg index that tracks the performance of Chinese government bonds is set for its first monthly loss since September 2023.
The ripple effects for banks and bond funds in the country show how China’s determination to defend its currency is increasingly becoming a problem for investors.
The PBOC’s stimulus blitz in September suggested a new era of loose monetary policy, but since then the central bank has flip-flopped, amid fears that too much easing will weigh on the currency.
Still, some market watchers think the central bank will soon offer relief.
Traders are paying particular attention to China’s all-important Two Sessions meeting in March, when senior officials in Beijing will announce their policy priorities for the year.
“By tolerating some tightness in funding for now, China is likely just seizing the window of some temporary relief on a smaller-than-expected US tariff hike,” said Australia & New Zealand Banking Group senior strategist Zhaopeng Xing. “The current delay in PBOC easing measures may eventually turn into more effective easing in the future.”
The onshore renminbi was trading at around 7.2486 per US dollar on Feb 24.
It has strengthened against the greenback in 2025, but remains far weaker than the roughly 7 yuan per dollar level it was at before the PBOC’s stimulus blitz in late September. BLOOMBERG
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