January 22, 2014 4:00 am JST

Default fears spook Chinese financial markets

SHUNSUKE USHIGOME, Nikkei staff writer

TOKYO -- Heavy demand for funds ahead of the traditional holiday has sent China's short-term interest rates soaring and stocks tumbling, and while a liquidity injection from the central bank helped calm jitters for now, the move has failed to dispel smoldering worries about a possible default in the shadow banking sector.

   The overnight Shanghai Interbank Offered Rate, or Shibor, jumped to 3.888% Monday, its highest level so far this year, and the Shanghai Composite Index hit a five-month low. The People's Bank of China resumed its regular fund provisions Tuesday after a four-week hiatus.

   But "caution is needed ahead of the Lunar New Year holiday," warned Yuji Saito, director at Credit Agricole in Tokyo.

   The market is keeping a close eye on a particular high-yield investment product maturing at month's end, when the Lunar New Year begins. The instrument was issued by a trust company for a coal firm to raise funds and sold by banks to wealthy investors. The coal company's finances have turned out to be deteriorating, fueling fears of a default.

   "The rise in short-term interest rates partly reflects growing alarm over the shadow banking problem," Saito said.

   Some worry that a default by the coal firm could ripple through all financing via shadow banking. "There's a risk that it will cause the Chinese economy to slow down," said Junya Tanase, chief forex strategist at JPMorgan Chase in Tokyo.

   Even if the repayments for this product are made at month-end, problems over China's vast shadow banking are far from over. "Chinese authorities are tightening the money market as a way of curbing shadow banking," said Xiao Minjie, economist at SMBC Nikko Securities. "So, we'll continue to see wild swings in short-term interest rates."

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