While the local sharemarket sell-off was largely focused on US Federal Reserve chairman Ben Bernanke's comments and the latest in a slew of underwhelming factory data coming out of China, credit markets are engrossed in figuring out whether something altogether more sinister could be lurking around the corner.
Interbank lending rates in China's money market have soared alarmingly to record highs, prompting fears the banking sector's liquidity problems could spiral into a full-blown credit crunch.
The main driver for tightening credit has been the reluctance of the central bank, the People's Bank of China, to pump cash into the market. This has been seen as a tactic to combat another potentially out-of-control problem - the economy's so-called shadow-banking system and the prevalence of dodgy wealth management products, fuelled by punters wanting a better return than the lower-than-inflation interest rates on bank deposits.
Credit ratings agency Fitch this week warned what many had already suspected, that wealth products worth $US2 trillion of lending were in reality a "hidden second balance sheet" for banks, allowing them to run rings around efforts by regulators trying to rein in excessively loose lending.
The Chinese government stance can also be seen as a reflection of its determination to wean itself off its addiction to cheap credit, a byproduct of the post-financial crisis stimulus-fuelled growth binge.
"What people underestimate is the degree to which the People's Bank of China views the credit growth that's taken place as unsustainable," Patrick Chovanec, a former professor at Tsinghua University, told BusinessDay.
There have been strong signals that Beijing is satisfied to let its once sacred GDP growth rate slide further to fix its structural problems.
On Wednesday the central government released a statement saying China's financial markets must "serve real economy development in a better way, promote domestic demand in a more targeted way and prevent financial risks in a more concrete way".
The state-run China Securities Journal ran a front-page commentary emphasising China's monetary policy was at a critical juncture. So while many are nervously comparing their Bloomberg charts to similar interbank lending rate spikes before Lehman Brothers collapsed, the assumption most analysts are hanging on to is that China's central bank remains in control. With an inherent advantage as a command economy, it also has plenty of levers to pull to alleviate the credit squeeze, so the theory goes. But as Professor Chovanec points out, "all the liquidity injections in the world won't save bad investments from being bad".
Beijing is waging war against its shadow banking problem, even if it means momentarily freezing its banking system. To flinch too early, and cave in to the banks' craving for cash, would mean it loses its $US2 trillion game of chicken.
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