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Continued from Part 1
The impact of China’s financial industry
The financial industry is an essential part of any economy. Without a stable financial system—one that supplies liquidity to businesses and individuals and bridges the gap between savers and borrowers—an economy can’t function as efficiently and productively as it could. So a collapse in the financial industry would grind an entire economy to a halt. This collapse would affect oil demand because when the economy slows down, less oil is used in factories and cars.
Interbank repo rate falls to 4.3%
On July 8, 2013, China’s interbank three months repo rate stood at 4.3%. The rate, expressed in annual terms, reflects the interest that banks charge each other to borrow cash for three months in exchange for securities such as government bonds. The good news is that the rate has fallen from a record 13% on June 20, as China expressed openness to fine-tune its monetary policy on June 21.
What we saw two weeks ago in China, a sudden jump in repo rate, is a cash squeeze or cash crunch—a condition of high demand or low supply of cash available in the financial system—just like when some people in the United States weren’t able to find money to pay off record interest on their mortgage debt when the housing bubble began to collapse in the late 2000s. Crash crunch, also known as “liquidity issue,” is often tied to over-investment, which can have a negative effect on the economy.
Rising repo rates are negative and present a risk for the economy because they often mean not enough money is available to flow through the financial system. Without the flow of money, nothing can be done. Companies that rely on banks to run their daily operations—such as paying suppliers and workers as well as purchasing new equipment—will not be able to use banks’ services as usual. As these bills go unpaid and purchases are postponed, the economy will fall into a recession or weaker growth. This happened back in 2008. Since China is the world’s second largest importer of crude oil, this cash crunch will affect oil shipments, shipping rates, and tanker stocks’ revenues, too.
Implication for tankers
The recent decline in the interbank repo rate is positive and has supported the popular iShares FTSE/Xinhua China 25 Index (ETF), which primarily invests in several financial companies in China, and tanker stocks such as Teekay Corp. (TK), Tsakos Energy Navigation Ltd. (TNP), Ship Finance International Ltd. (SFL), Nordic American Tankers Ltd. (NAT), and Teekay Tankers Ltd. (TNK). The decline has also supported the Guggenheim Shipping ETF (SEA).
But will the interbank repo rate stay low? Read on to see the long-term trend.
© 2013 Market Realist, Inc.