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Dry bulk shippers discuss China’s interest rate in earnings call (Page 2)

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High repo rates follow high repo rates

History shows that volatile increases in interbank repo rates have preceded persistently high or volatile rates. In late 2007, for example, the interbank three months repo rate spiked from ~3.0% to 6.0%. Although it came down to 3% for a few days, it went right back above 6.0% a few days later. This zig-zag action continued until the first quarter of 2008. Even as volatility fell, the repo rate remained above 4.0%. Generally, interbank repo rates rise because of over-investment in the economy, which coincides with high inflation, so the central bank doesn’t have the tools to bring interest rates down by injecting liquidity into banks, which increases the cash reserves and liquidity of banks. As the problem unravels and spreads to other parts of the economy, industrial output cools and so does demand for dry bulk shipments. Only after inflation cools does the central bank move to bring interest rates down in order to halt a decline in economic growth.

China Interbank Repo 3 Months 2013-07-31 LTEnlarge Graph

Shipping rates, often known as the leading indicator of the world’s economic activity and trade, for example, eventually collapsed. While standing above 4,000 at the beginning of January 2008, they fell to below 1,000 by the end of the year.

Baltic Shipping Index by Ship Class 2013-07-09Enlarge Graph

China curbing excessive lending

However, central banks will sometimes let rates stay high to punish banks that irresponsibly issue loans that may be uncollectible in the future, as well as companies that over-invest, anticipating that the central bank will bail them out in the end and create a bubble along the way. This is what we’re seeing now: as China prepares itself for an economy led more by private enterprises and consumer spending, it’s trying to discover and expose excessive lending so that it can correct this practice. Many financial companies in China predict that rates will stay high, as Governor Zhou Xiaochuan (People’s Bank of China) calls for a correction to excessive lending. In addition, a high rate would increase the opportunity cost for these financial firms to move money back into the real estate sector, thereby reducing investments in the short term.

Possible impact for dry bulk shippers

The move has a negative impact on China’s economy in the short to possibly medium term, because economic growth could remain restricted. China’s June money supply growth was also negatively affected by the central bank’s move, and HSBC’s latest flash manufacturing PMI (Purchasing Managers’ Index) pointed towards further deterioration. This could negatively affect dry bulk shipments such as iron ore, coal, and grain, hurting companies such as DryShips Inc. (DRYS), Diana Shipping Inc. (DSX), Eagle Bulk Shipping Inc. (EGLE), Knightsbridge Tankers Ltd. (VLCCF), and Navios Maritime Partners LP (NMM).

But, as always, it’s important for investors to follow other key indicators such as Australia’s iron ore shipments and China’s steel output to get a sense of whether high repo rates are affecting other sectors of the economy at the moment. Plus, since all news is no news the moment it’s published, the market has likely already priced in the news and may be forming a bottom over the next few months, as the Chinese government will likely step up reform to maintain its economic growth target for the year.