CHINA will face more frequent liquidity shocks this year, according to the manager of the nation’s biggest money market fund, which plans to hold extra cash to protect against the risk of rising redemptions.

    The government’s efforts to curb risk in the financial system and support the sliding yuan are likely to “over-stretch a rope that’s already tight,” said Wang Dengfeng, who manages the 800 billion yuan (US$115 billion) Yu’EBao fund at Tianhong Asset Management Co.

    “The biggest challenge for us this year is to appropriately manage our own liquidity risks — that we have ample cash to meet demand when large redemptions occur,” Wang said. “We’ll set aside much more cash than needed, rather than allocating into high-yielding assets.”

    China’s investors don’t have to look back far to assess the damage that a liquidity squeeze can do: as the average interbank repurchase rate surged to a 20-month high in December, bonds slumped by the most in six years to end a record bull run. The size of money market funds in China shrank by 247 billion yuan from a month earlier to 4.5 trillion yuan at the end of December, according to Stanley Lei, a Shanghai-based analyst at Chinese fund tracker Howbuy.

    Yu’EBao is sold on Alibaba Group Holding Ltd.’s Alipay platform, and can be used to make credit card payments and buy products. That means that most of its investors — who numbered some 300 million as of June last year — are individuals rather than cash-starved companies or financial intermediaries. In fact, Yu’EBao has been a beneficiary of the recent market volatility: the spike in borrowing costs is driving up money-market fund returns, attracting inflows in December, Wang said, without being more specific. Assets stood at 800 billion yuan as of September, according to the most recent quarterly report.

    The average seven-day return for Yu’EBao investors was last at an annualized 3.36 percent, versus 2.52 percent at the end of November, data from Tianhong’s website show. The pool is the world’s fourth-largest money-market fund.

    The central bank has been driving up the cost of money in China since August, when it started injecting longer-term funds into the financial system that carry a higher interest rate. Adding to the liquidity shortage, lenders may need to hoard capital from this quarter as the central bank will start to include shadow banking in an assessment of financial institutions’ credit growth and risks. The average interbank repo rate climbed to 3.05 percent at the end of last month, before moderating in January.

    Wang is girding for higher credit risk in 2017 as waning liquidity forces banks to be more parsimonious with their lending and officials refrain from state-supported rescues of ailing companies. His fund is being more choosy with who it lends to, he said.

    “The central bank is showing increasing tolerance over more volatile funding costs, which is needed to lower leverage,” said Wang. “Monetary policies will be tighter than last year. We’ve created a white list of banks we feel comfortable to lend money to, based on their size, financial indicators, reputation, etc, as risks diverge within the banking system.”

    The number of onshore bond defaults in China more than quadrupled last year from just seven in 2015. The central bank said in November that it will proactively cut leverage and prevent asset bubbles, and smaller banks were last month paying the widest credit spreads relative to large lenders since at least October 2015.

    Tianhong is the biggest money manager in China, overseeing 845 billion yuan in assets at the end of last year, according to a statement on its website.

    (SD-Agencies)