China Money: Commercial paper gears up for tighter liquidity

By Karen Yeung

SHANGHAI (Reuters) - Trading in commercial debt over the past month suggests banks are preparing for the possibility of much tighter liquidity, with the economic recovery looking sustainable and longer-term inflation risks expected to rise.

Supply has shifted down the yield curve in recent months to the short-term commercial paper market from medium-term notes, while yields in the secondary markets have surged far above the primary markets for both sections of the curve.

These shifts are the clearest signs in China's debt markets that loose monetary policy is expected to be unwound in coming months, despite the authorities' continued insistence -- most recently in a central bank statement after last week's economic data -- that they will stick to a loose policy stance and keep sufficient liquidity in the banking system.

"Liquidity is expected to tighten, so people don't want to invest in commercial paper. The primary and secondary market yields are likely to stay inverted into next year," said Shi Lei, analyst in Bank of China Beijing.

Chinese commercial paper has tenors of up to one year and is generally used by companies to buy materials or manage working capital, while medium-term notes are used primarily to finance long-term investments.

But firms are shifting from medium-term notes to shorter-term commercial paper as expectations for an eventual unwinding of ultra-loose monetary policy have caused a sharp steepening of the yield curve, hiking firm's fund-raising costs in longer tenors.

Commercial paper issuance rose to 160.2 billion yuan ($23.5 billion) in the third quarter from 57.4 billion yuan in the second, while medium-term note issuance fell to 132.7 billion yuan from 275.4 billion yuan, according to a third-quarter bond report by the National Association of Financial Market Institutional Investors (NAFMII), a unit of the central bank.