By Shen Hong

SHANGHAI--Anxiety is lingering in China's money market after Beijing showed no signs of reversing its effort to use higher interest rates to rein in the speculative investment threatening to destabilize the financial system and derail long-term economic growth.

Borrowers and lenders remain edgy after the Chinese central bank held off injecting cash into markets for the second day in a row, ending a three-day streak of pump priming this week. As a result, short-term funding costs remain close to levels unseen in more than two years, testament to Beijing's resolve to reduce its economy's unhealthy reliance on cheap credit and ballooning debt.

"What the central bank is doing is a proactive choice, which sends a clear message to markets that they aren't getting what they want," said Ding Shuang, an economist with Standard Chartered in Hong Kong.

The People's Bank of China on Friday resumed its tightening in the money market by withdrawing a net 30 billion yuan ($4.36 billion) via its daily liquidity operation. After injecting 110 billion yuan between Monday and Wednesday to meet a seasonal surge in cash demand, it ended the largely symbolic gesture Thursday by switching off the tap again.

A mini funding squeeze jolted China's financial system this week, as banks and other financial institutions scrambled for cash to make tax payments and set aside extra money for regulatory requirements on capital. Talk of loan defaults among several small rural lenders Tuesday turned nervousness into panic, sending the cost of seven-day interbank loans, a benchmark indicator known as repurchase agreements or repos, to a 26-month high of 5.01%.

The situation has eased somewhat in the past two days amid market chatter that the PBOC has asked large state banks, which usually act as its agent bank for covert market intervention, to release more funds into the market to quench the thirst.

But the PBOC's latest move to resume liquidity draining revived concerns about a short supply of cash, at least in the near term. The seven-day repo rate shot back up to 4.87% at midday Friday, from 4.13% on Thursday.

"Again, it shows that deleveraging and prevention of risk in the financial system remains the top priority for policy makers in Beijing," said Suan Teck Kin, senior economist at United Overseas Bank in Singapore.

The PBOC has raised a suite of key short-term interest rates, including the seven-day repo rate, twice since late January, despite a slowing economy that theoretically requires the help of cheaper borrowing costs for businesses.

But since the country's worst stock-market crash, in 2015, Chinese leaders have looked increasingly determined to rein in debt-fueled speculative investment that has inflated prices in the past year for everything from bonds to iron ore and garlic, even at the expense of weaker economic growth.

The PBOC doesn't want to cause panic, but it does want to use higher funding costs to punish financial institutions that have taken on excessive leverage at already-high costs, said Mr. Ding. "Providing more liquidity would have been the easiest thing for the PBOC to do to appease markets, but obviously that's not on the table now," he said.

Write to Shen Hong at hong.shen@wsj.com

(END) Dow Jones Newswires

March 24, 2017 02:52 ET (06:52 GMT)

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