Down but not out

China money market craze slower but not over

China's money market craze has slowed but it is far from over. Funds like the one linked to e-commerce giant Alibaba grew less quickly during the second quarter. Falling yields, which track interbank rates, help explain the slowdown. But as long as bank deposit rates are capped, China's savers will continue to seek out other places to put their cash.

China's money market funds had 1.7 trillion yuan ($272 billion) in assets under management as of the end of June, Credit Suisse reckons, an increase of 148 billion yuan from the previous quarter. That's a sharp slowdown from the first three months of this year when net inflows were over four times as large. Alibaba's 574-billion-yuan Zeng Libao fund, the largest money market fund in China and the fourth-largest in the world, attracted just 33 billion yuan from April to June.

Falling interbank rates are largely to blame. The Chinese funds make a return by sucking cash out of regular deposit accounts and then lending it back to banks through the interbank market, where rates are set by the market. In January, a liquidity crunch caused interbank rates to jump over 200 basis points. As a result some funds were able to offer annualised returns of almost seven per cent. But interbank rates have since declined to 3.7 per cent, and yields offered by money market funds have remained below five per cent since May.

The slowdown offers some respite to banks alarmed by the loss of deposits. But it isn't the end of the fad. Official deposit rates are capped by law: An account that locks up money for one year pays no more than 3.3 per cent, while typical demand deposits pay only 0.35 per cent. Even at current yields of between four to five per cent, Alibaba's online fund is still more alluring than keeping money in the bank.

Chinese households still have almost 49 trillion yuan in personal deposits, so even a small shift can mean sudden inflows or outflows for money market funds. When the authorities finally liberalise bank deposits, money market funds will have to compete on a more level playing field. But as long as interest rates are kept in check, China's craze for these funds - as well as other investment products - will continue.