China corporate debt dumped as rates surge, lifting firms' borrowing costs
As banks protect themselves after interbank rates jump, Chinese companies are paying more for loans - prompting many to defer bond sales
China's decision to tolerate the worst cash crunch on record is evolving from a stress test of banks into a threat to the ability of companies to raise funds.
As their overnight borrowing costs neared 13 per cent, banks switched focus towards shoring up their own finances and slashed investments in the bond market they dominate. The one-year yield on AAA corporate debt jumped a record 121 basis points, or 1.21 per cent, this month to 5.15 per cent, ChinaBond indices show. Bond sales slumped to 157.9 billion yuan (HK$200 billion) in June, the least in 17 months and down 57 per cent from May.
China's cabinet, led by Premier Li Keqiang, said following a June 19 meeting that finance companies must do more to support economic transformation and reduce risks, after administrative measures to crack down on property and local government investment failed to halt the accumulation of debt. The timing of the credit squeeze has puzzled economists since official data shows a worsening contraction in manufacturing, easing inflation and a slowdown in foreign investment inflows.
"The current level of tightness in real market rates is excessive and, if continued, may disrupt growth rather than make it more balanced," said Dariusz Kowalczyk, a strategist in Hong Kong at Credit Agricole CIB. "Balancing growth would be achieved easier by boosting consumption, not by restricting credit. I think they will ease monetary settings soon, via open-market operations or reserve-requirement ratio cuts."
The central bank has refrained from adding funds to the financial system and sold two billion yuan of notes on Thursday to drain capital, even as money market rates hit a record high. The World Bank, HSBC, Morgan Stanley and UBS cut 2013 gross domestic product estimates for China this month.
Yuan forwards fell the most in five weeks on Thursday after Federal Reserve chairman Ben Bernanke said the central bank may reduce monetary stimulus that helped spur fund inflows to emerging-market assets. More than US$19 billion has left funds investing in developing-nation assets in the three weeks to June 12, the most since 2011, according to US research firm EPFR Global. Foreign direct investment in China rose in May by the least in four months.
The one-day repo rate surged as much as 604 basis points, or 6.04 percentage points, to a record high of 13.12 per cent on Thursday, according to the weighted average of quotes from the National Interbank Funding Centre. The yield on China's 10-year government bonds has risen 26 basis points this month to 3.7 per cent yesterday, while the rate on one-year debt climbed 69 basis points to 3.56 per cent.
Regulators are forcing trust funds and wealth-management plans to shift assets into publicly traded securities, taking so-called shadow banking funds away from property developers and local government finance vehicles. The China Banking Regulatory Commission told banks in March to cap investments of client money in debt that is not publicly traded at 35 per cent of all funds raised from the sale of wealth-management products.
Shadow banking has thwarted efforts to rebalance the economy. The increase in money supply has exceeded the government's 13 per cent target every month this year, rising 15.8 per cent in May. Aggregate financing - a measure of credit that includes trust loans, stock and bond sales - totalled 9.1 trillion yuan in the last five months, a 50 per cent jump from the first five months of 2012.
"The PBOC clearly has an agenda here," said Patrick Perret-Green of Mint Partners in London. "To fire a massive warning shot across the banks' bows and to see who is swimming naked."
He added that the moves fit in well with President Xi Jinping's disciplinarian approach. Since becoming president in March, Xi has vowed to combat corruption and promised a "thorough cleanup" of the ruling Communist Party.
The central bank is trying to exert its influence over shadow banking activities through its executive powers as it waits for tougher regulations to be put in place, said Marshall Mays, director at Emerging Alpha Advisors. Policymakers want to create a credit spread for corporate bonds that better assesses risk, while keeping support for some state-owned enterprises, he added.
"This is a wake-up call for the SOEs," Mays said in an interview from Manila.
"A more cynical interpretation is that the new government is starting by setting a harsh hurdle for all and offering those who will come to the new throne and kiss the new emperor's ring a chance at a lower hurdle."