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Bonds

China’s finance regulators walking a fine line after year of indecision over inflating bubbles

China’s economic balancing act is becoming ever more perilous and any regulatory stumble could trigger a vicious downward spiral

PUBLISHED : Wednesday, 11 January, 2017, 5:46pm
UPDATED : Wednesday, 11 January, 2017, 10:59pm

Top of the agenda for China’s financial regulator in 2017 is to deflate various economic bubbles without crushing them.

The steepest yuan depreciation in more than two decades, runaway house prices, booming bad loans, and a sudden bond market rout by at the end of last year suggested financial risks surged in China in 2016, after years of easy credit.

As the US enters an interest rate-rise cycle, and while China is still struggling to fix an economic structure still heavily relying on investment while facing downward pressure on maintaining its GDP target, the top priority for China’s policy makers in 2017 is to curb those bubbles, while at the same time avoid triggering any other major systematic turbulence –and that’s going to be tough ask, say analysts.

“It is crystal clear that those bubbles cannot be inflated any more, but they cannot be allowed to burst either,” said Hong Hao, chief strategist with Bocom.

“The central government’s balancing act is becoming more and more difficult, as it has to monitor too many more things: the currency, housing, and the bond and stock markets… any stumble could trigger a vicious downward spiral,” he said.

The central government’s balancing act is becoming more and more difficult, as it has to monitor too many more things: the currency, housing, and the bond and stock markets… any stumble could trigger a vicious downward spiral
Hong Hao, chief strategist, Bocom

Early signs of the jitters have already started to appear in China’s US$9 trillion bond market.

The sudden bond sell-off at the end of last year triggered a chain reaction among brokerage firms, funds and banks, as panicky investors – both individual and institutional – rushed to cash out their investments packaged up as bond-related wealth or asset management products.

Bond prices first started falling in November, as the People’s Bank of China (PBOC) decided to steer money-market rates higher to encourage deleveraging, and to cushion the falling yuan.

Those falls then morphed into a record sell-off of government bonds in early December, as well as an intensive wave of defaults by corporate bonds, as bearish sentiment deepened after Donald Trump won the US presidential election, pushing up expectations of a more hawkish approach to interest rates.

Hong thinks the central bank actually meant just to squeeze liquidity to force out risky investments based on high leverage – but that caused bigger-than-expected volatilities, forcing it to inject further liquidity into the market.

More than 165 billion yuan and 90 billion yuan were poured in on December 20 and 21 respectively, via open market operations – the buying and selling of government securities in the open market in order to expand or contract the amount of money in the banking system – before bond futures rebounded, stabilising the debt market.

“The bond market is still only temporarily stabilised for now using big fresh liquidity injections. But further volatility may return again this year,” he said, adding with the Fed raising interest rates and Trump introducing more economic stimulus policies after assuming the presidency, bonds may again drop sharply.

Li Yimin, a senior analyst with Shenwan Hong yuan Securities says the key dilemma facing the PBOC is on the one hand it is under pressure from the decision makers to squeeze out dangerous leverage in the economy, while on the other prevent “any over tightening of liquidity that might trigger systemic volatily”.

That situation has deteriorated over the past few years, with the flood of easy credit effectively fuelling the runaway growth of the financial sector.

The latest economic data shows China’s real economy is plagued with industrial oversupply, while new economy growth is not fast enough to make up for older economy industrial losses.

But as China’s finance sector continues growing, so does the risk of bursting bubbles.

The added value contribution to GDP by the financial sector had surged to 9.2 per cent by June, up from 5 per cent in 2007, dwarfing the US (7 per cent), and Japan (5 per cent), the official Chinese Securities Times reported in August.

Debt carried by non-financial corporates has already surpassed 130 per cent of GDP, ranking China high among major economies, according to leading government think-tank, the China Academy of Social Sciences (CASS).

Non-performing loans (NPLs) among Chinese banks accounted for 1.76 per cent of gross loans at the end of September, up from 1.67 per cent at the end of last year and 1.25 per cent at the end of 2014, Moody’s reported in December.

Another major challenge, meanwhile, is to clearly define the powers and responsibilities of the different authorities overseeing the different markets, said Liu Shenjun, deputy director of the CEIBS Lujiazui Institute of International Finance in Shanghai.

Some authorities will be unwilling to relinquish their existing powers, while others will be eyeing more. Separate industry players involved will be lobbying purely for their own interests
Liu Shenjun, deputy director, CEIBS Lujiazui Institute of International Finance

“Obviously China’s financial regulatory framework is crying out for reform, but that’s being stymied, mainly due to the complicated network of interested groups involved,” he added.

“Some authorities will be unwilling to relinquish their existing powers, while others will be eyeing more. Separate industry players involved will be lobbying purely for their own interests,” he added.

Criticisms against the current regulatory framework started swirling in the summer of 2015, when a bull run abruptly ended on the Chinese stock market, wiping trillions of yuan in value from the market in two days.

The securities regulator was caught flat footed, and was heavily criticised for not finding and then handling the huge leveraged capital inflow into the shadow banking sector quickly enough.

Last year, again, fresh turmoil swept listed companies as deep-pocketed insurers began snapping up shares – including in the country’s then-biggest property developer China Vanke – in an effort to improve their earnings, by making short-term stock investment gains.

Once again, the regulators were caught short, and criticised for their slowness in stepping in to curb the practice.

President Xi Jinping, as early as October 2015, raised the issue that the “existing regulatory framework does not fit the development of China’s financial industry”, and urged reform to prevent systemic risk growing, during a meeting with senior party members.

Regular discussions have since been held on how the PBOC can work more effectively with the three main bodies overseeing the securities, insurance and banking markets, and how their structures could be reshuffled to allow better information sharing and coordination.

But according to experts little concrete progress was made on either front last year, meaning the pressure is well and truly on, to get their heads together and follow Xi’s lead in creating not only a more efficient framework, but more effective mechanisms, should further financial crises emerge.

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