The View

Enigmas abound in China’s financial markets

PUBLISHED : Monday, 18 May, 2015, 8:38am
UPDATED : Monday, 18 May, 2015, 8:38am

There are a number of fascinating market mysteries in China at the moment. Why, for instance, has the renminbi held up despite large capital outflows and even as the US dollar rally has knocked other Asian currencies hard?

Why is a dour, “Chinese values,” no-flashy-cars-allowed administration allowing everyone and their grandmother to leverage up and make speculative and decadent profits in an explosively rising stock market?

And in light of that equity market, why is China purportedly experiencing such hefty capital outflows, estimated at 5.6 per cent of GDP in the first quarter of this year.

In research last week the investment bank Jefferies noted another little enigma.

Why, if there is a supposed “mini-stimulus” going on, are China’s leading infrastructure plays not signing more new contracts?

In the first quarter of this year, new contracts in infrastructure were down 9 per cent compared to the same period in 2014, which analysts Johnson Leung and Charles Cheng described as “alarming” in a report published last week.

“The media has us believe the NDRC [the state planning body] has approved so many infrastructure projects that it may amount to a mini stimulus. Then why are the constructors not getting more new contracts?”

One possibility is that the government and private investors may be in a stand-off over terms of the newly launched public-private partnership initiative. That means even projects that have been approved are not yet going out to tender and “the local governments may be short of funding to go it alone with those projects,” Jefferies says.

Or to put it more bluntly: construction firms are not going to tender for pump-priming infrastructure projects whose returns look iffy. Nor are banks going to provide the financing. If the government wants to do stimulus, it will have to either rely on government funding, or put a gun to the heads of country’s listed construction firms.

Corporate caution may be just half the story. The rest of the story is the NDRC has not actually given the green light for an array of infrastructure projects. It seems the purported “mini-stimulus” is all talk and no action.

Railway makes up the majority of approved projects, but even here approvals suggest only flat capital expenditure in the sector. As to toll roads and other types of projects, approvals are down, according to Jefferies.

Much was made last week of sluggish economic data figures for April, including news that fixed asset investment (FAI) growth dropped to 12 per cent YoY in the first four months of the year, down from 13.5 per cent YoY in the first three months

Many brokers still expect further fiscal expansion, at least at the central government level. Meanwhile, authorities are focused on opening up local government financing channels, such as developing the municipal bond market and also swapping out troubled loans. Yet even if decelerating, fixed asset investment is still expanding at a pace that is much faster than overall GDP growth.

And this might partly explain why the NDRC has been hesitant to approve new infrastructure projects. As Jefferies put it: maybe the state planning agency, just like some shy private investors, “also does not see many economically viable infrastructure projects to be built.“

The government has, of course, stated that it intends to reduce the country’s economic reliance on gross capital formation. But then in the face of declining growth, the government appeared to cave in – cutting rates, encouraging banks to lend and publicly discussing “selective” areas of renewed infrastructure investment.

Gross capital formation is still half of GDP, but there’s little evidence that planned expenditure on everything from rails to roads to power stations is slated to expand at a “stimulating” pace. Which in the long run is perhaps a good thing, since overcapacity is a famous and blatant problem.

But in the short run, it means that sector stocks are ignoring new contract activity, or taking a leap of faith that the situation will change.

“The infrastructure constructors are expensive due to lack of sustainable growth ahead,” Jefferies said. This includes the rails firms - China Railway Construction Corp and China Railway Group as puffed up on exaggerated hopes of bonanza rail spending, in Jefferies view.

The million dollar question is whether authorities end up turning to residential property to boost construction activity and economic momentum.