China’s Debt Hits Close To Home

THIS BYSTANDER HAS been far from alone in highlighting the tightrope that China’s policymakers have to walk between stimulating growth and accumulating more debt as they manage the structural slow down of an economy switching from industrial to services-led growth and facing adverse demographic changes.

Thanks in  part to the People’s Bank of China (PBOC)’s counsel of restraint, driven by the central bank’s twin concerns of the debt bubble bursting and inflation getting out of hand and its measured but steadfast drive for financial sector liberalisation, Beijing has been selective in its stimulus measures to keep a slowing economy expanding at a sufficient pace to hit the official 6% GDP growth target for this year and the larger one of doubling total and per capita GDP between 2010 and 2020.

While the plan has always been to manage a slowing of the economy as it rebalances towards a more sustainable long-term growth model, the impact of the trade and technology disputes with the United States on world trade have put at risk the 5.5-6.0% growth China needs to achieve in 2020 to hit the overarching decade-long goal.

Earlier this month, the central bank cut its lending rates for the first time in three years. The cuts were a token five basis points for the five-year, one-year and seven-day loan rates. There remains plenty of headroom for further monetary stimulus, but not the appetite, on the central bank’s part at least, to occupy it.

Taking a barb at the United States, PBOC Governor Yi Gang said in September that “unlike central banks of some other countries, we are in no hurry to resort to a considerable interest rate reduction or QE policy”. Yi is keeping his powder dry, in the event that significant rate cuts do become necessary to provide monetary stimulus. Yet his priority is to deleverage the economy, or at least in current circumstances to maintain a “stable leverage ratio…to ensure the debt sustainability of the entire society”, as he put it at the same press conference.

In its latest annual financial stability report released this week, the PBOC gave a stark warning about the potential systemic risk in the buildup of household debt, whose total now equals total household income. One figure that caught this Bystander’s eye was the central bank saying that household leverage had hit 60.4% of GDP at the end of 2018. The Bank for International Settlements had pegged the ratio at 54% (four percentage points higher than in the EU, by way of comparison).

The PBOC is particularly concerned about the growth of mortgages and consumer loans. It has warned previously of the buildup of corporate and local-government debt, but turning its spotlight on household debt is a notable change of focus. Easing of mortgage lending standards to boost property investment and the use of consumer credit to increase retail sales have been the main stimuli of growth in recent years. Rising household incomes make the rise in consumer loans manageable for now, although further buildups would test that assumption, especially among low-income households.

A new IMF working paper on China’s household debt notes that

High household indebtedness could constrain future consumption growth and increase financial stability risks…we find that low-income households are most vulnerable to adverse income shocks which could lead to significant defaults. Containing these risks would call for a strengthening of systemic risk assessment and macroprudential policies of the household sector. Other policies include improving the credit registry system and establishing a well-functioning personal insolvency framework.

Regardless, further consumer-focused fiscal stimulus is likely, perhaps a second income tax to follow last year’s 420 billion yuan ($59 billion) one, and the reintroduction of subsidies for electric and hybrid vehicles.

It is the rise in mortgage loans that more concerns PBOC policymakers. Mortgages account for more than half of all consumer debt. There is evidence that they are inflating a speculative bubble, as well a making affordable housing a politically sensitive issue. Nearly two-thirds of outstanding mortgage debt is accounted for by families owning at least two properties. Some of last year’s tax cut has gone into savings rather than retail consumption, with the saving being in the form of property investment.

This all comes against the background of the crackdown on shadow banking, which included unlicensed digital-payments businesses, online lending and other internet finance companies, in the process shutting down all cryptocurrency trading platforms and more than two-thirds of online peer-to-peer lending platforms.

This has split over into the formal banking sector. Three regional banks, Baoshang Bank, Hengfeng Bank and the Bank of Jinzhou, have needed bailouts this year. Up to 30 more have been late in filing financial accounts required by regulators, suggesting further bailouts to come. In addition, corporate bond defaults this year will likely exceed last year’s record.

The ‘big-four’ state-banks are financially robust enough that any such losses can be absorbed without systemic risk. However, having spent several years engineering higher bank asset quality and lending standards, the PBOC will not want to put the big banks in the position of having to underwrite other institutions’ bad debts. Yi has been clear that any can carrying at a troubled financial institution should be done by its shareholders, not the state via the big-four banks.

Part of the exercise in risk management will require financial-markets reform and further opening to foreign investors. China has moved steadily but cautiously on that. The addition of Chinese stocks to MSCI’s benchmark indices and the likelihood that other index providers will follow suit, adds new urgency.

The changes will bring an inflow of foreign capital into Chinese equities of at least $40 billion this year and, on best guesses, a further $30 billion in 2020. That will provide a welcome influx of capital, particularly for companies in the private sector. It will also offer some relief for a central government whose consolidated deficit, the IMF forecasts, will grow to 6.1% of GDP this year and next, from 4.8% of GDP in 2018. As the late US banker Walter Wriston famously said, “capital will go where it is wanted, and stay where it is well-treated.”

China Readies A New Era In Financial Policymaking

THE GOVERNANCE REORGANISATION rubber-stamped by the recently concluded National People’s Congress has significantly changed the policy-making and regulatory landscape of the financial system.

As with other parts of the administration, it has consolidated agencies and strengthened the Party’s leading role over state administration.

The People’s Bank of China (PBOC) has emerged as the institutional lynchpin of the system with the banking and insurance industry regulators merged into the new China Banking and Insurance Regulatory Commission (CBIRC) and now reporting to the PBOC.

The central bank will be headed by Yi Gang, previously deputy to Zhou Xiaochuan, now 70 and who is retiring after 15 internationally respected years as governor. Yi nominally reports to the Standing Committee of the NPC but in effect to Liu He, long President Xi Jinping’s closest economic advisor and now elevated to vice-premier in charge of economic policy.

This all leaves China’s prime minister, nominally the country’s second-ranking official and customarily the one responsible for running the economy, pretty much out of the picture. That has been the de facto case for some time as Liu has been steering financial and economic policymaking from the leading group on the economy.

As vice premier, his remit will run to the financial sector, state-owned enterprise reform, industrial policy and relations with the United States. The remit underlines the twin challenges that China faces from a level of debt approaching 300% of GDP and in dealing with a United States that seems ready to start a trade war if that is what it thinks will let it get the upper hand in what the Trump administration sees as the United States existential struggle with China.

Liu’s academic credentials and worldliness are immaculate for a policymaker. However, his bureaucratic experience does not match. Yi’s promotion at the PBOC signals not only policy continuity at the central bank as it tackles deleveraging but the need for operational expertise, which Yi, a 21-year veteran of the central bank, brings.

Similarly, the appointment of Guo Shuqing as the Party boss in the central bank, and thus Yi’s senior in its political hierarchy, adds another experienced and tough-minded financial regulator to the mix — not to mention another ally of Xi’s.

Guo also heads the new CBIRC, previously having been chairman of the China Banking Regulatory Commission where he led the crackdown on shadow financing and helped clean up the interbank lending market. He has also been prominent in taming the more ambitious overseas acquisition ambitions of some Chinese companies and has experience as a stock market and foreign exchange regulator.

How the duopoly at the head of the PBOC will work in practice is illustrated by the fact that Guo also becomes deputy governor, with the ‘reform’ mandate, while Yi has been appointed deputy Party chief.

Zhou combined both the Party boss and governor’s role (although the foreign ministry has a similar split arrangement.)

China has no truck with Western notions of central bank independence as given to the US Federal Reserve, the Bank of England or the European Central Bank. The PBOC is subordinate to the government, which in the Xi era means evermore to the Party as he strengthens the Party’s leading role.

In that light, it will be Liu who will be setting the direction of, and Yi who will be running China’s financial and monetary policy with Guo ensuring regulatory and supervisory coordination on the one hand and political coordination on the other.

All three men are long-standing advocates of financial liberalisation. However, there are urgent short-term issues to resolve, notably the United States and debt, that will slow progress toward liberalisation. Cautious opening up of access to the financial system to foreign investors and more internationalisation of the yuan will continue, albeit not at the cost in either case of deregulation elevating financial risk.

One of the reasons for the consolidation of the supervisory agencies is to cut out as much as possible the regulatory fragmentation that has allowed the shadow banking system to take root. Financial stability is the political priority right now. The marching orders from the trio’s now all-powerful boss are to clean up the debt and rebalance the economy without crashing it — or having the United States crash it for them.

China Pumps Up Its Currency, But To What End?

China’s most recent manufacturing data showed recovery spluttering with exports soft, yet the yuan follows that by hitting a 19-year high agains the dollar. More intriguingly, the People’s Bank of China has let the currency rise within the allowable limits of its daily trading band; the yuan can rise or fall by 1% from a daily reference rate fixed in the morning by the central bank.

The yuan certainly isn’t off the leash, but the central bank is giving it more latitude of late than it has in the past. The currency has gained five times as as much so far this year as it did in all 2012. The question is whether this is part of the central bank’s preparations to open further China’s capital account, a next step being to widen the daily trading band of the currency. Those of that view latch onto the words of PBoC deputy governor Yi Gang who told last month’s annual meeting of the International Monetary Fund in Washington that the band would be widened “in the near future.” The previous revision was announced in April last year, when the band was doubled.

Another doubling might  be on the cards. If it is, it would most likely be to get the currency swiftly to an equilibrium level with the dollar as much as anything. The aim would be to discourage the present one-way bet on appreciation that currency speculators now regard the yuan to be. Policy makers are exasperated by that. They  consider the yuan to be close to where it should be against the dollar (real trade weighted value might be another thing, though). Except in exceptional circumstances most freely convertible currencies aren’t so volatile on a daily basis that they bounce around in a 4% range, so there doesn’t seem much need to widen the band just to accomodate regular daily trading fluctuations.

The Dollar And The Yuan, Not A Turkish Delight

The finance ministers’ meetings in Istanbul over the weekend revealed a deep crack in the veneer of harmony over the global financial crisis that the world’s leading economies have been seeking to present to the world. Ministers from the seven largest rich nations urged China to take steps to strengthen the yuan, a move Beijing has resolutely declined to undertake since the crisis broke. Yi Gang, a Peoples Bank of China vice governor, who was also in Istanbul for one of the plethora of finance-related meetings, made it clear that wasn’t going to change anytime soon: Beijing’s policy would continue to emphasize stability for now, for all the intention it says it eventually has to free up the yuan, which its critics now hold is undervalued.

This now sets up an interesting confrontation in the foreign-exchange markets. The U.S. dollar has fallen by 15% on a trade-weighted basis over the past six months. The G7 has as good as said it will not intervene to prevent it continuing to decline. China is not going to let that happen, at least not against its own currency: This commentary on Xinhua about what it calls the “G7’s RMB complex” gives a flavor of its mood.

Beijing can manage holding the line (the dollar/yuan rate has barely budged since the crisis began) but  it will have to deal with the consequent hot money and inflation implications even as it faces down the forex traders.

Long-term Washington wants and needs a strong dollar, especially if inflation becomes not just a clear but also a present danger as the economy recovers. For now, at least, it is in the U.S.’s interest, to keep its currency low to shore up exports, particularly those of its beleaguered manufacturers, and to lower the value of the debt that the U.S. Treasury is piling up. Similarly, it is in China’s near-term interest to keep its currency stable (for which read low)  to shore up exports, particularly from its beleaguered manufacturers, and to protect the value of the U.S. Treasury debt it is piling up. Though, of course, neither would admit it.

Higher Yuan Signaled

Another signal from the central bank that it will let the yuan rise faster this year to stimulate domestic demand as part of its fight on inflation, now at an 11-year high.

The Peoples Bank of China’s latest monetary policy report says currency appreciation will play a bigger part in a push to tighten monetary policy, along with higher interest rates and slower money growth. The central bank has already let the currency reach its highest level since the mid-2005 scrapping of its dollar peg in favour of a (highly) managed float. The yuan gained 7% last year versus the dollar, twice its rise in 2006. Analysts are forecasting a 12% gain this year.

Central bankers are struggling to sterilize the inflationary impact of the reserves piling up as a result of the country’s current-account. But now that short term interest rates are higher in China than the U.S., policy makers also worry that the prospect of further currency gains will suck in hot money.

PBOC vice governor Yi Gang told a financial conference in Beijing on Sunday that the fallout from the U.S. subprime mortgage mess and the severe winter that has hit central and southern China posed threats to growth (though with the economy growing at 10% plus such worries are relative) , “but taking into consideration all of these changes, we still think inflation is our biggest threat and we should spare no effort to tame prices.”