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Sun, 25th June 2017

Anirudh Sethi Report

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Archives of “Economy of the People’s Republic of China” Tag

MSCI Finally Adds China A Shares To Its Emerging Market Index

After three consecutive unsuccessful attempts by China to have its A Shares included in the MSCI Emerging Market index, moments ago the fourth time proved to be the charm, when MSCI finally relented and agreed to add China’s A shares to the much desired index.

  • MSCI WILL INCLUDE CHINA A SHRS IN MSCI EMERGING MARKETS INDEX

The news means that China’s $6.8 trillion domestic stock market will finally be added to the flagship EM index, forcing the $1.6 trillion in investment funds that track the index to buy mainland equities, even as they will likely remain dwarfed by overseas-listed Chinese stocks which have an increasing sway over MSCI’s developing nation gauge.

The inclusion comes as China’s Shanghai Composite Index has struggled to rise amid a government crackdown on risk in the financial sector and waning interest by the nation’s army of individual investors, who have instead discovered bitcoin and ethereum. The SHCOMP has fallen more 4% since its mid-April peak, sending correlation ratios with the rest of the world to below zero. It also means that China’s offshore shares have become the priciest relative to Shanghai since 2014.

Kyle Bass: “China’s Credit Bubble Metastasizing”, Still Short The Yuan

Hayman Capital’s Kyle Bass made a brief media appearance today, when he confirmed to Reuters that unlike some other “China tourist bears”, he remains staunchly negative on China, saying he is still short the Yuan because problems from China’s credit bubble are “metastasizing.”

Speaking to Reuters’ Jennifer Aboan, Bass said that “what the public narrative is and what they have been doing behind the scenes are two completely different stories,” and added that “China has been masterful controlling the public narrative. As a fiduciary, I have no idea how anyone can invest in China.

Discussing his specific trades, Bass said Hayman’s yuan short is a “core” position and has “always been meaningful.” He also identified “fresh” warning signs that China’s credit problems are spreading.

First, Bass pointed to the yield on five-year MTNs, which are trading at 5%, exceeding the bank loan rate, about 4.75%, for the first time. We first highlighted this paradoxical “cross” one month ago when we observed that “rising base funding costs and interbank credit risk concerns have pushed banks’ cost of borrowing beyond the rate they charge customers for loans for the first time in history.”

Bass then noted last month’s downgrade of China by Moody’s – the first since 1989 – which however did not have a material impact on China so far, aside from prompting a panicked response by Beijing which actually sent the Yuan surging as the PBOC engaged every trick in the book to prevent Yuan bears from gaining momentum, including the recent change in the Yuan fixing mechanism. Next, he discussed his concerns about China’s shadow-banking system and the country’s capital controls as “multi-nationals can’t get their money out.”

Indeed, CBRC vice-chairman Cao Yu said China established 12,836 creditor committees by the end of last year, to help manage credit of 14.85 trillion yuan. Bass said this amount represents 20 percent of the loans in Chinese banks, net of mortgages.

Going back to the original “bear” thsis, Bass also said he believes that non-performing loans at Chinese financial institutions are currently approximately 20%, not the 1.7% rate that has been widely reported. “14.85 trillion is more than all of the equity in the entire banking system,” he said. “The Chinese have masterfully swept all of this under the rug.”

Bass also addressed the recent change to China’s Yuan fixing mechanism and said Beijing has been looking to force out one-way bearish bets on the yuan with the previously discussed second change this year in how the currency’s guidance rate is calculated. “This fixing mechanism throws a bit of unknown into the calculation,” he said.

Still, he said he was not throwing in the towel on his short position. “The PBOC wants you to do that,” Bass said. “I don’t know how they can hold this all together. The numbers are telling me that we are right. The numbers are getting so bad so quickly.”

Finally, a couple other things Bass should have thrown in the mix are the recent reemergence of China’s “ghost collateral” as a major risk factor, one which as Reuters framed, “lax lending practices and overvalued collateral spurred the U.S. financial crisis in 2008. Now, banks in China face risks of their own as fraudulent borrowers and corrupt bankers burden the financial system with loans lacking genuine collateral.” There is also the recent, rapid rise in interest rates which as explained last night, has led to a record plunge in net corporate bond financing, as companies find it increasingly difficult to issue new and rollover existing debt, especially that maturing in under one year. 

Emerging Market :An Update

  • Moody’s downgraded China’s rating from Aa3 to A1 with stable outlook.
  • Reports suggest that the PBOC has informed local banks that it is changing the way it sets the daily fix.
  • Moody’s downgraded Hong Kong’s rating to Aa2 from Aa1 with stable outlook.
  • Philippine President Duterte declared martial law on Mindanao island.
  • Egypt’s central bank unexpectedly hiked rates by 200 bp.
  • S&P moved the outlook on Bolivia’s BB rating from stable to negative.
  • Reports suggest Brazil President Temer is losing support from his own PMDB.
In the EM equity space as measured by MSCI, Korea (+2.9%), Brazil (+2.7%), and Turkey (+2.6%) have outperformed this week, while Hungary (-2.9%), Indonesia (-1.3%), and UAE (-1.2%) have underperformed.  To put this in better context, MSCI EM rose 2.1% this week while MSCI DM rose 0.9%.
In the EM local currency bond space, Brazil (10-year yield -94 bp), South Africa (-12 bp), and Thailand (-10 bp) have outperformed this week, while Russia (10-year yield +12 bp), Colombia (+2 bp), and Mexico (+2 bp) have underperformed.  To put this in better context, the 10-year UST yield was flat at 2.24%. 
In the EM FX space, ZAR (+2.9% vs. USD), MXN (+1.3% vs. USD), and MYR (+1.2% vs. USD) have outperformed this week, while COP (-0.9% vs. USD), BRL (-0.4% vs. USD), and PEN (-0.1% vs. USD) have underperformed. 

Moody’s downgrades Hong Kong after China ratings cut

Where China goes, so goes Hong Kong.

Moody’s has cut Hong Kong’s local and foreign currency ratings by a notch to A1 on Wednesday just hours after it downgraded its rating on China amid concerns over the country’s rising debt and slow pace of economic reforms.

In a statement, the US ratings agency cites Hong Kong’s exposure to the mainland for the move. It said:

The downgrade in Hong Kong’s rating reflects Moody’s view that credit trends in China will continue to have a significant impact on Hong Kong’s credit profile due to close and tightening economic, financial and political linkages with the mainland.

In the nearly 20 years since Hong Kong reverted back to Chinese rule, the economic and financial ties between the two have tightened considerably. As Moody’s noted:

Directly, China accounts for more than half Hong Kong’s exports of goods, three quarters of tourist arrivals and 40 per cent of exports of services in general. Indirectly, Hong Kong is a very open economy with exports, the vast proportion of which are re-exports, accounting for nearly 190 per cent of GDP. Combined with China’s rising share in world GDP and global trade, Hong Kong’s very high openness to global trade intensifies the effective economic links between Hong Kong and China.

Financial linkages between Hong Kong and China are broad in nature and large in the size of the assets involved. The Hong Kong banking sector’s exposure to mainland China increased further in the second half of last year. Total mainland-related lending rose to HKD3.6 trillion at the end of 2016, up 3.5 per cent compared with last June, while other non-bank exposures also increased by 11.4 per cent to HKD1.2 trillion.

Nasdaq’s “Big 5” Stocks Near $3 Trillion Market Cap

Since President Trump was elected – much to the heart-crushing chagrin of the billionaire class in Silicon Valley and its epic funding of Hillary – the big 5 stocks of the Nasdaq (Alphabet, Amazon, Apple, Facebook, and Microsoft) have gained a stunning $675 billion in market cap.

This pushes them near $3 trillion and well over 10% of the entire US equity market…

For context, Bloomberg notes that is more than the total value of stocks in any single equity market worldwide except the five largest: the U.S., China, Japan, Hong Kong and the U.K.

China Reserves Jump Most In 3 Years to $ 3.03 Trillion

In all the drama surrounding the French elections, few noticed the PBOC’s announcement that China’s FX reserves rose for the third straight month in April, increasing by $20.45 billion to $3.03 trillion, more than the $11 billion expected and the single biggest monthly increase in three years going back to April 2014, on the back of a weaker dollar and increasingly more draconian capital controls on outflows.

Cited by the WSJ, some economists attributed April’s increase to a dollar that continued to decline in the past month especially after Trump said the U.S. currency “is getting too strong.” The value of other currencies in China’s reserve basket, including the euro, the British pound and Japan’s yen, similarly played a significant role in the rise, said Yan Ling, an economist with China Merchants Securities.

Besides USD softness (USD has weakened against the CFETS basket by over 2% year-to-date through April) and perhaps stronger RMB sentiment, the capital flow management measures introduced over the last several months have also contributed to the slowdown in outflows, Goldman speculated in a Sunday note. That could reverse, as there may be incremental relaxation of the capital account as the flow situation has improved and an overly tight capital account could hinder legitimate international trade and the authorities’ long-term RMB internationalization goals.

Yuan falling out of favor in global trade

Overseas use of the yuan for trade and other payments has fallen dramatically as government efforts to stem capital outflows sideline Chinese President Xi Jinping’s ambition to take the currency global.

Yuan trade settlement had surged after Beijing first allowed it in 2009, with the proportion of Chinese cross-border trade settled in the currency peaking at 27% in 2015. But its share fell to 19% in 2016, marking the first year-on-year decline, and slumped further to 14% in January through March of this year. Excluding trade with Hong Kong, where the yuan is often used, would likely push the figure even lower.

 The decline is not limited to trade. Cross-border yuan settlements in Shanghai totaled 441.3 billion yuan ($63.9 billion) in the January-March quarter, down 23% from a year earlier, data from the People’s Bank of China shows. This figure encompasses trade as well as other payments ranging from capital transactions to costs for studying abroad. Settlements have fallen by more than half on a quarterly basis since July-September 2015, when they reached 1 trillion yuan.

The yuan was used for just 1.8% of international payments in March, ranking sixth behind the U.S. dollar, euro, pound, yen and Canadian dollar, according to the Society for Worldwide Interbank Financial Transactions, or SWIFT. The Chinese currency had placed fourth in August 2015 with a 2.8% share, overtaking the yen.

Overseas yuan holdings are shrinking as well. In Hong Kong, the largest yuan hub outside mainland China, yuan deposits hit a six-year low of 507.2 billion yuan at the end of March. This represents a drop of nearly half from 1 trillion yuan in December 2014.

This trend stems mainly from stepped-up capital controls. The Chinese government has gradually imposed stricter curbs since 2015, aiming to rein in outflows and the ensuing softening of the yuan. A measure implemented last November made advance approval necessary for currency conversions or overseas transfers — including in yuan — exceeding $5 million.

China banks’ shadow assets exceed Mexico’s economy

It may be too soon to say that glimmers of hope can be seen in the quality of Chinese bank assets, considering they have off-balance-sheet assets that are collectively larger than the world’s fifteenth-largest economy.

The country’s six biggest commercial banks revealed this week that their off-balance-sheet assets — likely held through trusts and wealth management products — were worth 7.78 trillion yuan ($1.13 trillion) as of March — more than Mexico’s 2016 nominal gross domestic product of $1.06 trillion, or about a tenth of China’s economy.

 Bringing these previously hidden assets to light immediately boosts their already substantial balance sheets by 7-9%, and smaller banks’ by 11-13%.

The six are Industrial and Commercial Bank of China (ICBC), China Construction Bank (CCB), Agricultural Bank of China (ABC), Bank of China (BOC), Bank of Communications, and Postal Savings Bank of China.

Yet these “second” balance sheets also prompt questions on the significance of banks’ reported declines in nonperforming loan ratios as well as the sufficiency of their capital, since they were all under pressure to set aside more provisions for losses on impaired loans.

China greasing economy with $55bn in tax breaks

China’s State Council on Wednesday approved 380 billion yuan ($55.1 billion) in tax relief that will mainly favor farmers and small businesses in a move that is seen as both economic and political.

The second large-scale tax cut to follow last year’s comes as China’s economy is forecast to slow down in the latter half of 2017, during which the Communist Party will convene its 19th National Congress and reshuffle top leadership.

China will modify its value-added tax this July by removing the 13% bracket while retaining the 6%, 11% and 17% tiers. The 13% rate currently applies to farm products and natural gas, but they will move to the 11% category. Farmers as well as households that purchase rice and vegetables will likely benefit from this change.

For smaller companies, those that pay 300,000 yuan or less in annual taxable revenue qualify for preferential tax treatment. The ceiling will be lifted to 500,000 yuan. Furthermore, small businesses and startups will be allowed to deduct 75% of research and development costs, up from 50%. These tax breaks will remain in effect until the end of 2019.

The Chinese government enacted about 500 billion yuan worth of corporate tax cuts in 2016. Helped also by a surge in infrastructure spending, the real economy grew 6.9% during the January-March period this year, marking the second quarter of economic acceleration. However, the People’s Bank of China, the country’s central bank, has been gradually raising market interest rates in order to rein in the real estate bubble.

Japan – Trade balance for March: Y 614.7bn (expected Y 608.0bn)

Here’s the Trade balance for March, from the Ministry of Finance
Y 614.7bn
  • expected Y 608.0bn, prior was Y 813.5bn
Trade balance (adjusted): Y 172.2bn
  • expected Y172.0 bn, prior was Y 680.3bn
Exports for March y/y:  12.0% big BEAT
  • expected 6.2%, prior was 11.3%
  • fastest rise in exports since January of 2015
  • exports to US +3.5% y/y
  • to China +16.4% y/y
  • to Asia +16.3% y/y
  • to EU +1.4% y/y
Imports for March y/y:  15.8% and another big BEAT
  • expected 10.2%, prior was 1.2%
The improvement in Japanese exports continued in March.