Default Swaps Jump Most Among BRICs as Inflation Breaches 5%: China Credit
Chinese President Hu Jintao
Toshiyuki Aizawa/Bloomberg
Chinese President Hu Jintao.
Chinese President Hu Jintao. Photographer: Toshiyuki Aizawa/Bloomberg
Investor perceptions of China’s credit are worsening at the fastest pace among the largest emerging markets on concern policy makers will slam the brakes on economic growth to curb inflation.
The cost to insure against default on Chinese government debt in the past month advanced 13.5 basis points, more than in any of the so-called BRIC markets, according to CMA prices. Brazil’s similar five-year contracts increased 10 basis points, while those for Russia climbed 4 basis points. Bond risk for the State Bank of India, the benchmark for the nation’s sovereign risk in the absence of sovereign dollar securities, rose 1 basis point. The derivatives are used to speculate on market performance as well as hedge against non-payment.
Inflation accelerated to 5.1 percent in November, the fastest in 28 months, adding pressure on the central bank to raise interest rates, threatening expansion that’s averaged more than 10 percent in the past five years. The government pledged to focus on stabilizing prices and maintaining “relatively fast” growth after President Hu Jintao and Premier Wen Jiabao attended an annual economic policy meeting in Beijing on the weekend.
“If you look at China risk in the last two or three weeks we’ve seen a fairly pronounced reversal in trends evident for the last six months,” said John Woods, the Asia chief investment strategist at the private banking unit of Citigroup Inc. “China’s golden era of low inflationary growth, underpinned by compliant domestic savers and enthusiastic external consumers, could well be at an end.”
Reserve Ratio
Policy makers increased banks’ reserve-ratio requirements by 50 basis points, or 0.50 percentage point, on Dec. 10 -- the third time in five weeks -- in a bid to cool lending. They raised interest rates in October for the first time since 2007.
Inflation for the first 11 months was 3.2 percent, more than the government’s full-year target of 3 percent, a statistics bureau report showed on Dec. 11. Producer prices climbed 6.1 percent in November, more than any of 28 economists surveyed by Bloomberg News had estimated.
The spread between China’s dollar bonds over Treasuries as measured by a JPMorgan index widened to 150 basis points at the end of November, its highest level since May 2009, from 87 basis points on Nov. 1, indicating investors are more concerned about deteriorating credit quality. It was at 119 on Dec. 10.
Cooling the Economy
Five-year default swap contracts on the nation’s bonds rose to 71.5 basis points, from a two-year low of 52 basis points on Oct. 13, according to data compiled by CMA. Timothy Ash, an analyst at Royal Bank of Scotland Group Plc, predicted this month that the swaps may trade as high as 150 basis points next year and recommended investors buy them as a hedge.
“China is trying to cool things down and manage a deflation of the bubble,” Ash said in a phone interview from London. “If that fails then that’s how CDS gets driven up, because concern will be that the sovereign balance sheet will have to bear the costs of restructuring banks.”
The net amount of protection bought and sold on Chinese government debt with credit swaps has doubled over the last year, according to the Depository Trust & Clearing Corp., which runs a central repository for the market. The net notional value of swaps on China has risen to $4.6 billion as of Dec. 3, from $2.3 billion a year earlier, the DTCC data show.
Food Prices
Credit-default swaps typically decline as investor confidence improves and rise as it deteriorates. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to debt agreements.
China’s inflation mostly stems from food, not a broad-based increase in all products, Donald Straszheim, International Strategy & Investment Group’s head of China research, said in an e-mail. The biggest risks to China are from Europe, the U.S. and Japan, he said.
“The insurance ought to be bought on the prime mover, not on one of the down-the-line casualties like China,” he said.
Nick Chamie, global head of emerging markets research at RBC Capital Markets, said buying a basket of credit default swaps on Latin American bonds where China is a major buyer of commodities is a good strategy for investors.
Yuan Gains
The yuan had its biggest weekly gain in almost a month last week, climbing 0.12 percent, on speculation China’s central bank would raise rates to temper inflation after a report showed export growth beat economists’ estimates. The currency fell 0.17 percent to 6.6670 as of 4:18 p.m. in Shanghai, as China delayed increasing borrowing costs. Twelve-month non-deliverable forwards fell 0.02 percent to 6.5121 reflecting bets the yuan will gain 2.4 percent in a year.
The one-year swap rate, the fixed cost needed to receive the floating seven-day repurchase rate, declined for the first time in four days, dropping five basis points to 3.09 percent. The benchmark 10-year yuan government bond yield fell one basis point to 3.84 percent. Exports increased 35 percent in November to $153.3 billion from a year earlier, compared with 22.9 percent in October, the customs bureau reported on Dec. 10.
China will step up management of local-government debt and prevent officials “blindly” starting new projects as the next national five-year plan begins, Xinhua News Agency reported yesterday. Officials will also seek to better manage liquidity, the news agency said after the Central Economic Work Conference.
Loan Targets
The government is likely to set a target of at least 7 trillion yuan ($1.1 trillion) of new loans for 2011, down from 7.5 trillion yuan this year, said two people briefed on the matter. The government also aims for 4 percent inflation, 8 percent economic growth and 16 percent money supply expansion for next year, the people said, declining to be identified because the information isn’t public.
Yields on China’s $1 billion of 4.75 percent due October 2013 notes rose nine basis points to 1.624 percent this month, RBS prices show. Brazil’s $1.25 billion 10.25 percent notes due June 2013 yield 1.6 percent, according to Bloomberg data, while Russia’s $2 billion 3.625 percent due April 2015 yield 3.3 percent, according to RBS.
“The potential of a slowdown in China following a sharp policy response to inflationary trends is arguably the greatest risk to the global economy at the moment,” said Daniel Arbess, who manages the $2.4 billion Xerion fund for Perella Weinberg Partners in New York, in an e-mailed comment.
To contact the editor responsible for this story: Will McSheehy at wmcsheehy@bloomberg.net
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