China’s borrowing costs are climbing at the fastest pace since late 2010 and Bank of America Corp. says that’s making stocks vulnerable, just as it did back then.
The benchmark 10-year yield jumped 37 basis points this quarter and 48 basis points in the three months through September, the biggest increases since a 57 basis point gain in the final three months of 2010, a ChinaBond gauge shows. The Shanghai Composite Index slid 22 percent in 2011, after touching a nine-month high in November 2010, and shares are near the most expensive level relative to corporate bonds since February, according to data compiled by Bloomberg.
A stock slump would knock the wind out of a recovery in the world’s second-largest economy just as policy makers show signs of allowing the first initial public offerings since October 2012. The return of equity financing would provide a new source of funds as the government clamps down on unregulated lending to limit risk buildup at the nation’s banks.
“China’s stocks may come under selling pressure within weeks just as surging borrowing costs preceded tumbling markets in 2010-2011,” David Cui, a Hong Kong-based strategist at Bank of America, said in a Nov. 26 e-mail interview. The crackdown on lending is “different from a tightening in response to strong economic growth, which is often a positive sign for the equity market in the early part of the cycle.”
A People’s Bank of China pledge to prevent excessive leveraging has contributed to the surge in borrowing costs, with the monetary authority warning in a Nov. 5 report that the process of cutting debt ratios will continue for an extended period of time. The China Banking Regulatory Commission has drafted rules to restrict interbank financing, which escape internal risk controls, after imposing limits on wealth management products earlier this year and starting a nationwide audit of local government debt.
Aggregate financing, a measure of credit that includes trust loans, stock and bond sales, was 1.4 trillion yuan ($229 billion) in September, more than double the amount five years ago. The broadest measure of new credit fell to 856.4 billion yuan in October, suggesting authorities are trying to keep shadow-finance risks in check.
The enhanced supervision comes as the nation’s leaders look to speed up the liberalization of interest rates. The PBOC will free deposit rates when banks are able to use a new benchmark, such as the seven-day repurchase rate or a Shanghai interbank offered rate, as a gauge of funding costs, Deputy Governor Yi Gang said in an interview with the official Xinhua News Agency published on Nov. 26.
“This round of tightening is driven by the government’s desire to slow unbridled credit growth, especially in the shadow-banking sector,” Bank of America’s Cui said. “It could add to the corporate sector’s interest burden and make debt rollover more difficult. When growth starts to disappoint, we may see selling pressure.”
Premier Li Keqiang has set a 7.5 percent expansion target for this year as the government seeks to increase the economy’s reliance on consumption rather than on exports. Manufacturing growth beat analysts’ estimates in November, with the Purchasing Managers’ Index at 51.4, the same as the 18-month high reached in October. A number above 50 signals expansion.
The news helped push sovereign bonds lower, with the 10-year yield rising 10 basis points to 4.5 percent as of 12:22 p.m. in Shanghai, according to the Interbank Funding Center. The seven-day repo rate, a gauge of funding availability in the banking system, soared to a record 10.77 percent on June 20, according to a daily fixing from the China Interbank Funding Center. The average rate has climbed to 4.39 percent since Oct. 1, from 3.24 percent in the fourth quarter of last year.
“Liquidity will continue to be tight and the A-share market will be a casualty,” Heather Hsu, Shanghai-based equity strategist at Fortune CLSA Securities Ltd., said in a phone interview on Nov. 28. “The stock market will continue to be lackluster next year.”
Yields on five-year AAA corporate bond soared to a record 6.23 percent on Nov. 26, widening the spread over government notes to 178 basis points, the highest since May 2012, according to ChinaBond data. Corporate bond yields are among the most responsive to interbank rate changes, according to a Nov. 25 report by Goldman Sachs Group Inc.. The yuan, which has risen 2.3 percent this year, was little changed at 6.0928 per dollar in Shanghai today.
The bank has an overweight rating on the stocks of Chinese companies such as brokerages, health-care firms and banks which are set to benefit from reforms announced at a Nov. 9-12 Communist Party meeting. The plenum promised a more decisive role for markets in the allocation of resources.
“We rate China equities as an overweight market versus Asia ex-Japan,” Helen Zhu, Hong Kong-based chief China strategist at Goldman Sachs, said on Nov. 27. While the near-term outlook is favorable, it can be “potentially interspersed with occasional domestic cyclical concerns as liquidity fluctuates and year-on-year growth rates may plateau.”
State-owned companies, many of which have relied on debt for expansion rather than earnings, are among the worst performers in the stock market. The Shanghai Composite Index, whose biggest members include state-owned firms such as China Petroleum & Chemical Corp., has declined 23 percent over the past three years. The ChiNext index of smaller, non-state companies has gained 12 percent.
More than one in four state enterprises make a loss, the World Bank and Development Research Center of China’s State Council said in a report last year. The debt of listed companies excluding financial firms has doubled since 2009 to some $2 trillion.
China’s securities regulator has issued a reform plan for initial public offerings, as the government prepares to lift a more than one-year freeze on new listings. About 50 companies are expected to complete the IPO approval preparations and list or be ready to do so by the end of January, the China Securities Regulatory Commission said in a Nov. 30 statement on its website. There are more than 760 companies in the queue for approval and it will take about a year to complete an audit of all the applications, it said.
The central bank is curbing investment by ensuring long-term borrowing costs rise at a similar pace as those in the money markets. It rolled over maturing three-year notes from July, while resuming sales of seven-day and 14-day reverse-repurchase contracts at higher rates than at the beginning of this year to calm markets.
“The central bank’s strategy of locking up liquidity in the long end while ensuring cash supply in the short-term helps achieve deleveraging,” Hong Hao, a Hong Kong-based strategist at Bocom International Holdings Co., said by e-mail on Nov. 27. “If bond yields increase, it makes it hard on companies.”
— With assistance by Helen Sun