In Bailouts, China’s Bias for the Complex May Store Up Risk

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The second major bailout program from China’s leadership this year underscored its preference for relying on the banking system to shore up markets, a strategy that risks the need for further intervention over time.

As details emerged last week on a stock-support plan valued at as much as $483 billion, investors became better acquainted with an agency called China Securities Finance Corp. that previously had a limited role in economic policy. The unit is now being deployed, with financing from state-owned banks, to buy up the nation’s depreciated equities.

The maneuver -- with a magnitude that’s drawing comparisons with the U.S. government’s emergency funding during the 2008 financial crisis -- is the latest in a series of policy measures that avert short-term pain even as they potentially store up risks for the longer term. It follows a decision in May to reopen back-door lending to heavily indebted local government financing vehicles, through an order to banks to keep funding projects even if borrowers couldn’t meet payments.

“This scale of intervention reinforces the moral hazard that is already rampant in the credit side of the Chinese financial industry,” said Victor Shih, a professor at the University of California at San Diego who studies China’s politics and finance. “With the moral hazard spreading to the equity side, there will be no end to the expansion of the central bank’s balance sheet, which is necessary to keep both credit and equity afloat.”

Debt Load

China’s total debt already has reached 282 percent of gross domestic product after a lending binge following the global financial crisis, according to the McKinsey Global Institute.

The complexity of China’s latest market intervention is a contrast with more straightforward moves by others in recent decades. Hong Kong during the Asian financial crisis in 1998 used its central bank to do the buying of equities, and Japan in the 1990s used the state-run postal savings and social security system for the job. Much of the $700 billion U.S. Troubled Asset Relief Program went toward boosting banks’ capital levels and rescues of automakers and American International Group Inc.

China’s stocks bailout is more akin to the efforts that took shape earlier this year to shore up local government debt. That strategy relies on pressing banks to buy longer-maturity, lower-yielding bonds to keep fiscal spending going and hold up economic growth. It appeared to bear fruit last week, with data indicating GDP gains stabilized last quarter, with infrastructure spending rising more than forecast.

Markets Decisive?

Both initiatives test the credibility of policy makers’ late 2013 pledge to let markets play a decisive role in the economy.

“This is one of the largest-scale interventions in the history of any government in its country’s equity markets,” said Dariusz Kowalczyk, a Hong Kong-based strategist at Credit Agricole CIB.

Even so, World Bank President Jim Yong Kim, for one, remained convinced in Premier Li Keqiang and Finance Minister Lou Jiwei’s commitment to market-driven change after he met them in Beijing, he said at a briefing Friday. China is in the midst of a campaign to secure official reserve-currency status for the yuan from the International Monetary Fund, which requires fewer restrictions on its international use.

Others agree that China’s interventions are needed to prevent the possibility of a market collapse that could itself derail market reforms. The Shanghai Composite Index rebounded almost 13 percent from July 8 through July 16 after tumbling 32 percent in a month as investors unwound margin-debt positions. Stocks swung between gains and losses in volatile trading Monday after the index briefly surpassed the 4,000-point level.

Jury Out

“Chinese regulators appear to be doing their best to temper the ultimate verdict of a market-based bursting of an enormous equity bubble,” said Stephen Roach, a senior fellow at Yale University. “Only time will tell if these actions are successful -- or if they only buy time before the final stages of this correction run their course.”

Averting an equities collapse would preserve the stock market as an arena for China’s companies to raise capital, lessening their dependence on bank loans.

China stands in good company in its bailouts, after Japan, the U.S. and Europe in recent years all similarly supported markets, though more indirectly, through monetary easing, Roach said.

“What we are seeing today in China is not exceptional,” said Kenneth Courtis, former vice chairman at Goldman Sachs Asia and now chairman of Starfort Investment Holdings, which holds ownership interests in private equity, funds management, advisory, and commodity merchandising and trading. “It may be done in a more clumsy manner than in some places, but it is pretty much quite common practice around the world.”

Lending Capacity

Yet with banks pressed into service to support the local government debt restructuring program, and now to extend funds to the stock market rescue, their wherewithal to direct more credit to private companies may be limited.

“Tying the lifeblood of the entire financial system more intimately to the fragile equity market will only increase systemic risk and likely require further regulatory intervention down the road,” said Andrew Polk, a Beijing-based economist at the Conference Board who previously worked at the U.S. Treasury.

— With assistance by Kevin Hamlin, and Enda Curran

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