Growth-Focused China Signals It Hasn’t Forgotten Leverage

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China Outlook: Is the Worst Over?
  • China must develop robust capital markets to handle debt level
  • Government's `bottom line' is avoiding risks to the system

Chinese policy makers underscored their concern about a surge in leverage in the world’s second-largest economy, days after the conclusion of a gathering of the national legislature that showed their top priority is securing at least 6.5 percent annual growth for years to come.

The comments from People’s Bank of China Governor Zhou Xiaochuan and Vice Premier Zhang Gaoli suggest China’s leaders are trying to avoid a repeat of what happened under their predecessors, when unbridled stimulus created an overhang of bad debt. At the same time, none of the officials, speaking at the annual China Development Forum in Beijing on March 20, offered specific prescriptions for reining in debt.

“Lending as a share of GDP, especially corporate lending as a share of GDP, is too high,” Zhou told the forum. He said China still has a problem with illegal fundraising and financial services are insufficient.

QuickTake China's Debt Bomb

Earlier in the day, Vice Premier Zhang Gaoli said the government should address the problem of local-government debt and ensure that a plan for them to swap high-cost debt for cheaper municipal bonds goes ahead. He said the government would do what it must to avoid turmoil in stocks, the currency, bonds and property.

“There will be no systemic risks -- that’s our bottom line,” Zhang said.

The remarks struck a cautionary note four days after Premier Li Keqiang promised the government would press ahead with plans to cut overcapacity in state-owned sectors without massive layoffs while still meeting its target of 6.5 percent growth in each of the next five years. Speaking at his annual news conference, Li said a high corporate debt ratio “is not new in China” and leaders would seek to bring it down with capital-market reforms and by converting debt to equity stakes.

The country’s debt now totals 250 percent of GDP. Corporate debt alone now stands at 160 percent of China’s GDP, according to the Organization for Economic Cooperation and Development. The group’s secretary-general, Angel Gurria, said at the forum that industries with especially high leverage include cement, steel, coal and flat glass, and China must address the issue.

‘Juggling Act’

"It is a difficult juggling act," said Lim Say Boon, chief investment officer at DBS Bank Ltd. in Singapore. "Economies do not raise productivity or the size of the work force at the drop of a hat. That leaves them with leverage to boost growth. China could go for even more leverage -- to buy economic growth and social stability -- but it then risks a greater bubble down the line."

Leaders including the PBOC’s Zhou have stepped up efforts to cushion China’s economic slowdown, with the central bank announcing on Feb. 29 a 0.5 percentage point cut to the amount of deposits banks must hold as reserves. Excessive monetary policy stimulus isn’t necessary to achieve China’s growth targets and prudent monetary policy will be maintained if there isn’t any big economic or financial turmoil, he said March 12.

Zuckerberg Comes

Sunday was the second day of the three-day forum, where some of the world’s best-known executives -- including Facebook Inc.’s Mark Zuckerberg, UBS Group AG’s Sergio Ermotti and International Business Machines Corp.’s Ginni Rometty -- mingled with top government officials. Commerce Minister Gao Hucheng encouraged foreign investors to take part in mergers and acquisitions in China, adding that China would maintain stable law enforcement for foreign companies.

Chinese Finance Minister Lou Jiwei downplayed a decision by Moody’s Investors Service Inc. to cut his country’s credit-rating outlook, saying the move had little market impact.

The March 2 downgrade didn’t lead to irrational market behavior or aggressive short-selling, Lou said at the forum. He noted that the offshore yuan even rose afterwards.

“Internationally there was no ensuing action, for example shorting on China, so we didn’t care that much about it,” Lou said.

Lagarde Optimism

Otherwise, officials sought to ensure the audience that China’s transition from an economy powered by infrastructure investment and exports to one fueled by consumer spending and services was on track even as growth slows. The economy grew at the slowest pace in 25 years in 2015.

“That transition is going to be good for China and is going to be good for the world,” International Monetary Fund Managing Director Christine Lagarde said at the event. “Like any transition, it will not go without some bumps on the road. And we should expect them because there is a delicate balance to be struck between a deliberately slowing economy and reforms that need to be accelerated.”

One option for addressing high leverage is to develop “robust capital markets,” Zhou said. The country should channel more savings into the capital markets, which will help reduce leverage in the corporate sector and boost equity financing, he said.

Cold Comfort

“We’ve moved beyond the stage where Chinese officials simply being aware of these challenges provides any comfort,” said Andrew Polk, director of China research at Medley Global Advisers. “And while a major reflation of the economy via big bang monetary stimulus doesn’t seem to be unfolding, there simply is not an exit strategy from the current trajectory.”

China’s yuan has declined 4.5 percent since a surprise devaluation in August spooked global investors and spurred capital outflows. The nation’s defense of the currency depleted its foreign-exchange reserves by $513 billion last year, the first-ever annual drop.

Asked about a rapid decline in China’s foreign-exchange reserves, Zhou said growth in reserves have been “explosive” after 1997 and between 2002 and 2008. Given the speed with which inflows grew, it was now only natural to see big outflows. He said the country didn’t want a completely free-floating yuan.

“It may well be that for too long a lot of investors were being used to having a currency that was appreciating, and of course it moves both ways depending on circumstances,” Lagarde said at a question-and-answer session with Zhou. She said the yuan’s rate was broadly in line with fundamentals.

— With assistance by Heng Xie, and Kevin Hamlin

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