Stress Test for Banks Inflicting Collateral Damage: China Credit
China’s decision to tolerate the worst cash crunch on record is evolving from a stress test of banks into a threat to the ability of companies to raise funds.
As their overnight borrowing costs neared 13 percent, banks switched focus toward shoring up their own finances and slashed investments in the bond market they dominate. The one-year yield on AAA corporate debt jumped a record 121 basis points this month to 5.15 percent, ChinaBond indexes show. Bond sales slumped to 160.2 billion yuan ($26 billion) in June, the least in 17 months and down 56 percent from May, data compiled by Bloomberg show.
China’s cabinet, led by Premier Li Keqiang, said following a June 19 meeting that finance companies must do more to support economic transformation and reduce risks, after administrative measures to crack down on property and local government investment failed to halt the accumulation of debt. The timing of the credit squeeze has puzzled economists since official data shows a worsening contraction in manufacturing, easing inflation and a slowdown in foreign investment inflows.
“The current level of tightness in real market rates is excessive and, if continued, may disrupt growth rather than make it more balanced,” said Dariusz Kowalczyk, a strategist in Hong Kong at Credit Agricole CIB. “Balancing growth would be achieved easier by boosting consumption, not by restricting credit. I think they will ease monetary settings soon, via open-market operations or reserve-requirement ratio cuts.”
The central bank has refrained from adding funds to the financial system and sold 2 billion yuan of bills yesterday to drain capital, even as money market rates hit a record high. The World Bank, HSBC Holdings Plc, Morgan Stanley and UBS AG cut 2013 gross domestic product estimates for China this month.
A report showed yesterday China’s manufacturing is shrinking at a faster pace this month. The preliminary reading of 48.3 for a Purchasing Managers’ Index (EC11FLAS) released yesterday by HSBC Holdings and Markit Economics is below the 49.1 median estimate in a Bloomberg News survey of economists. A reading below 50 indicates contraction.
Zhu Haibin, chief economist of JPMorgan Chase & Co. in Hong Kong, wrote in a report yesterday that there was a risk the PBOC may artificially create a liquidity squeeze that would put pressure on “already weak” economic activity.
Yuan forwards were headed for their biggest weekly drop this month after Federal Reserve Chairman Ben S. Bernanke said the central bank may reduce monetary stimulus that helped spur fund inflows to emerging-market assets. More than $19 billion has left funds investing in developing-nation assets in the three weeks to June 12, the most since 2011, according to U.S. research firm EPFR Global. Foreign direct investment in China rose in May by the least in four months.
The one-day repo rate dropped 442 basis points, or 4.42 percentage points, to 8.43 percent, after the central bank was said to have made funds available to lenders. The rate touched an all-time high of 12.85 percent yesterday, according to a daily fixing announced by the National Interbank Funding Center at 11 a.m.
Regulators are forcing trust funds and wealth management plans to shift assets into publicly traded securities, taking so-called shadow banking funds away from property developers and local-government finance vehicles. The China Banking Regulatory Commission told banks in March to cap investments of client money in debt that isn’t publicly traded at 35 percent of all funds raised from the sale of wealth management products.
Shadow banking has thwarted efforts to rebalance the economy. The increase in money supply exceeded the government’s 13 percent target every month this year, rising 15.8 percent in May. Aggregate financing, a measure of credit that includes trust loans, stock and bond sales, totaled 9.1 trillion yuan in the last five months, a 52 percent jump from the first five months of 2012.
“The PBOC clearly has an agenda here,” said Patrick Perret-Green, a former head of Citigroup Inc.’s Asian rates and foreign exchange who works at Mint Partners in London. “To fire a massive warning shot across the banks’ bows and to see who is swimming naked.”
He added that the moves fit in well with new Chinese President Xi Jinping’s disciplinarian approach. Since becoming president in March, Xi has vowed to combat corruption and promised a “thorough cleanup” of the ruling Communist Party.
The central bank is trying to exert its influence over shadow banking activities through its executive powers as it waits for tougher regulations to be put in place, said Marshall Mays, director at Emerging Alpha Advisors Ltd., which advises funds on investment of about $100 million as well as regulators on market development. Policy makers want to create a credit spread for corporate bonds that better assesses risk, while keeping support for some state-owned enterprises, he added.
“This is a wake-up call for the SOEs,” Mays said in an interview from Manila. “A more cynical interpretation is that the new government is starting by setting a harsh hurdle for all and offering those who will come to the new throne and kiss the new emperor’s ring a chance at a lower hurdle.”
The cost of protecting China’s government debt from default surged 30.5 basis points to 133.6 basis points yesterday in New York, according to prices from data provider CMA. The contracts pay the buyer face value in exchange for underlying securities or the cash equivalent if a borrower fails to adhere to its debt agreements.
Demand for bonds has waned in the past two weeks in the primary market. The finance ministry sold 9.53 billion yuan of 273-day bills on June 14, less than its 15 billion yuan target, and its 10-year auction on June 19 drew the least bids times the amount on offer in 10 months. Agricultural Development Bank of China Co. on June 6 raised 11.51 billion yuan in a sale of six-month bills, short of its 20 billion yuan goal.
The Export-Import Bank of China halved sale targets for a June 14 auction of five- and 10-year bonds to 10 billion yuan for each tenor. Agricultural Development Bank of China scaled back the size of a bond offering on June 18 by 31 percent.
Nomura Holdings Inc. expects a “painful deleveraging process in the next few months” that may result in defaults in the manufacturing and non-bank financial sectors, according to a report by economists Zhiwei Zhang and Wendy Chen yesterday. Local government financing vehicles and property developers are also at risk, the report said.
“The cash crunch has hit the economy,” said Chen Jianheng, a bond analyst in Beijing at China International Capital Corp., the nation’s biggest investment bank. “Banks are extending less loans and their demand for bonds is falling. We may see more signs of deceleration in economic figures next month.”
Chongqing Commerce Group issued 500 million yuan of five-year AA-rated bonds at 5.43 percent last month. Quanzhou State-Owned Asset Investment Operation Co. sold 800 million yuan of similar-rated and similar-maturity debt at a yield of 5.9 percent on June 18.
The yuan weakened 0.08 percent to 6.1328 per dollar as of 12:26 p.m. in Shanghai, according to the China Foreign Exchange Trade System. Non-deliverable forwards due in a year strengthened 0.09 percent to 6.2995 in Hong Kong, according to data compiled by Bloomberg. The discount to the spot rate was 2.8 percent yesterday, the deepest since February 2009.
Economists forecast China’s gross domestic product will expand 7.6 percent in the April-June period from a year earlier, according to the median estimate of 35 respondents to a Bloomberg News survey conducted from June 14 to 19. That compares with a 7.8 percent median projection in last month’s survey and first-quarter growth of 7.7 percent.
“If the liquidity squeeze worsens and the interbank rate stays at such high levels for longer than expected, that will lead to higher borrowing costs for companies,” said Tang Jianwei, a Shanghai-based economist at Bank of Communications Co., the nation’s fifth-biggest lender. “It will be devastating to an economy that’s already struggling,”
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