China's Christmas Gift
Everything comes at a cost.
To ensure steady economic growth, China is considering softening its focus on cutting debt in 2018, the Wall Street Journal reported Tuesday. "Let's face it. It's not realistic to reduce leverage when the whole economy relies on banks for financing," an official told the Journal's Lingling Wei.
For emerging-market bulls, that's the best news this holiday season.
More than the U.S. Federal Reserve, China is now the main emerging markets mover and shaker. Although the MSCI Emerging Markets Index dropped 16 percent in just over 30 days during the 2013 taper tantrum, the slumps caused by policy changes in China have been deeper, and more prolonged.
A sharp correction in mainland stocks during the summer of 2015, followed by Beijing's surprise devaluation of the yuan in August of that year, propelled an almost 30 percent decline in the benchmark in less than three months. In January last year, authorities sparked another selloff after installing, and then scrapping, a stock circuit breaker.
Four years ago, companies from Asia's largest economy accounted for just over 15 percent of the MSCI Emerging Markets Index. Their weighting now, in part due to the index maker's decision to include U.S.-listed Chinese ADRs, is 26.5 percent and will increase further from next year to about 32 percent once mainland shares are included.
Equity strategists are clamoring for more, with emerging-market stocks set to beat the U.S. in 2017 for the first time since 2010. JPMorgan Chase & Co. sees the asset class gaining 15 percent in dollar terms next year.
But here's the caveat: One of the primary reasons for global investors to buy into emerging-market equities is the assumed growth premium, analysts at the bank wrote in a recent note.
In other words, for this bull market to continue, China has to keep expanding. According to the World Bank, over the next three years, about 35 percent of global GDP growth will come from China, twice as much as the U.S. and four times as much as India. When China sneezes, all developing markets catch a nasty cold. The some $67 billion that global investors have poured into those countries' stocks this year is predicated on the assumption of buying earnings growth at a sweet discount.
China has similar heft in the dollar-bond market. Issuers from the nation already account for more than 20 percent of total emerging-market offerings. In 2017, more than $185 billion has been raised, data compiled by Bloomberg show, and a lot more may be to come.
That's because while avoiding a Minsky moment is all well and good, firms, particularly state-owned enterprises, need the cash. Of the more than 870 state entities listed on the mainland, 20 percent require at least 6.6 years of operating profit to pay off their net borrowings. The debt of many local government financing vehicles also starts to mature in 2018.
Already, borrowing costs are climbing. Ten-year government bond yields touched 4 percent last month while top-rated five-year corporate notes yield 5.4 percent, up from 4.4 percent 12 months ago.
That makes international debt capital markets an attractive venue for refinancing. In October, Beijing issued its first sovereign dollar bond since 2004.
To date, global investors are lapping China Inc. debt up, even going so far as to assume Alibaba Group Holding Ltd. will be around in 40 years. Will such appetite exist if the supply floodgates open?
China has always prided itself on its rapid modernization and swift economic development. President Xi Jinping's policy boffins should bear that in mind lest they prematurely kill this young emerging bull.
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Katrina Nicholas at email@example.com