Photographer: Qilai Shen/Bloomberg

Pimco Urges China to Get Tougher in Cat-and-Mouse Debt Game

Updated on
  • Policy makers’ ‘cautious tightening’ largely ignored by banks
  • China is aiming to curb leverage without derailing growth

Whatever China is doing to deleverage, it isn’t enough.

Beijing’s “cautious tightening signals” are largely being ignored by banks and at the local level, where attention is focused on maintaining steady economic growth, especially with key Communist Party meetings looming this year, according to Gene Frieda, executive vice president and global strategist for emerging markets at Pacific Investment Management Co.

“The cautious type of tightening usually doesn’t work that well for China” as it turns into a “cat-and-mouse game” between regulators and lenders, London-based Frieda said in a phone interview. “If there’s a willingness to allow credit to expand, credit expands. The only way to slow it down is to impose tight constraints.”

The People’s Bank of China, which says its role is to enact prudent monetary policy, has been relying on more targeted tightening measures. In early February, just after the Lunar New Year holiday, it raised the interest rates charged on open-market operations and on funds lent via its Standing Lending Facility. The central bank hasn’t altered its benchmark rate since October 2015, when one-year lending and deposit rates were cut to record lows.

Read more: China tightens monetary policy by raising money market rates

“A hike in benchmark loan and deposit rates would send a stronger signal of a desire to tighten policy, but blunt tightening would be in the form of quantitative restrictions on various types of credit growth,” Frieda said. These restrictions could be introduced as soon as next quarter should inflation continue to build and credit growth doesn’t slow, Frieda said, though he added this isn’t his base-case view.

While China has pledged to deflate asset bubbles and reduce corporate leverage, aggregate financing jumped to a record 3.74 trillion yuan ($544 billion) in January. On the inflation front, there are signs policy makers may need to contain growth, with data showing factory prices last month jumped the most since 2011.

Trump Factor

But tightening is a tricky proposition given the economy is growing at the slowest pace in a quarter of a century and there is uncertainty over the global picture, not least the impact of U.S. President Donald Trump’s potential policies.

Meanwhile, China wants to support the yuan and limit capital outflows as the Federal Reserve looks set to raise interest rates. Financial News, a PBOC publication, cited a regulatory official on Saturday as saying the impact of a Fed rate increase on capital flows and the yuan constrain what they can do with monetary policy.

Pressures from the U.S. will weigh on Chinese bonds in the first half of this year, Frieda said, with the market only recently emerging from a record selloff. The nation’s 10-year government debt has declined this year, with yields rising 27 basis points from December. The yuan rallied 1.1 percent in 2017, following its worst annual slump in more than two decades.

“It’s going to be challenging for the bonds in the first half of this year,” he said. “For the second half, we may see some inflation pressures recede. At that point, yields can look more constructive and interesting.”

Here are some other views the executive at Pimco, which had more than $1.4 trillion under management as of December, shared on China’s markets and economy:

  • The yuan will be stable near term due to tighter capital controls but it will decline in the long run
  • Liquidity will remain tight in the offshore yuan market as China has reduced channels for the currency to flow offshore
  • If the economy weakens, the yuan will be used as a “pressure release valve”
  • China’s leaders will be more reactive to developments in the U.S. and will attempt to be conciliatory, apart from in matters such as the “One China” policy
  • Caution is needed as the U.S. may wage a trade war against China given the hawkish voices in government. What Trump said during the campaign trail shouldn’t be ignored
  • China and U.S. will likely communicate more efficiently as the stakes are high and “everyone tends to lose in a trade war”

— With assistance by Tian Chen, and Robin Ganguly

(Updates bond and yuan trading in ninth paragraph.)
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