China's Deleveraging Bill Tops $500 Billion

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  • Bonds, stocks and metals sink as regulators tackle leverage
  • JPMorgan Asset says markets may fall 10% before Beijing blinks

How much pain can China’s leaders stomach? It’s becoming a key question for investors as the government’s clampdown on financial leverage ripples through markets.

The tightening campaign has erased at least $453 billion from the value of Chinese stocks and bonds since mid-April, spurred $21 billion of canceled debt sales and compelled the People’s Bank of China to inject $48 billion into jittery money markets. Sales of asset-management products by lenders and trust companies have plunged by more than 30 percent, while domestic real estate transactions have slowed and metals prices have buckled.

The upheaval hasn’t reached crisis levels yet. But as the nation’s equity crash in 2015 showed, market declines in China have a habit of snowballing. As authorities juggle the conflicting goals of curbing leverage and maintaining economic growth before a Communist Party leadership reshuffle later this year, some money managers are bracing for more turbulence.

“It would take a lot for the country to move into easing mode,” said Howard Wang, the Hong Kong-based head of greater China at JPMorgan Asset Management, which oversees about $1.8 trillion worldwide. “They will adjust their policies if markets go down another 10 percent or the currency cracks under pressure. Only these very drastic swings will make them move the other way.”

China’s banking, insurance and securities regulators have all played a part in the clampdown, focusing much of their attention on the nation’s shadow banking system. The investment products produced by that system have funneled huge sums of cash into local asset markets, but critics say they employ too much leverage, create dangerous asset-liability mismatches and reduce transparency. Shadow banking assets in China increased by 21 percent in 2016 to the equivalent of $9.3 trillion, or 87 percent of gross domestic product, Moody’s Investors Service said in a report on Monday.

To learn more about the measures, read this QuickTake Q&A

The tightening campaign adds to a nine-month-long effort by China’s central bank to curtail excessive borrowing by gradually raising interest rates. The nation’s key seven-day repo rate has climbed to about 3 percent from 2.3 percent in August, and would likely be higher if not for cash injections by the PBOC via daily open-market operations over the past month. The rate topped 12 percent during a brief shakeout in the shadow banking system in 2013.

Overseas money managers including Franklin Templeton Investments and Fidelity International have applauded the latest clampdown as necessary to curb a $28 trillion debt pile that threatens China’s long-term economic stability. Yet the reception by local investors has been anything but sanguine.

The Shanghai Composite has dropped for four straight weeks, even as MSCI Inc.’s gauge of global equities rallied to all-time highs. The Chinese benchmark index fell 0.8 percent to the lowest level since October on Monday, the biggest decline among major Asian equity gauges. The Bank of America Merrill Lynch China Broad Market Index of government and corporate debt has lost 0.9 percent since the new regulations began impacting markets, while borrowing costs for the nation’s top-rated companies have climbed to the highest levels in two years.

Last week, the selloff spread to commodities. Concerns over tighter credit conditions, combined with signs of excess supplies, sent iron ore futures in Dalian down more than 8 percent.

Traders worry that higher borrowing costs will weigh on China’s metals-hungry real estate industry. Home sales in square meter terms dropped about 30 percent in the final week of April from the same period a year ago, according to data for 26 major Chinese cities tracked by CREIS, a research institute run by the country’s most popular property website.

The clampdown’s impact on shadow banking activity has been swift. The number of wealth-management products issued by Chinese lenders sank 39 percent in April from the previous month, while trust firms distributed 35 percent fewer products, according to data compilers PY Standard and Use Trust. WMPs -- popular savings vehicles that offer higher returns than deposits -- generate fees for Chinese banks while typically residing off their books.

“What the top policy makers want is to bring lending back onto balance sheets,” said Shen Jianguang, chief Asia economist at Mizuho Securities Asia Ltd. in Hong Kong.

Shen said that while the tightening measures are likely to weigh on economic growth, now is a good time for the government to act. China’s expansion unexpectedly quickened to 6.9 percent in the first quarter, giving policy makers room to tighten without jeopardizing their growth target of around 6.5 percent this year.

“It’s a balancing act,” said Kenny Wen, a strategist at Sun Hung Kai Financial in Hong Kong. He said authorities are likely to keep their focus on the clampdown unless the Shanghai Composite falls below the 3,000 level, a 3.3 percent decline from Friday’s close.

Investors shouldn’t assume that Chinese leaders can meet their “incompatible” objectives of maintaining an acceptable rate of economic expansion and reining in shadow banks, John-Paul Smith, a London-based emerging markets strategist at Ecstrat Ltd., wrote in an emailed report titled “The Stability Illusion” on May 3. The market reaction to tightening measures over the past month has highlighted the fragility of an economy that depends on ever-increasing amounts of debt to grow, according to Smith.

“Beijing is caught between a rock and a hard place,” he wrote. “The risk is that any serious attempt to curtail the growth of financial intermediation will be the catalyst for the economy to relapse.”

— With assistance by Helen Sun, Lianting Tu, Emma Dong, Tian Chen, and Jun Luo

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