Graphic Novel: Extinguishing the Fires in Chinese Markets


By Geoffrey Smith – China’s financial markets have been on the news lately as the Communist Party grappled with two sensitive issues: how to reduce the leverage that has built up in major asset classes from last year’s stimulus, and how to rein See the influence and growing power of its thriving internet company.

At first glance, these issues may seem somewhat mysterious to investors in the US or elsewhere in the world outside of China, but the scale and interconnection of the Chinese economy and – increasingly – its financial markets – with the rest of the world mean it does It would be foolish to completely ignore any problem.

Of paramount importance to the global economy are recent measures to combat over-indebtedness. China’s rapidly rising debt problems are not a new development, and much like concerns about overvaluation of US tech stocks, many are tired of waiting for a bubble to burst: politicians and central bankers have seemingly inexhaustible possibilities for what bears feel procrastinating must be an inevitable day of reckoning.

But the signs are that Beijing is serious this time around. The country’s top banking regulator warned of bubbles in financial markets just two weeks ago, and the government working document presented at the end of the National People’s Council earlier this month has set a growth target of at least 6% – well below what many had expected . For example, the (relatively conservative) International Monetary Fund had forecast GDP growth of 8.1% for China in January this year.

Government announcements since then have set out what the NPC was only implying: “Governments at all levels must tighten their belts,” the South China Morning Post quoted a statement from the State Council this week. “We need to resolve the potential risks and consolidate the economic recovery.”

China’s debt-to-GDP ratio rose nearly 25 percentage points to over 270% of GDP last year as the People’s Bank of China again borrowed heavily from “shadow banks,” the majority of which appear to have gone to local government affiliates. The SCMP cited figures from the China Chengxin International Credit Rating showing such vehicles sold 4.49 trillion yuan ($ 920 billion) in bonds over the past year, up 28% from 2019 .

This would be less of a concern if investors could see where the ultimate credit risk lies. Most of the time, however, local investors seem to be chasing returns assuming Beijing won’t allow government-affiliated companies to fail. Defaults – like that of China Fortune Land, a Ping An affiliate, for a $ 530 million international bond in early March – remain the exception rather than the rule.

But if investors in China are still (largely) ignoring credit risk, it’s a different story with equity risk – the risk associated with a particular business that falls out of favor with the ruling Communist Party. The government is currently in an increasingly open battle with the country’s largest internet-based companies, which appears to be an expression of their enormous financial strength and data capacity.
Chinese stocks sold strongly last week as markets interpreted a string of antitrust fines as a warning against companies like Tencent Holdings, search giant Baidu and hail-fighting firm Didi Chuxing.

Again, what was implicit last week has become explicit this week. In a prime-time slot on state television, Xi is said to have told the country’s highest economic committee to tighten the regulation of the country’s Internet platform companies, “close loopholes” and end exceptions for them.

Almost certainly this isn’t a mere change to a little rule here and there. Beijing’s last minute intervention to impose capital requirements on a number of quasi-banking activities shattered the plans of Alibaba Subsidiary Ant Group will go public last year in what would have been the world’s largest IPO of all time. Reports since then suggest the actions have knocked Ant’s valuation by around $ 140 billion.

Alibaba (NYSE 🙂 stocks have fallen 24% since the Ant fiasco. Baidus (NASDAQ 🙂 is down 20% and Tencent (OTC 🙂 is down a relatively modest 18%. By comparison, Tencent’s stock fell a third in 2018 after it argued with Beijing that its video games are too addicting.

Tencent’s rebound since then is a good reminder that equity risk can and has been effectively managed by a business elite who knows which way the political winds are blowing. Even so, until Xi’s news changes, the forces trying to put out the fires in Chinese markets appear to outweigh those trying to ignite them in the near future.

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