Macro Strategy: China credit watch

China to manage leverage risks
Chang Wei Liang, Philip Wee22 Jan 2021
    Photo credit: Unsplash Photo

    Credit: Managing China’s credit boom

    China’s credit trajectory since the outbreak of COVID-19 has been strikingly similar to that in the wake of the 2008 Global Financial Crisis. China unleashed a RMB4trn fiscal stimulus in 2009, largely fuelled by bank loans to local government financing vehicles (LGFVs). This resulted in a surge in China’s loans-to-GDP ratio by over 20% in the subsequent 12 months, before stabilizing in 2010. 

    Post COVID-19, we have also seen Chinese loans increasing significantly in response to stimulus demands, further aided by payment relief measures. Coupled with record net bond issuance (which was almost non-existent in 2009), the rise in China’s total credit post-COVID 19 has matched the magnitude of 2009’s jump in loans, measured as a proportion of GDP.

    Despite these similarities, there are important differences to recognize. First, China is much larger today as a proportion of the global economy, so spillovers from its credit boom through commodity and asset market channels will be larger. Second, the starting point for the 2020 credit boom is very different compared to 2009. China’s credit-to-GDP ratios were already stretched pre-COVID19, and its room to deleverage will be further hampered by slower growth compared to yesteryear’s 8%.

    The implication of such outsized credit growth is that policymakers will need to actively manage leverage risks going forward. Measures such as the “three red-lines” limits target to curb bond issuance for highly leveraged developers, while some SOEs were allowed to default in Q4 with no government intervention. That said, stability is and will continue to be paramount. The State-owned Assets Supervision and Administration Commission (SASAC) affirmed this week that policy will focus on the maintaining debt levels at SOEs, rather than outright deleveraging. In a similar vein, media reports this week have flagged “tiered” restrictions for LGFV issuance. LGFVs belonging to “red” areas with the highest local government debt will be barred from bond issuance, while those in “yellow” areas could be allowed to carry out bond swaps through the stock exchanges. Such new guidance add further impetus to last week’s announcement that Chinese banks will face curbs in their exposure to the property sector (see Macro Strategy: Chinese HY spreads widen as lending curbs weighed – 15 Jan 2021). We think it likely that China will introduce further debt control measures for macro-prudential reasons, but expect these to be suitably calibrated to avoid financial stresses.

    FX Daily: Looking over shoulder

    The Dow and S&P 500 were flat on Thursday; the Nasdaq Composite achieved another record close ahead of earnings reports next week. President Joe Biden warned that Covid-19 deaths would reach half a million in February. With the previous administration having no vaccine distribution plan, the Biden administration has to start from scratch to meet the president’s pledge of 100mn innoculations in his first 100 days in office. Also, investors may have been too hasty in brushing aside the risk of Congress blocking Mr Biden’s USD1.9tn American Rescue Plan. Next week, investors may start to realise that there is a difference between what Mr Biden wants to do and what he can achieve

    EURUSD was locked in a 1.2135-1.2170 range throughout the US session. Euro Stoxx 50 ended the session 0.2% flat after the European Central Bank warned, at its governing council meeting on Thursday, that the new infections and new variant of the virus posed a risk to the EU recovery. The ECB signalled its readiness to downgrade last month’s 2021 growth forecast of 3.9% and if needed, more measures to support the economy. Overall, the ECB did not give the impression that the EU bond yield curve would not be steepening as quickly as its US counterpart.

    AUD closed higher at 0.7764 for a third session but is approaching the ceiling of its two-week range between 0.7660 and 0.7810. Despite the recent improvement in data, the Reserve Bank of Australia has no intention to change its loose monetary stance in the next three years. While the unemployment rate has fallen to 6.6% in December from its high of 7.5% in July, it is stll above its pre-pandemic levels below 5.5%. PMI has stayed firm in January at 56.0 but has flattened from 56.6 the last month of last year, undermined by services but underpinned by manufacturing. CPI inflation out on 27 January is expected to slow to 0.7% QoQ in 4Q20 from 1.6% a quarter earlier. In YoY terms, CPI is expected to ease to 0.6% from 0.7%, still well below the official 2-3% target range. The RBA is scheduled hold its first monetary policy meeting this year on 2 February.



    Chang Wei Liang

    Credit & FX Strategist

    Philip Wee

    FX Strategist - G3 & Asia

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