China feels the squeeze of Trump’s trade war

China is expected to manage the trade dispute’s impact on growth amid ongoing campaign to contain debt

The world’s second largest economy is at the crossroads, having to sustain growth while at the same time looking to ride out bouts of external and internal uncertainties.

Date

9 Jan 2019

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Speakers:

Raymond Yeung                                

chief economist, Greater China, ANZ

Xuanlai He

executive director and senior fixed income portfolio manager, China Life Franklin Asset Management

Andrew Fennell

director, Asia-Pacific sovereign ratings, Fitch Ratings

Grace Wu

senior director and head of China bank ratings, Fitch Ratings

Arthur Lau

co-head of emerging markets fixed income and head of Asia ex Japan fixed income, senior portfolio manager, Pinebridge Investments

Jason Ho

managing director, head of debt financing and debt capital markets department, China Merchants Bank International

Freddy Wong

chief investment officer, China and fixed income portfolio manager, Fidelity International

Olivier Delfour

managing director and head of global infrastructure & project finance, Fitch Ratings

Su Aik Lim                              

senior director, Asia Pacific corporates, Fitch Ratings

Terry Gao                                           

senior director, international public finance, Fitch Ratings

Kenneth Ho                           

head of Asia credit strategy research, Goldman Sachs

Becky Liu                                           

head, China macro strategy,   Standard Chartered

Moderator:

Daniel Yu                                           

editor-in-chief, The Asset

 

China embarks on a new phase of growth

The world’s second largest economy is at the crossroads, having to sustain growth while at the same time looking to ride out bouts of external and internal uncertainties.

China carries a lot of weight when it comes to the health of the overall global economy. There are questions over the country’s next move after achieving unprecedented growth on the back of the nation’s strong manufacturing capabilities.

The effects of an ongoing trade war with the US and a mounting debt now contribute to the economy’s overall weakness. China data show economic growth slowed to 6.5% in the third quarter, dropping 0.2% compared to the quarter before.

At the Fitch on China Forum organized by The Asset, several experts shared their views on how China could reshape its economy and reduce debt, particularly off-balance sheet debt.

They believe that China needs to focus more on being a consumption-led economy, leveraging on the growth of the middle class and its large population. “As a strategy in the medium term, policymakers definitely want to increase the share of the consumption-driven sector of the economy as opposed to investment-led growth,” says Raymond Yeung, chief economist of Greater China at ANZ.

For Arthur Lau, co-head of EM markets fixed income and head of Asia ex-Japan fixed income at Pinebridge Investments, it’s a matter of how adaptable the Chinese government will be to changes in the market climate. “The policy needs to keep on changing to accommodate internal or external shocks. China is planning to have some sort of sustainable quality growth rather than quantity of growth,” he adds.

Within China there are a number of factors at play that needs to be addressed. Apart from sustaining economic growth, the government is also trying to shape reforms around deleveraging and taxes. However, what reforms will be implemented is still being heavily debated among various groups.

“There has clearly been a change to the policy stance underway. Which direction they will go will have implications on the sovereign rating. I feel that there is still a genuine policy debate that is happening,” explains Andrew Fennell, director, sovereign ratings at Fitch Ratings. “There are some people saying that if you do some of these tax measures you might get the growth and more consumption. However, you have to be patient with that type of fiscal policy.”

The banking sector was also cited as a hurdle to further economic growth even as banks continue to work to reduce non-performing loans. A live poll of the audience at the forum revealed that 41% of participants saw shadow banking and wealth management products as the biggest problem facing China’s banking system, followed by deteriorating asset quality.

“Banks fail because of liquidity issues, not because of asset quality. But when banks have asset quality issues, this locks up funds over time and that would eventually impact bank liquidity,” says Grace Wu, senior director and head of China banks at Fitch Ratings. “The Chinese authorities are aware of the potential threat from the size and scale of off-balance sheet shadow activities. They also know if they clamp down on these activities too quickly, they may self-engineer a liquidity crisis.”

Nevertheless, there is growing encouragement from the government for the banks to support China’s private sector, particularly the ones operating in the real economy to steer those companies away from shadow banking lending activities. “As long as you have banks that are highly influenced and controlled by the state, there is a lot of flexibility for authorities to manoeuvre through administrative measures in order to safeguard those economic targets, but at the expense of delayed recognition of problem assets,” says Wu.

Whatever the future may hold for China’s economy there are challenges and opportunities ahead as the country continues to re-evaluate its policies. “Policymakers need to rethink the path going forward,” says Xuanlai He, executive director and senior fixed income portfolio manager at China Life Franklin Asset Management.

The change in China’s economic structure comes with a mindset change, “it’s not just a number”, he adds. “The fundamental structure of the economy going forward will have to change.”

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Polarization in the Chinese fixed income market is still ongoing

Domestic investors are a force to be reckoned with in China’s fixed income market.

Privately-owned enterprises with low credit scores are expected to face difficulty tapping the capital market in the next 12 months. 

On top of bond defaults, the US-China trade war and the asset management regulation that restricts the amount of money flowing into the financial system are some of the factors adversely impacting the bond market. In the past, asset managers buy most of the credit bonds on behalf of the banks. That has changed under the new ruling. Banks have become more reluctant to acquire credit bonds.

“If you ask banks, they would certainly not buy the credit bonds unless it is under guidance. If you do the calculation, excluding the capital charge and tax, the current credit bond yield is actually lower than that of government bonds,” says Becky Liu, head of China Macro Strategy at Standard Chartered. As a result, there was a flight to high quality short-dated assets to reduce volatility. Also, the domestic yield curve has massively steepened and a large portion of demand has gone to high-tier and short-dated bonds.

The fear of more defaults further loomed over market sentiment, pushing small and medium-sized corporates to an even tougher position. “If you look at the balance sheet of some companies, you may find some companies’ cash reserves are only sufficient to pay for the short-term liabilities, leaving a lot of long-term liabilities on the side unpaid. With a credit crunch due to the financial deleveraging last year, default in the private sector will be getting worse,” says Freddy Wong, chief investment officer, China and fixed income portfolio manager at Fidelity International.

Compared to onshore investors international bond investors appear more upbeat. Kenneth Ho, head of Asia credit strategy research at Goldman Sachs says he receives calls from investors in London and New York asking if they should buy Chinese bonds as they are now relatively cheap. Ho says that participants in the bond market behave similarly to a Mexican standoff scenario.

“Offshore investors want to buy because the bonds are cheap but they hesitate because the onshore investors are not buying,” Ho says. Onshore investor’s sentiment is important as they represent a meaningful part of the Chinese bond market.

For now, polarization is evident in two sectors: property and local government financing vehicles (LGFVs). “Especially in the offshore market, people saw the LGFV tenor is relatively short and it caused some misreadings in this sector,” says Terry Gao, senior director of international public finance at Fitch Ratings.

Property companies’ access to the onshore capital market was largely closed from the second quarter except for investment-grade or government-linked companies. “Polarization is still happening, and it has not gone to the complete bipolar stage,” says Su Aik Lim, senior director of Asia Pacific corporates at Fitch Ratings.

Olivier Delfour, managing director and head of global infrastructure and project finance at Fitch Ratings, says that international investors are seeing opportunity in China where spending is growing not only in the property sector, but also in infrastructure.

Jason Ho, managing director, head of debt financing and debt capital markets department at China Merchants Bank International notes that the activities in the local bond market are currently  “demand driven”.

 

Date

9 Jan 2019

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