China’s battered bond connections
China’s Hong Kong to the mainland Bond Connect was launched amid fanfare focused on the handover’s 20th anniversary rather than foreign investor access enthusiasm, with just $1 billion traded of the $9 trillion market the first day and no timetable for a southbound channel. According to the central bank, 475 overseas institutions, 200 based in Hong Kong, already hold domestic government bonds for 1.5% of the total since direct ownership was authorized earlier this year, with the goal of near-term JP Morgan benchmark index entry just as with the MSCI recently for “A” shares. International firms can now fully serve as underwriters, and the Big Three ratings agencies have been allowed in on their own and not solely through joint ventures. The lackluster debut was foreshadowed by poor 5% daily quota use since Shenzhen was added to the equity pipeline several months ago, but fixed income remains subject to its own domestic and external instrument squeezes, alongside erratic economic and banking system indicators ahead of the signature Party Congress, which will continue to stifle pursuit despite yields above big advanced economy global markets.
The IMF, in its latest Article IV report, lifted the GDP growth forecast to 6.7% this year due to “expansionary credit and public investment,” but could not rule out a medium-term “sharp correction.” The official PMI manufacturing index stayed above 50 in May with a 20% jump in infrastructure spending in the first five months. Fixed-asset outlays and exports rose 8-9 % and property and retail sales 10% over the period. The yuan strengthened 2% against the dollar through June on suspected central bank intervention, and May’s $25 billion foreign reserve increase continued the inflow trend with the total now at $3.05 trillion despite discrepancies that could mask capital outflows and currency weakness. The foreign exchange body SAFE reported that corporate and household dollar exceeded renminbi buying by $150 billion in the first quarter, and a US Federal Reserve study estimated that capital flight related to overseas tourism may come to over 1.5% of GDP. To close this loophole banks were ordered to collect information on personal credit card and international cash transactions above RMB1,000 as of September, as the Institute for International Finance suggested that the minor Q1 $22 billion capital exit it tallied may not last as companies and individuals adapt to the recent control onslaught. Big nominally private conglomerates with founding state shareholders, including HNA, Fosun, Dalian Wanda and Anbang, were in the cross-hairs in June as the bank regulator warned of system risks from aggressive investment programs abroad and ordered detailed exposure breakdowns. The trade surplus, in turn, could be pared as the US threatens steel import retaliation and additional curbs for North Korean business, among the high-priority topics at the G-20 summit in Germany.
Normal loan creation continues at an RMB1 trillion monthly clip, but a shadow banking crackdown slowed M2 expansion, which does not capture wealth management products, to 9.5% in May, a two-decade low. Negotiable certificates of deposit, with over half due to mature by year-end, were recently targeted for further disclosure, and new rules will likely curb burgeoning trust loans, which quintupled in January-April to almost RMB900 billion from the same period in 2016. Insurance has come under the microscope with Anbang’s complicated organizational web and product lines and $2.5 trillion in assets. Its chairman was detained and fresh investment offerings were suspended after the solvency ratio dipped 50% in the first quarter.
Moody’s sovereign ratings downgrade cited state enterprise contingent liabilities as a “material risk” at one-quarter of GDP
These pressures have weighed on domestic government bonds through an inverted yield curve with higher short- than long-term rates, and corporate ones with over a dozen defaults so far this year. In May net corporate bond financing was negative RMB220 billion, with maturities outstripping new issuance, as high-yield names scramble to seal less than one-year deals avoiding official registration amid tighter banking, securities and insurance sector oversight and monetary policy. International fund managers have demanded a premium for or shunned recent property company offshore bonds, with Evergrande and other longtime sponsors facing credit and sector doubts amid stretched external corporate debt valuations. Moody’s sovereign ratings downgrade cited state enterprise contingent liabilities as a “material risk” at one-quarter of GDP, while private firms have their own dodgy bookkeeping with debt cross-guarantees at one-tenth of equity, according to Citic Securities. Bond Connect is presented as relatively clean and simple, but tangled interrelationships should be handled with detachment and discretion.