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Saturday, 2 August 2014

The reform legacy - Part II

Since the last post there have been a couple of articles which highlight quite well the importance of the reform debate and the main themes.  As the PBOC launched further stimulus (including via a new tool called "Pledged Supplementary Lending" involving 1 trillion yuan for new lending), James MacKintosh, Investment Editor of the Financial Times filmed an interesting presentation giving some context to the resulting rise in share prices. While ordinarily share prices would be indicative of higher confidence and expectations for growth, MacKintosh noted that the sectors which had shown the greatest share price increases (and saw the best response to stimulus measures) were companies in the banking, property and industrial sectors - all sectors which the Chinese authorities wanted to steer investment away from (and into other sectors) as part of the reform and rebalancing process.  Or as James put it:
 "a return to pre-crisis business as usual...a pause in reform means less risk in property and banking as well as the old line state-owned enterprises".

"China Property Gamble" (c) Financial Times
Of course what James didn't dwell on (but certainly implied) is that there would be more risk overall and in the medium to long term (hence the need for reform to reduce the risk, sadly not carried through).  Over at FTAlphaville, the suppression of risk was covered well in an article by David Keohane who noted falling bond yields, the bailing out of one trust which had been set to default and a pessimistic analysis from reputed analyst Diana Choyleva of Lombard Street Research who noted:
 ...But the more sinister explanation [of failure of domestic demand to drive economic growth] is that the authorities are unable to provide a significant boost to growth even if they want to. They may be trying to boost credit to SMEs, but demand for loans has come off again. China needs to clean up after its debt binge, not stoke it further. The current level of debt may just about mean that Beijing has a chance to reform successfully even if that will involve a few years of meagre growth and financial distress. But the ongoing rapid rate of increase in debt suggests that policymakers do not have too long to postpone much-needed defaults...

Zerohedge meanwhile has taken a much more vigorous editorial line and especially with the Qingdao commodity financing scandal (including discussion of a note from Goldman Sachs as to the impact from an unwinding of metal-based rehypothecation).  On the new stimulus measures and their indication of the slowdown in reforms, contributorTyler Durden is blunt:
 
So whatever way you look at it, the PBOC thinks China needs more credit (through one channel or another) to keep the ponzi alive. Anyone still harboring any belief in reform, rotation to consumerism is sadly mistaken. One day of illiquidity appears to have been enough to prove that they need to keep the pipes wide open. The question is where that hot money flows as they clamp down (or not) on external funding channels.
And also:
Simply put - you can kiss goodbye any hopes of China ceasing its exuberant credit creation... (especially now that the CCFD ponzi scheme has been exposed via Qingdao -and drastically reduced that channel). Reforms are all talk and the bubble will just grow bigger with fewer and fewer attractive outlets for that hot money (now that the US real estate transmission channel has been identified and likely closed)... cue real inflation.

From those Zerohedge articles are two charts of note, the first showing the total amount of credit (bank assets) in the Chinese economy and its rapid growth:


and the second the rise in rates which preceded the recent PBOC stimulus (after it apparently stopped conducting repo operations), which corresponds nicely with the increase in share prices mentioned before (imagine the effect on share prices if repo rates continue to rise and there is no new liquidity from the PBOC?!):

 

Finally, while it will still remain for the next post to discuss some summer reading about the history of reform in China, it can be added one extra piece of reading on exactly this point - a 2013 IMF Working Paper:  "China’s Path to Consumer-Based Growth: Reorienting Investment and Enhancing Efficiency" (here), which " proposes a possible framework for identifying excessive investment".

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