Further empowered by the October Communist Party Congress, President Xi Jinping and his economics team led by newly minted politburo member Liu He are stepping up efforts to rein in the large and still growing debt burden of China’s corporates.
Deleveraging and not negatively affecting economic growth and bond and equity markets is never an easy task. But China’s latest industrial profit numbers (October 2017) released Monday by the National Bureau of Statistics make it at least a bit less daunting.
Profits were up a strong 25.1% year-on-year, just a mite less than September’s record-setting pace of 27.7%, a six-year high. Indeed, what we’re seeing is a good series going back to March of this year when – at 23.8% – profits exceeded 20% for the first time since 2013. Year-to-date, profits are up 23.3%, rising to 6.25 trillion yuan (US$946 billion).
The ongoing profit surge is supported by robust producer price inflation, which stood at 6.9% year-on-year, unchanged from September and on a strong run above 5% since last December.
Continued high PPI and profit numbers would do a significant amount of the heavy lifting for the government’s deleveraging policy.
It would also soften the blow from regulatory measures to reduce leverage such as the recent rules to curb risk in China’s US$9 trillion market for asset-management products. The rules include first and foremost a ban on principal guarantees (financial system “landmines,” according to a Xinhua editorial) and also impose leverage caps, provision requirements and a ban on “capital pools” (products with different risk levels, maturities and investors).
Such softening of blows is necessary if market dislocations are to be avoided and negative growth impact is to be minimized.
Financial institutions hoard cash in anticipation of added deleveraging measures, which pushes up borrowing costs. Bond yields actually have been rising steadily over the past two months and now bond market pain is spilling over into equity markets for fear that corporate balance sheets will be affected by higher interest rates.
China’s 10-year bond yield is up 30bps since early October to 3.98% at present. The Shanghai Shenzen CSI 300 Index is down nearly 5% since November 21.
While markets will feel some of the pain of government deleveraging measures, this is nonetheless both necessary and healthy. We remain bullish on both China equities and fixed income markets precisely because the much needed corporate debt reduction measures are now being pursued with greater urgency by the Xi administration. Chinese equities still have quite a bit of catching up to do relative to other major global markets. If you can stand the volatility of the ride, coming months should prove profitable.