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FRIDAY, AUGUST 21, 2020

China Markets Dispatch

Policy intelligence that drives markets

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exec summary

One big thing: Sheng Songcheng argues for greater capital account opening as part of the dual circulation strategy

Macro: MofCom confirms phase one trade deal review

Finance: Structured deposits decline for third consecutive month

Rates: Supreme People’s court slashes legal private lending rates

Commodities: Iron ore price jumps 64% in four months

Property: More on tighter financing rules

 

one big thing

1. Dual circulation and the capital account

If you’ve been reading our notes closely over the past few weeks, you know that the “dual circulation strategy” (DCS) is Chinese officials’ big new economic framework (see the August 19 and July 23 Markets Dispatch).

The problem – it’s still not fully defined.

  • That’s why every official, former official, and policy advisor is weighing in – looking to help shape the specific policies that will define the framework.
Some context: This isn’t unusual in China. Top-level policymakers often lay out overarching policy frameworks, around certain policy goals or principles, and then let the experts debate the best way to achieve those goals and uphold those principles.

The key goal of the DCS: To make the domestic economy more resilient against external shocks and vulnerabilities.
  • Enter former central bank official Sheng Songcheng.
On Thursday, Song argue that part of the dual circulation strategy should be to focus on further opening the capital account.

You heard that right. While it may seem counter-intuitive that capital account opening would make the domestic economy more resilient against the vagaries of the global economy, Song makes a pretty strong argument. 
  • His key point is that now is a good to time to encourage more Chinese companies to invest abroad.
  • He says the risk of hot money outflows is low at the moment, and that given the crisis of the pandemic, it’s a particularly good time to acquire overseas assets.
  • Moreover, he says outbound spending will help improve the flow of the RMB globally, which will help with RMB internationalization – a key component of the DCS.
Finally, he says now is the moment to send more capital abroad, rather than simply seeking to bring capital into China’s market.
  • As a quick aside, he has one of the pithiest explanations of China’s capital account opening sequencing we’ve ever heard. The plan has always been (Yicai):
  • "First inflow and then outflow, first long-term and then short-term, first direct then indirect, first institutional and then individual.”
  • Nailed it.
Our take: This is a very smart piece by Song, and it’s worth a read.

Get smart: Policy advisors will continue to jockey to push their ideas forward under the DCS in the coming months – it’s unclear for now whether Song’s ideas will gain currency (pun intended).
  • But if Chinese leaders want to see a genuinely globalized RMB as part of the DCS, they are going to have to open the capital further. Watch this space.
One big question: Given the current geopolitical climate, will Chinese outbound investment be welcomed throughout the world?

Your thoughts? We think this is a particularly important and interesting policy proposal, and we’d love to hear readers’ opinions of it, so don’t be shy.
 

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macro

2. Trade deal review to be rescheduled


On Monday, we told you that the review of the US-China phase one trade deal, originally scheduled for last weekend, had been postponed (see August 17 China Markets Dispatch).

Did you panic?

  • We told you not to!
On Thursday, the Ministry of Commerce (MofCom) confirmed that the talks were still on.

MofCom spokesman Gao Feng gave this laconic reply to a journalist’s question on the status of the review (MofCom):
  • “Both sides have agreed to hold a call in the near future.”
So there you have it!

So far, the US side has kept mum about the rescheduling (Reuters):
  • “Two U.S. sources familiar with the plans said on Thursday no new meeting date has been scheduled.”
  • “White House economic adviser Larry Kudlow did not comment on possible talks with Chinese officials.”

Get smart: Beijing wants to keep the trade deal alive at all costs. It’s the only point of light in an otherwise abysmal bilateral relationship.

Get smarter: The Trump administration doesn’t want to see the deal sunk either, since it’s got China buying literally tons of American agricultural products.

The big question: How will the two sides spin China’s failure to buy US goods at a rate consistent with its obligations?
 

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finance

3. Structured deposits unravel


On Thursday, the People’s Bank of China said that structured deposits dropped by RMB 654.7 billion in July to RMB 10.17 trillion.

  • After peaking in April, structured deposits have declined by almost RMB 2 trillion over three consecutive months.
This is an unequivocal victory for the banking regulator. 
  • After structured deposits surged in the first few months of the year, the China Banking and Insurance Regulatory Commission (CBIRC) gave banks strict deadlines to unwind the products.
Why we’re still watching. The regulators’ victory may have complicated banks’ liquidity positions.
 
Caixin cites an anonymous banker as saying that structured deposits had become a key way for banks to attract large-scale deposits.
  • Those deposits are now flowing off-balance-sheet into wealth management products.

Additionally, Caixin notes that relatively slow growth in banks’ conventional deposits, combined with a flood of money into the stock market, might also be taking a toll on bank liquidity.
 
Get smart: Chinese officials have said a thousand times in recent weeks that they will keep liquidity at reasonable and sufficient levels. It’s worth taking them at their word.

  • That said, we’re keeping an eye out for hiccups, as banks are forced to shift funding sources.
 

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rates

4. Usury, but not as usual


Well folks, it’s official.
 
The legally sanctioned upper limit on lending rates for private loans has been reduced by more than 8 percentage points.
 
On Thursday, the Supreme People’s Court (SPC) said that the ceiling will now be capped at four times the loan prime rate (LPR) level.

  • That puts it at about 15.4% based on the current LPR.
Some context: Previously, non-bank lenders had been protected by the courts if they charged interest no higher than 24%.
  • Rates between 24% and 36% were permitted by the courts, but not protected.
  • Rates above 36% were outright illegal.
More context: The SPC flagged that the change was on its way about a month ago.
 
In a press conference on Thursday, He Xiaorong, a full-time member of the SPC said (Caixin):
  • “Reducing the financing costs of small, medium and micro enterprises and guiding the overall market interest rate downward are important measures to restore the economy and protect market entities.”
Get smart: This decision is controversial. While Beijing – quite reasonably – wants to lessen borrowing costs for firms struggling with the pandemic, it might have the effect of cutting off a swathe of borrowers from access to credit entirely (see July 29 Markets Dispatch).
 

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commodities

5. Gimme more ore!


Iron ore prices have been skyrocketing in China.

According to data from the Dalian Commodity Exchange:

  • Iron ore futures closed at RMB 910/ton on August 6 – the highest price of the year.
  • That’s a nearly 64% jump since the rally started in April.
The moves have gotten the financial media all excited about stimulus-led infrastructure spending (CNBC):
  • “The strong gains come after Beijing pumped hundreds of billions of dollars of fiscal stimulus into its economy to help it bounce back from the coronavirus pandemic. Much of this stimulus would go into infrastructure.”
But domestic futures traders think limited supply is driving up the price (Caixin):
  • “The main catalyst behind the current price surge was Chinese port pressure, where [an] estimated 30% of stockpiles of imported ore [are] currently languishing onboard freight ships waiting to unload their cargo.”
  • “When the ships come, the people on them are checked for Covid-19. But the efficiency of the checkup system is poor, creating a backup of more and more ships that prevents the product from entering ports." 
  • "Meanwhile domestic steel mills are seriously low on stock and prices have skyrocketed.”

Get smart: Some media outlets can’t help attributing everything to government-led stimulus in China. The real driving force is often more nuanced than that.

Get smarter: It’s true that Beijing has pumped lots of stimulus money into the economy, but these measures were calibrated to target specific parts of the economy rather than relying on traditional infrastructure buildout.

What to watch: If the supply bottleneck can be addressed, iron ore prices will come down in a hurry.
 

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currency / property

6. More on tighter financing rules for developers


On Thursday, we told you the People’s Bank of China and the Ministry of Housing and Urban-Rural Development were having a sit down with real estate companies to go over new financing rules (see yesterday’s China Markets Dispatch).

Now, more details on the proposed measures have emerged:

  • The measures will be applied on a pilot basis to individual companies
  • Documents on the pilot measures will be released in the coming days
Looks like some developers will have to change their evil ways:
  • Haitong Securities analyzed 224 real estate companies based on 2019 data, finding that only 68 companies would not violate any redlines while 51 companies would violate 3 redlines, 45 companies would violate 2 redlines, and 60 companies would violate 1 redline.
Get smart: While the new rules are currently in the pilot stage, companies would be smart to rectify their debt levels soon, rather than waiting for regulators to get on their case.

Get smarter: Applying pilot measures to individual companies is an easy way for regulators to test out the new measures without disrupting the entire industry.

What to watch: Which companies will be subject to the pilot program, what the criteria for inclusion in the pilot program are, and how long the pilot will run are all known unknowns.
 

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The information contained in this newsletter does not constitute investment advice.

 

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