China update: local government debt, Yasukuni reaction, IPOs and more

By The Brown Brothers Harriman Currency Strategy Team

We call attention to four recent items in China: First, central bank deputy governor penned an article yesterday saying that China will expand the opening-up of the foreign exchange market and increase its participation. Second, there has been much talk about new IPOs in China. Third, there was quite a bit of backlash against Japan for the Yasukuni Shrine visits by Prime Minister Abe and Internal Affairs Minister Yoshitaka Sindo. Fourth, the latest country-wide debt survey was released a few days ago.

Central bank deputy governor (and head of SAFE) Yi Gang penned an article yesterday saying that China will expand the opening-up of the foreign exchange market and increase participation. He also noted that the nation will curb inflows and outflows of funds seeking short-term speculative and arbitrage gains, preventing the impact of cross-border capital flows. USD/CNY is making new lows for this move. Also note that 12-month USD/CNY NDFs are down 0.22% on the day, a large move. The NDF now implies a 1.2% appreciation in 12-months, using the simple back-of-the-envelope calculation. We think further CNY appreciation is in the cards for 2014, albeit at a modest pace.

There is much talk about new IPOs in China. The CSRC cleared the way for six new IPOs, the second batch since the year-long freeze. The largest of the six is Shaanxi Coal, which is planning to raise RMB17.2 bln ($2.8 bln). With some 750 company applications pending, an increase in IPO approvals could prove a headwind for companies already listed in major stock markets. Besides the potential new supply of China IPOs, we think it will be hard for EM equities in general to gain much traction in 2014 as tapering continues.

There was quite a bit of backlash against Japan for the Yasukuni Shrine visits by Prime Minister Abe and Internal Affairs Minister Yoshitaka Sindo. Chinese Foreign Ministry spokeswoman Hua Chunying said in a statement that the visit to the shrine is another provocation of the Japanese cabinet members on historical issue. Meanwhile an article in Xinhua said that “Abe’s conspicuous lack of historical honesty contrasts shamefully with the courage and vision of late West German Chancellor Willy Brandt.” Brandt’s gestures in the 70s were thought to reflect repentance for the German acts during WWII, helping pave the way for better relations with the rest of the world. China’s ambassador to London Liu Xiaoming accused Abe of deliberately raising tensions in Asia and putting the world on a “perilous path.”

Lastly, here is a summary of the latest country-wide debt survey released a few days ago, conducted between August-September by some 544k auditors:

– As of June 30, the total debt held by the central and local levels of government has reached RMB30.3 trln ($5 trln). Of that, local governments owed RMB17.9 trln ($3 trln). Compared with the late 2010 survey, local government debt increased 67%. China’s total debt rose to 216% of GDP from 128% in the 2008 survey (the first conducted).

– Suspicions of misreporting notwithstanding, the numbers were, if anything, lower than expected. The wider range of expectations was between RMB15-25 trln – with foreigners on the high end and locals on the low end.

– Also as expected, the numbers referring to the shadow banking system were very high. Bank loans accounted for about 56.6% of local governments’ total debt, down from almost 80% in 2010. Conversely, shadow banking financing accounted for 11% of all new lending. Bond issuance by local governments has also increased, accounting for 10.3% of local government liabilities at the end of June, up from 7.1% at the end of 2010.

– According to calculations by the local newswire Caixin, the burden the interest payments required by existing loans amounts to 5-11% of the country’s tax income. This assumes interest rates of 3-7% on direct liabilities held by local governments.

– Now there is talk of new measures to tackle the problem. One example is letting local government alleviate some of their high-cost debt by issuing bonds. Other possibilities would be creating a bad bank of sorts or letting local governments borrow directly from the central government.