China’s Current Account Surplus and the Politics of Currency Intervention

China’s current account surplus is about to become a much larger issue for global markets and policy-makers, as it represents a drain on global demand. Recently released 2Q 2020 balance of payments data show China’s surplus expanding again after the COVID-19 outbreak, along with China’s share of global exports. Some of this expansion may moderate as outbound travel from China resumes and the services trade deficit expands once again.

Policy measures in Beijing appear to be driving stronger surpluses, though, rather than promoting market-based adjustments that would reduce external imbalances. China’s “dual circulation” push, the PBOC’s recent management of yuan appreciation, and implied hidden intervention in foreign exchange markets all imply larger surpluses. Recent on-the-ground conversations with exporters suggest a strong outlook for outbound shipments through the end of the year, at least. If there were ever a time for China to back away from currency intervention, that time is now—but we do not expect that to happen.

Posted October 2, 2020
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Geographic Counterparty Risks

Traders and investors in China’s financial markets are starting to question the capacity of local governments to back implicit and explicit guarantees on bonds and corporate borrowing, including those from local government financing vehicles (LGFVs). Local debt risks are now interacting with local economic development: if banks and investors do not view a local government as creditworthy, the entire local economy can suffer, along with its banks, LGFVs, property developers, and state-owned enterprises. Many traders and lenders are now implicitly pricing geographic counterparty risk.

In this note, which updates our analysis of local debt from last December, we take a comprehensive look at financial data from 2,262 LGFV bond issuers, and break down the corresponding local debt burden by province and by city. Key findings include:

• Total LGFV debt has risen to at least 57.4 trillion yuan ($8.4 trillion) by June 2020. Local governments assume most of these implicit liabilities on top of 24.2 trillion yuan in official local debt, bringing total local debt to around 82% of GDP. But interest costs have come down, consistent with PBOC monetary easing.

• Default risks in the corporate bond market by province are highly correlated with provincial credit growth rates. Banks and traders are starting to restrict credit to risky localities.

• Infrastructure investment growth is slowing in highly indebted provinces even though these regions have issued more bonds, showing linkages between debt levels and the potential effectiveness of fiscal stimulus.

Beijing is trying to balance maintaining economic growth and reducing debt risks through its local government bond issuance, but in regions facing weaker fiscal conditions, these bonds will primarily be used to repay debt, not to fund new spending. Many more localities will face difficulties accessing new credit or investment as local debt risks rise, particularly in China’s northeastern and southwestern regions. Funding chains that have been critical to sustaining investment and policy credibility are starting to break down.


Posted September 9, 2020
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Taking Stock: Industrial Inventories and the 2H 2020 Cyclical Outlook

China’s economy has recovered from the COVID-19 outbreak, led by infrastructure investment and property construction, while household consumption has lagged. That rebound has been positive for heavy industry, but inventories have also played a significant role in GDP growth in Q2.

In this brief note, we break down China’s industrial inventory data and show that commodity-intensive upstream sectors are likely to reduce output in the second half of the year. Production in downstream sectors should pick up, but the sustainability of the recovery depends upon household consumption, which is still underperforming. On balance, cyclical activity in China’s economy is more likely to slow sequentially than accelerate in 2H 2020. That may be consistent with stable or slightly higher year-over-year GDP growth in Q3, before a deceleration in Q4.

Posted August 12, 2020
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