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24 Nov 2017

China Debt, Bond Yields and Equities

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The biggest worry for global financial markets is China.

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Arjun Parthasarathy

The biggest worry for global financial markets is China. The sharp fall in China’s equity indices on the 23rd of November is leading to questions on the repercussions globally. China is the 2nd largest economy in the world and holds enormous economic clout with its trading partners.

China blue-chip stock index,  CSI 300, suffered its worst fall in 17 months on 23rd November 2017. CSI 300 index fell by 2.93% as the market became concerned about rising bond yields and PBoC deleverage campaign. China bond yields are rising sharply due to the deleveraging campaign, China 10 year bond yields have risen by 93 bps this year and are trading at 3 year highs. Sharp rise in China bond yields indicate government’s determination to control corporate debt, which raises concern that Chinese economy could slowdown in future.

As per a Bloomberg report, China 5 year corporate bond yields have risen by 33 bps in November 2017, hitting a 3 year high of 5.3%. There are more than one trillion dollar of local bonds that will mature in 2018-19 and it is going to be expensive for these firms to roll over financing.

China CSI 300 Index

China 10 Year Bond Yields

Why PBoC Started the Deleverage Campaign

China corporate debt levels are too high, as per Bank for International Settlement China corporate debt has soared to 169% of GDP. China debt to GDP ratio rose to 277% in 2016 from 254% in 2015. China credit growth had been very fast and without a detailed strategy to tackle the overhang, there is a risk China will have a banking crisis or slow growth in the future.

In October 2017, PBoC chief, Zhou Xiaochuan, warned that China leverage issues have not gone away, Chinese firms have taken on too much of debt.

China Bond Market Sell-off

China 10 year bond yield has risen by 93 bps this year due to the PBoC campaign against excessive borrowing. Recently China 10-year bond yields crossed the 4% mark after a poor set of economic data and  tight liquidity conditions. Last week, PBoC introduced the toughest rule to curb shadow banking (PBoC restricted banks ability to buy bonds with borrowed money and to lend to corporate clients through off-balance-sheet channels.). This new rule will prohibit asset managers from promising investors a guaranteed rate of return and they will require to set aside 10% of fees for provisioning purpose.

On the economic data front, Fixed asset investment growth between January 2017 and October 2017 slowed to 7.3%, below the market expectation of 7.4% rise. Retail sales for October 2017 rose 10% against the market expectation of 10.4% rise. Industrial output rose 6.2% in October 2017, slightly below the market expectation of 6.3% rise.

 

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