China Macro Monday The Week Ahead (July 10-14) and the Week Behind (July 3-7) The focus in China this week may quickly shift back NFC Expectations from liquidity risks for financial sector firms to credit risks for real sector borrowers. This could be amplified In earlier pieces we have detailed expectations for by market anticipation of the National Financial the NFC, and refer you to NFC expectations and Conference (NFC), expected to open on July 14, and Debt Restructuring (July 7) and The NFC and Policy the near simultaneous PSC mid-year meeting on the Bull Market Possibilities (June 15). We will note, economy. As is the case for equities, we see the potential however, that just before the PSC mid-year meeting for divergent performance of SOE versus private sector on the economy in 2016, Beijing published two policy credit (large cap versus small cap), as part of a bias in documents which are arguably more relevant today the reform agenda that clearly favors the state sector. than they were then: first was “Leading Opinions on This week we are (again) flagging disinflation risks for the Promotion of Central SOE Structural Adjustment China in H2, with another misleading reading for PPI and Reorganization by the State Council”; second expected this week. The first weak print for PPI may not was “Opinions on Deepening Structural Reforms to show up until July, but nominal flows in the economy Finance and Investment”. As is typically the case, these are not as strong as PPI implies. documents did not include quantitative targets, but still read like signals that the pace of SOE financial Yield curve steepness is inversely correlated with the “reorganization” and debt restructuring was going to phase of the business cycle in China. For example, increase, as would impulse-style fiscal stimulus. Back just as did in June 2011 and June 2013, relative yield then we got the latter, but not the former. These curve flatness in China appears to be bottoming out as documents were setting the stage for the potential the cycle is peaking. Related to this is the real interest opening of the National Financial Conference in rate cycle, and historically the PBOC has allowed real November of last year, which was delayed due to rates and yields to peak as the cycle bottoms. This is personnel disagreements and a lack of consensus (see: precisely where we are now: the yield curve is sending Politburo Mid-Year Meeting on the Economy, July highly bearish signals and real rates are close to zero, 2016 and/or July 2016 “Opinions” in Financial Sector just as the cycle is rolling over and disinflation is set to Reforms, July 2016). accelerate. CGB Yield Curve A Predictor of Cyclical Peaks 2.5 China Business Cycle Index CGB 10Y/1Y Spread 2.5 PRC Macro proprietary 2.0 2.0 0.8 1.5 1.0 1.5 0.6 0.5 1.0 0.4 0.0 -0.5 0.5 0.2 -1.0 0.0 0.0 -1.5 -2.0 -0.5 -0.2 Jun 11 Jun 13 Jun 15 Jun 17 Mar 16 Jun 16 Sept 16 Dec 16 Mar 17 Jun 17 www.prcmacro.com [email protected] +1 (929) 225 6104 China Macro Monday (July 10) July 2017 Borrowing Costs for NBFs and Real Sector Spread Between Interbank Lending (NCDs) and Remain High Despite Ample Liquidity Real Sector Borrowing Costs Remains Elevated percentage points - as of 7/7 percentage points - as of 7/7 6 6 6M Discount Rate For Bank 6M Discount Rate For Bank Acceptance Notes Acceptance Notes 5 5 Avg. 6M 4 WMP Yield 4 6M NCD Rate 3 3 2 2 June 2015 June 2016 June 2017 June 2015 June 2016 June 2017 As a final preparatory step for the opening of the NFC coming two-weeks. Perhaps even before this occurs, we believe that Beijing has appointed a new chief we will be looking for emerging signs of corporate insurance sector regulator. The likely new CIRC chief is credit risks as important segments of financing to the Yang Xiaochao, formerly a vice-mayor of Beijing whose real sector continue to contract on year-on-year terms. only previous financial sector experience was as the Market sentiment should thus reflect a return to cyclical director the Beijing municipal financial affairs office credit risks, and away from the recent obsession with from 2008-2013. Yang’s career progression has been interbank liquidity. Among other things, rapidly falling 100% dependent on patronage from Wang Qishan, interbank rates reflect a liquidity preference on the and with him in place at CIRC, this would create the part of both banks and non-bank financials (NBF). appearance of clear Wang Qishan faction in the This has been apparent in an increase to the price financial sector. Recall that Wang is also a main political and reduction to the volume of credit available to the patron to Guo Shuqing at CBRC and Jiang Chaoliang, real sector. This could exacerbate short-term funding the likely successor to Zhou Xiaochuan at PBOC (see: stress, which is already rising on both a seasonal and Rumors and Two Candidates for PBOC Governor, cyclical basis. In recent weeks we have cited the RMB June 6). It is beyond the scope of this note, but we 1 trillion+ reduction to available discount bill financing think such a brazenly partisan appointment could since CBRC launched its regulatory storm, not to spark a significant technocratic backlash. Additionally, mention a RMB 1 trillion+ reduction to the volume of in the context of escalating attacks on Wang Qishan quasi-fiscal bond issuance compared to a year earlier by Guo Wengui and the reality that Wang Qishan has at the end of June. antagonized wide swaths of the bureaucracy with his own power consolidation as the head of the Party Liquidity Recap inspection apparatus, his expanding influence over the financial sector could increase pressure from the Party In addition to seasonal factors (i.e. interbank liquidity elite on Xi Jinping to rein Wang in. always tends to be loose in the beginning of the first month of each quarter due to reset of monthly loan A Shift from Liquidity Risks to Credit Risks quotas for banks by regulators), there are a couple of key underlying factors that have made interbank For now, financial market liquidity conditions in China liquidity unusually abundant in the last two weeks appear to be flush, but there are looming drains (starting from June 20) despite PBOC’s net withdrawals on liquidity that could reverse this perception in the via OMO. www.prcmacro.com [email protected] +1 (929) 225 6104 2 China Macro Monday (July 10) July 2017 Fiscal Fund Disbursement: The last month of each quarterly MPA inspection where the PBOC required quarter is normally the time for MOF to refund a hard cap on its measure of “broad credit growth”, tax revenues back to local governments, and local which is the M2 growth target +20%. Recall that “broad governments are supposed to spend the refunds. credit” includes loans, securities investment, interbank Recall that fiscal deposits are not included in monetary assets and lending to NBFs. In early June commercial aggregates, so a reduction to government deposits banks were worried that NCDs would be included in results in an increase to base money. The flip side of this definition, and NCD rates spiked hard. However, this is that when corporates andl local governments around June 20 banks were informed that NCDs would remit taxes it (increasing fiscal deposits) it shows up as be exempted from the cap for another quarter, and a withdrawal of liquidity from the system. Corporate rates began to come down. It is still unclear, however, tax submissions also occur regularly in the first month whether NCDs will be subject to MPA related caps in of each quarter (April, July and October), meaning the future, so banks have been attempting to suck in more withdrawals of base money, whereas tax as much funding possible via NCDs in the short-term. disbursements often takes place in the last months of On the funding side, banks and NBFs have been happy each quarter (June, September and December), which is to take advantage of elevated NCD yields, and the net often associated with a windfall increase for interbank effect is to draw liquidity into the interbank market, liquidity. It is believed that fiscal spending this June and away from segments of real sector lending. (the disbursement of tax refunds from MOF to local governments) was likely larger than previous years As mentioned previously, It is also rumored that a large because MOF has been sending inspection teams to proportion of commercial banks have lent out around urge local governments to initiate their spending more 70%-80% of their annual new loan quotas, and this quickly. For instance, MOF published a notice titled could mean that new loan growth in Q3 remains soft, “Implementing More Effective Measures to Strengthen as banks wait for yearend demand from their prime the Management of Local Government Deposits” on borrowers. Something else to keep in mind is that May 23. According to this add-on to the budget law, maturing OMO + MLF in July should total RMB 918 local governments are supposed to keep minimal billion. The breakdown is around RMB 358 billion in deposits on hand during regular months (except the MLF and RMB 560 billion in OMO. Add in the withdrawal months for tax submissions to MOF). Ideally, local of corporate deposits in July for the submission of tax governments should disperse tax refunds as soon as payments, and the amplitude of this first-month-of- possible once they are received from MOF.