by Ambrose Evans-Pritchard
February 10, 2017
China’s central bank is running out of ways to stem capital flight and faces a near impossible task trying to manage the fall-out from extreme credit growth, two of Asia’s most influential banks have warned.
“Defense of the currency by the People’s Bank (PBOC) is no longer a viable option,” says Eric Robertson, the head of global macro strategy for Standard Chartered.
Standard Chartered has been in the China since the 1850s and has over 6,000 staff in the country. Its warnings should not be taken lightly.
The Asia-focused lender says powerful forces are driving capital out of the country and the picture is fundamentally more disturbing than it was during last year’s devaluation panic. This is putting the PBOC in an invidious position as it attempts to deal with festering troubles in the banking system.
The Institute of International Finance estimates that outflows reached a record $725bn (£581bn) last year and there is little sign of any slowdown despite ever tighter capital controls.
Mr. Robertson says aggressive intervention on the currency markets to slow the fall of the yuan automatically drains liquidity and tightens financial conditions. “They risk doing enormous damage to the onshore banking system,” he says.
The Japanese bank Nomura issued a parallel alert on China’s “incredible five-ball juggling act,” warning that East Asia as a whole is sailing into a financial storm. There is a high risk of a region-wide credit crunch escalating into something hard to control.
“Asia is likely to be more vulnerable than people think,” says Rob Subbaraman, the bank’s chief global strategist. The risk is that fund managers could pull their money out “en masse,” puncturing the illusion of market liquidity.
While the PBOC still has $3 trillion of foreign exchange reserves, these bond holdings are hard to deploy in China’s internal economy without making matters worse. The country must now pick between poisons.
The reserves are not as large as they look given the scale of the financial pressures and the structure of the Chinese economy. The ratio of the M2 money supply to reserves has collapsed to a 15-year low and this may prove to be the crucial ratio in a confidence crisis.
Standard Chartered says nobody knows at what point the PBOC will lose its room for maneuver but the balancing act is becoming ever harder. “If the reserves are allowed to fall meaningfully below $3 trillion, people will start to worry about reserve adequacy. The markets will grab hold of this,” says Mr. Robertson.
The cautionary language from Standard Chartered is significant. The bank has close ties to China and is a key agent for the country’s offshore yuan transactions.
The PBOC is tapping on brakes – gently, so far – raising a range of rates last week in a calibrated move to cool the excesses. Economic consultants Capital Economics says it is the first official acknowledgement of stealth tightening that has been under way since November.
Until now the PBOC has been quietly dialing down the “quantity” of underlying loan growth, its usual method of micro-managing the cycle.
The PBOC is now starting to tighten the more visible “price” of loans as well. “It is only a matter of time before credit growth, a key tailwind behind the economic recovery in 2016, starts to become a drag,” says the consultancy.
Standard Chartered says the great worry is that the Trump administration and the US Congress will pass a “border adjustment tax” on imports, triggering ructions in the global currency markets.
Most economists fear such a tax could lead to a dollar spike of 15 to 20 per cent. This would set off an earthquake in a global financial system that has never been more dollarized and carries $10 trillion of offshore dollars with no lender-of-last resort behind it.
Mr. Robertson says the consequences for China do not bear thinking about. A move of this kind would be a psychological shock for Chinese savers who tend to follow the headline yuan-dollar exchange rate.
Nomura says much of East Asia is in the late stage of an exhausted credit cycle that has led to endemic mal-investment. The debt service ratio has jumped five-fold over after the last decade and is now 15 per cent of GDP, exactly where it was at the onset of the Asian financial crisis in 1997 – but on a much bigger scale.
The region is in the eye of the storm, at risk from US monetary tightening and the geopolitical fall-out from a trans-Pacific trade war.
“China has reached the point where the rubber hits the road: The problems of property and debt overhangs and keeping zombie companies afloat have become so large that they are bearing down on growth via falling returns on capital and rising debt-servicing costs,” says Mr. Subbaraman.
“Monetary and fiscal stimulus to achieve unrealistic growth targets is not the answer; they are losing efficacy and risk fuelling more bubbles and misallocating more resources,” he says.
The question remains: will the mandarins in Beijing who govern such matters stop ever digging the Great Hole they’re in, or again if ever, start digging themselves out?