China announces changes in policy stance towards credit easing

global perspectives

China announces changes in policy stance towards credit easing

Dhiraj Bajaj - Portfolio Manager, Asia Bond Fund

Dhiraj Bajaj

Portfolio Manager, Asia Bond Fund

In recent days, Chinese authorities and state-run media signaled a change in policy direction towards credit easing. This marks a significant shift from the tightening campaign of the past year as top-down reforms took shape to maintain the nation-wide ‘deleveraging campaign’. 

This, we believe, is the Chinese authorities’ effort to end the self-imposed credit squeeze in China . This easing, along with the recent weakness of the Yuan which authorities have allowed, is probably a response to the potential risk from trade tensions with the US. From a markets perspective, we expect to see Chinese corporate bond yields drop (both onshore and offshore), and this to have a positive impact on Asia as well as other emerging market credit assets, albeit to a lesser extent given the size and relevance of China to emerging market fixed income.


Key policy changes – announced or guided

1) Monetary easing 

  • The China Banking Regulatory Commission has asked financial institutions to do more to help small businesses by cutting borrowing costs. It has called on the big lenders to take the lead.
  • The People’s Bank of China (PBOC) will aid banks  in (i) expanding lending via corporate loans and (ii) increasing the investment in bonds issued by corporates and other entities. 
  • PBOC will introduce incentives to boost the liquidity of commercial banks. PBOC plans to ensure lenders have ample liquidity by encouraging banks to use its medium term loan facility (MLF), among other measures. The outstanding amount in the MLF facility totalled 4.4T yuan at end June and is expected to increase further.
  • Banks which invest in bonds rated AA+ (local ratings) and below will be especially supported. Bloomberg reported that the PBOC will provide commercial banks with the same amount of MLF funds for the portion of their lending exceeding the monthly loan quota as it will for investments in corporate bonds rated AA+ and above. Banks will receive double the amount of MLF loans for investment in corporate bonds rated below AA+ (Note: Ratings below AA- are considered HY by Chinese local ratings).
  • Financial institutions have been guided to use liquidity released from cuts to reserve requirement ratios (RRR) to support SME lending and partake in debt-for-equity swaps. They have also been encouraged to extend more SME lending through expanding guarantees for SME loans.
  • Beyond what has been already announced, we expect PBOC to reduce banks’ RRR by at least 100 bps in the second half of 2018.

 

2) New concerted fine-tuning in shadow banking regulations

  • New detailed guidelines have been issued by PBOC , the China Banking and Insurance Regulatory Commission (CBIRC) and the China Securities Regulatory Commission on 20th July which provide financial institutions more flexibility in unwinding their shadow banking activities. 
  • The new rules by CBIRC on Wealth Management Products (WMPs) and Asset Management Products (AMPs) are likely to soften the tone of “non-standard debt assets” and allow more flexibility in terms of timing and implementation.
  • These measures will likely relax the contraction in off-balance-sheet lending, which was another factor that led to tighter credit markets over the past year 

 

3) Fiscal easing (guided by State Council on 23rd July)

  • The State Council has announced that the government is eyeing further measures to boost domestic demand to support growth. 
  • This will likely include a more expansionary fiscal policy, including further corporate tax cuts  and accelerating the issuance of local government special bonds to support infrastructure investment.
  • Efforts will be stepped up to issue 1.35T Yuan of special bonds for local government to see more tangible progress on ongoing infrastructure projects


Market Implications

Reflecting the State Council meeting, we now expect further concerted policy fine-tuning from government bodies in the coming months on both the monetary and fiscal side. We expect further loosening of liquidity through loan programmes and a reduction in banks’ RRR. We also anticipate targeted measures to support SME lending, increases in local-government and special government bond issuance to support infrastructure spending, and changes in investment regulation to provide greater time for financial institutions to de-lever shadow banking activities. 

The change in policy direction is clear and forceful, given the extent of the measures put forth. This will likely provide confidence to lenders (banks, onshore asset managers and global capital market investors) to step-in and normalise funding conditions once again. This is already starting to have a positive effect as bonds bounce off lows and primary markets reopen this week for issuance. We believe this should mark the bottom for Asian credit valuations given the declines over the past six months. 

 

Fund details:

Asia Value Bond

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