Financial decoupling meets financial coupling - Capital Economics
China Economics

Financial decoupling meets financial coupling

China Economics Weekly
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Chinese firms are coming under increasing pressure to delist from US equity markets. But the broader trend is towards tighter financial ties between China and the rest of the world. The financial sector is one area where China may be able to avoid decoupling over coming years.

US to curtail China’s access to its capital markets

On Wednesday, the US House of Representatives passed the “Holding Foreign Companies Accountable Act”, which has already cleared the Senate. If it is signed into law by President Trump, as seems likely, Chinese firms listed in the US will have three years to comply with US audit requirements or face delisting. This could trigger a wholesale exit from US equity markets since China’s rules prohibit local firms from being subject to overseas audits.

There is still time for a compromise to be reached between regulators that averts this outcome. But in the meantime, the threat of delisting will dent appetite for Chinese IPOs in the US and will nudge firms that are already listed there to seek secondary listings closer to home. Chinese officials seeking to deepen China’s capital markets have an incentive to delay any compromise until the last minute.

Large-scale delisting would weaken financial links between the West and China. The US is the second-biggest offshore market for Chinese listings, after Hong Kong, with 217 firms and a market cap of $2.2trn (as of October). Some investors may simply rebalance their holdings toward shares issued by the same companies elsewhere. But others, such as funds passively tracking US-only indices, will not.

This is not the only recent US move targeting the financing of Chinese firms. Last month, Mr Trump signed an executive order barring US investors from holding the securities of 31 Chinese firms with military ties, including the three main telecom giants.

But foreign appetite for Chinese assets is growing

Efforts to encourage decoupling will continue under the Biden presidency. However, whereas we expect rifts to widen between China and the West over coming years in terms of technology and market access, the prognosis for financial links is less clear cut. In particular, steps taken in Washington DC are likely to be offset by the growing appetite of global investors for exposure to China. Foreign inflows into onshore assets have accelerated this year. (See Chart 1.) This is partly cyclical in nature. China’s strong recovery from COVID-19 and high yields relative to elsewhere have made its assets especially attractive. But the opening of China’s onshore markets to foreign investors is also encouraging a structural shift into Chinese assets, which have long been under-represented in global indices and portfolios.

Chart 1: Foreign Holdings of RMB Assets* (RMBtrn)

Sources: CEIC, Capital Economics

Policy steps by the US may slow this shift. But it would take much more draconian restrictions to block it. Instead, foreign demand for Chinese assets may depend more on the actions of Chinese officials. If they extend efforts to reform onshore markets and dismantle capital controls then foreign inflows should remain strong. But appetite could be dampened if they act in ways that reinforce lingering foreign concerns about political and regulatory risk.

The unanswered question is whether officials have turned over a new leaf since 2015/16 when they responded to market stress following an equity market implosion and a poorly-communicated shift in currency policy by imposing trading halts and tightening capital controls. China’s commitment to open capital markets will be tested not when times are good as now, but when the going gets tough.

The week ahead

Next week’s data should show exporters still benefitting from COVID-19-linked demand. But bond market jitters may have slowed credit growth. We expect a further sharp fall in inflation too.

Data Previews

Trade (Nov.) Mon. 7th Dec.

Forecasts

Time (China)

Previous

Consensus

Capital Economics

Exports (USD, % y/y)

(+11.4%)

(+12.0%)

(+11.5%)

Imports (USD, % y/y)

(+4.7%)

(+7.0%)

(+9.0%)

Trade Balance (USD)

+58bn

+54bn

+46bn

COVID-19 flare-up keeps Chinese goods in demand

Exports have strengthened further recently thanks to the strong rebound in retail sales among China’s major trading partners. A rapid domestic recovery has also boosted import volumes.

We think export growth remained rapid last month. The new export order components of the PMIs rose in November (see Chart 2), as did the PMIs of China’s trading partners. Both suggest that fresh lockdowns abroad have boosted demand for consumer goods and COVID-19 related products.

Meanwhile, import growth probably picked up in y/y terms. Most early indicators suggest that domestic demand continued to strengthen last month and the infrastructure investment at the heart of the ongoing stimulus is particularly import-intensive.

Chart 2: Exports & PMI – New Export Orders

Sources: CEIC, Refinitiv, Capital Economics

FX Reserves (Nov.) Mon. 7th Dec.

Forecasts

Time (China)

Previous

Consensus

Capital Economics

Foreign Exchange Reserves

$3,128bn

$3,150bn

$3,175bn

Direct FX intervention unlikely

The PBOC’s net foreign exchange purchases have been negligible in recent quarters, with changes in the value of reserves mainly the result of movements in bond prices and exchange rates.

The offshore renminbi was strong relative to the onshore rate during the first half of November. (See Chart 3.) This hints at official efforts to slow the pace of appreciation. We suspect that state banks have been intervening on the PBOC’s behalf in recent months to increase their net foreign assets.

But we doubt that the PBOC has resumed direct intervention after years of staying on the side-lines. The PBOC wants to avoid publicly adding to its FX pile, not least because doing so could trigger the ire of the US and other trading partners.

We therefore think that valuation effects will have been the main driver of changes in the official reserves last month. Our estimates suggest that this increased the headline number by around $50bn.

Chart 3: Difference between Offshore and Onshore RMB (Basis Points, 7d ave)

Source: Refinitiv, Capital Economics

CPI, PPI (Nov.) Wed. 9th Dec.

Forecasts

Time (China)

Previous

Consensus

Capital Economics

CPI (% y/y)

09.30

(+0.5%)

(0.0%)

(0.0%)

PPI (% y/y)

09.30

(-2.1%)

(-1.8%)

(-1.8%)

Food prices continue to weigh on CPI

Consumer price inflation has declined significantly since the start of the year due to falling pork prices. (See Chart 4.) Food prices look to have dropped further last month, even as demand-side price pressures continue to recover.

Daily data show that pork prices have continued to fall following the strong rebound in pig stocks in recent months. This will have pulled down headline CPI to its lowest since 2010. This isn’t cause for concern however since core inflation remains higher and appears to be bottoming out.

Factory gate prices are recovering too. Commodity prices, which correlate with producer prices, rose last month. Weekly producer price data and the output price components of the PMIs also suggest that the PPI picked up in November thanks to the ongoing improvement in economic activity.

Chart 4: Consumer Prices (%y/y)

Sources: CEIC, Capital Economics

Net New Bank Loans, M2, AFRE (Nov.) 10th – 15th Dec.

Forecasts

Time (China)

Previous

Consensus

Capital Economics

Net New Bank Loans (RMB)

+690bn

+1,450bn

+1,350bn

M2 (% y/y)

(+10.5%)

(+10.5%)

(+10.4%)

Aggregate Financing “AFRE” (RMB)

+1,417bn

+2,050bn

+1,900bn

Credit growth levels off as bond defaults weigh

Growth in aggregate financing (AFRE), the PBOC’s measure of broad credit, has quickened in recent months thanks to policy stimulus. It is likely to have levelled off in November.

We expect the net increases in new bank loans and AFRE to have increased last month. But given that these figures are highly seasonal, we prefer to focus on growth in the outstanding values which are a better guide to underlying trends in credit creation.

On this basis, bank loan growth likely slowed. The pace of bank lending is driven mainly by quantitative controls such as loan quotas, which PBOC statements suggest are no longer being loosened. Issuance of corporate bonds also eased last month. (See Chart 5.) A key factor has been the recent bout of bond defaults, which has led to cancelled bond issues due to concerns of weak demand. Worries over credit risk may also have put a halt to the nascent recovery in shadow lending. That said, other forms of non-bank financing appear to have picked up, including government bonds and equity. Taken together, we expect broad credit growth to be largely unchanged.

Chart 5: Direct Financing (outstanding, % y/y)

Sources: CEIC, WIND, Capital Economics

Economic Diary & Forecasts

Upcoming Events and Data Releases

Date

Country

Release/Indicator/Event

Time (China)

Previous*

Median*

CE Forecasts*

December

Mon 7th

Chn

Exports (Nov.)

(+11.4%)

(+12.0%)

(+11.5%)

Chn

Imports (Nov.)

(+4.7%)

(+7.0%)

(+9.0%)

Chn

Trade Balance (Nov., USD)

+58.4bn

+54bn

+46bn

Chn

Foreign Exchange Reserves (Nov., USD)

+3,128bn

+3,150bn

+3,175bn

Wed 9th

Chn

Consumer Prices (Nov.)

(09.30)

(+0.5%)

(0.0%)

(0.0%)

Chn

Producer Prices (Nov.)

(09.30)

(-2.1%)

(-1.8%)

(-1.8%)

Also expected during this period:

10th – 15th

Chn

M2 Money Supply (Nov.)

(+10.5%)

(+10.4%)

(+10.4%)

10th – 15th

Chn

Net New Lending (Nov., RMB)

+690bn

+1,450bn

+1,350bn

10th – 15th

Chn

Aggregate Financing “AFRE” (Nov., RMB)

+1,417bn

+2,050bn

+1,900bn

10th – 18th

Chn

Foreign Direct Investment (Nov., RMB)

(+18.3%)

TBC

Chn

Vehicle sales (Nov.)

TBC

Chn

CBRC Data on Fin. Inst. (Assets, Earnings, NPL, Nov.)

TBC

Chn

Job Openings to Job Seekers Ratio (Q3)

Selected future data releases and events:

December

Mon 14th

Chn

Home Prices (70 Cities, Nov.)

Tue 15th

Chn

Spending and Activity Data (Nov.)

Thu 17th

HK

Unemployment Rate (Nov.)

Fri 18th

Chn

Foreign Exchange Net Settlement and Receipts (Nov.)

Also expected during this period:

TBC

Chn

PBOC Depository Corp. Survey (Nov.)

TBC

Chn

PBOC Balance Sheet Data (Nov.)

TBC

Chn

Government Revenue and Expenditure (Nov.)

Main Economic & Market Forecasts

%q/q annualised (%y/y), unless stated

Latest

Q4 2020

Q1 2021

Q2 2021

Q3 2021

2019

2020f

2021f

2022f

Official GDP

(+4.9)*

(+7.0)

(+20.0)

(+9.5)

(+7.5)

(+6.1)

(+2.5)

(+10.0)

(+4.5)

GDP (CE CAP-derived estimates)

(+5.1)*

(+7.6)

(+29.0)

(+10.5)

(+5.4)

(+4.0)

(+0.5)

(+10.0)

(+3.5)

Consumer Prices

(+0.5)**

(+0.5)

(+0.6)

(+1.3)

(+1.3)

(+2.9)

(+2.5)

(+1.5)

(+2.0)

Producer Prices

(-2.1)**

(-0.5)

(+1.0)

(+2.5)

(+2.5)

(-0.3)

(-1.5)

(+2.0)

(+1.0)

Broad Credit (AFRE)

(+13.7)**

(+14.5)

(+13.0)

(+12.0)

(+11.0)

(+10.7)

(+14.5)

(+10.0)

(+8.0)

Exports (US$)

(+1.4)**

(+13.0)

(+12.5)

(+7.5)

(-1.0)

(+0.5)

(+3.0)

(+4.5)

(+4.0)

Imports (US$)

(+4.7)**

(+3.0)

(+11.0)

(+16.0)

(+9.0)

(-2.8)

(-1.5)

(+10.5)

(+5.5)

RMB/$

6.53

6.50

6.40

6.30

6.20

6.97

6.50

6.20

6.20

7-day PBOC reverse repo %

2.20

2.20

2.30

2.40

2.50

2.50

2.20

2.50

2.50

1-year Loan Prime Rate (LPR) %

3.85

3.85

3.95

4.05

4.15

4.15

3.85

4.15

4.15

1-year MLF Rate %

2.95

2.95

3.05

3.15

3.25

3.25

2.95

3.25

3.25

10-year Government Bond Yield %

3.30

3.30

3.30

3.20

3.00

3.16

3.30

2.80

2.60

RRR (major banks) %

12.5

12.5

12.5

12.5

12.5

13.0

12.5

12.5

12.0

CSI 300 Index

5,066

5,100

5,250

5,400

5,700

4,097

5,100

5,700

6,200

Hong Kong GDP

(-3.4)*

(+1.0)

(+9.5)

(+11.4)

(+9.6)

(-1.4)

(-5.0)

(+9.0)

(+3.5)

Hang Seng Index

26,804

27,000

28,050

29,125

30,175

28,184

27,000

31,250

35,000

Sources: Bloomberg, CEIC, Capital Economics *Q3; **Oct.; End of period


Julian Evans-Pritchard, Senior China Economist, julian.evans-pritchard@capitaleconomics.com
Sheana Yue, Assistant Economist, sheana.yue@capitaleconomics.com