China is resorting to increasingly forceful measures to contain risks to the financial system, in moves that threaten to undermine President Xi Jinping’s pledge to give markets greater freedom.
Authorities have in recent weeks ordered state firms to curb their overseas commodities exposure, forced domestic banks to hold more foreign currencies, considered a cap on thermal coal prices, censored searches for crypto-exchanges and effectively banned brokers from publishing bullish equity-index targets. A new rule will bar cash management products from holding riskier securities and limit their use of leverage. On Thursday, an official said China plans to sell metals from state reserves.
While the measures fall short of direct intervention, they risk reinforcing the notion of moral hazard. If traders know authorities are likely to step in to limit gains or losses in an asset class, they can bet on that outcome with some certainty. The implied government backstop can encourage one-way bets — a challenge for policymakers as they seek to make markets more efficient while supporting an imbalanced economic recovery.
“The problem for China is that there is more debt and more risks to the financial system, making it harder to give up control of domestic markets,” said Michael Pettis, a Beijing-based professor of finance at Peking University and author of Avoiding the Fall: China’s Economic Restructuring. “The more China stabilizes markets, the more fundamentally unstable they become because of moral hazard.”
Easy monetary conditions abroad are exerting pressure on Beijing. Much of the liquidity unleashed by governments and central banks in the past 15 months has headed straight into China — a huge market offering higher yields, a strong currency and increasingly better access for foreign nationals. One-sided capital controls mean prices can be skewed by too much money entering the mainland.
Officials have warned of asset bubbles on multiple occasions since January. Even before surging commodities started to stoke inflation risks, authorities had already encouraged a correction in stocks and cornered leveraged bond traders.
The rhetoric intensified last week at a key forum in Shanghai, with the country’s chief banking and insurance regulator calling for “relentless” efforts to battle financial risks. Companies speculating in the currency are “doomed to lose,” said the head of China’s foreign-exchange watchdog. Investors should be wary of yuan depreciation risks as the dollar strengthens, said the China Foreign Exchange Committee in a Wednesday post.
“Policy makers are keenly monitoring financial stability risks,” Morgan Stanley economists including Jenny Zheng wrote in a June 10 note. “China’s Covid stimulus response was meaningful and effective in leading a recovery in the real economy, in contrast to a ‘flood-like stimulus’ approach in some developed markets which partly contributed to record-high asset prices.”
That doesn’t mean the Communist Party is abandoning efforts to reduce the state’s influence. Beijing’s silence on the future of China Huarong Asset Management Co. — a bad-debt manager deeply entwined in the nation’s banking system — has shocked investors and challenged long-held assumptions that the government will always bail out systemically important firms to maintain stability.
The notion of “too big to fail” may no longer apply to Chinese borrowers, according to Goldman Sachs Group Inc. analysts.
The government is battling against extraordinary forces. A gauge tracking commodity prices rose to a 10-year high this month, with gains in fuel, metals and food proving more persistent than thought. That’s feeding into faster inflation in emerging markets as well as developed economies such as the U.S. and the euro area.
Guo Shuqing, chairman of the China Banking and Insurance Regulatory Commission, warned last week that global inflation may not be as transitory as some experts predict, while central bank Gov. Yi Gang said China must not let its guard down as it faces inflation and deflation pressures “from all sides.”
Complicating the picture is the fragility of China’s economic recovery. Data Wednesday showed retail sales and industrial output grew slower than expected in May. This may fortify the the government’s preference for intervention over more blunt tools. The People’s Bank of China has said it won’t significantly tighten monetary policy. Unlike its counterparts in other emerging economies like Russia, Brazil or Angola, the PBOC is not expected to hike interest rates any time soon.
This means targeting risks at the micro level will likely continue, even though this reinforces the belief that the state will always step in when the threat to stability is perceived to be too great, thus making truly free markets a more distant prospect.
For now, the Communist Party may consider this a cost worth bearing, especially as it seeks calm in the run up to its centenary on July 1.
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