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Why China’s financial stability law is not the answer in a tough 2022

For long-term investors, confidence in China will only return when visibility improves around the regulatory crackdown and Covid Zero policies.
Why China’s financial stability law is not the answer in a tough 2022

While China’s proposed financial stability law - which includes a designated fund - makes sense for long-term credit risk prevention, it won't do much to lift investor confidence over the short term, experts say.

Instead, investor appetite for China still depends on policy visibility around interest rates and a potential reverse in the housing and technology sector, they say.

The People's Bank of China (PBOC) on April 6 released a draft of the financial stability law which includes a designated financial stability guarantee fund as a backup fund to deal with major financial risks when necessary.

For the first time, the law puts local government front in preventing financial risks, holding them accountable for dealing with illegal financial activities such as illegal fundraising locally.

As a comprehensive risk-prevention mechanism at the national level, the proposed law also lays out systematic arrangements on principles, accountability, distribution of resources, funding, and liability among regulators, central government, financial institutions, and local governments.

Public consultation period of the draft law will end on May 6.

The law comes at a time when the debt crisis in the real estate sector has emerged as a national-level problem that challenges the stability of the whole financial system.

Carlos Casanova, UBP

LONG-TERM SOLUTION

Given that China faces the big task of restructuring all the debt before they can open up their capital account - including those of private property developers, state-owned enterprises and other companies - Carlos Casanova, senior economist for Asia at UBP, thinks it makes sense to have such a mechanism in place.

“The real estate sector is the main one, but there are going to be other credit issues that will emerge down the line and there will be other sectors that are affected once the housing sector is stabilised. So even if they reflect in the short term, it's just going to keep coming back over the coming years,” Casanova told AsianInvestor.

“It becomes quite important to have a financial stability mechanism to try to iron out some of the issues that might arise from this, especially if you're then asking the state banks to shoulder some of the cost or play a role (which could cause them) to experience losses. They need to be able to tap into specially designated financial reserves so that they're not going bankrupt which would threaten all the deposits of the Chinese people,” he said.

Credit markets in China are being influenced by two related political campaigns, both of which could impact market behaviour or the implementation of the policies in the sector. The first is a campaign to break the link between capital and power, while the second is a campaign to break the links between local government finances and credit, said Howe Chung Wan, head of Asian fixed income at Principal Global Investors.

Howe Chung Wan,
Principal Global Investors

“We expect PBOC, not the Ministry of Finance, to shoulder the heaviest burden for growth support in 2022, even while the PBOC remains stuck between inherently deflationary political priorities and the need to reinflate asset prices and support growth,” Wan told AsianInvestor.

“Ultimately, however, by addressing some of the debt issues in specific sectors regarding inequality, China markets may become more sustainable and resilient in the long term,” he said.

SHORT-TERM PAIN

Noting that the financial stability law is a long-term mechanism, UBP’s Casanova thinks over the short term, investor appetite for China is linked more to policy easing, its Covid zero policy, the regulatory crackdown, and the rate hikes in the US which leads to fewer allocations to risky assets in emerging markets.

To answer the woes of the housing sector in 2022, it’s more about policies on reflation and easing restrictions on leverage, which must be trodden carefully, he said.

For the global strategy of long-term investors, such as pension funds and life insurers, they need to see more policy visibility before re-evaluating their positions, he added.

In the technology sector, even though the Politburo of the Communist Party of China sent out strong signals last Friday (April 29) that the country will formulate detailed measures to support platform economy, which concerns the hard-hit technology and internet sectors, the market is still waiting for concrete measures before anyone can say with certainty that the crackdown has eased.

“Even if they eventually call off the crackdown, it is at best only just positive for market expectations. From the perspective of economic growth, the damage has been done. Tech giants will not stop laying off employees for example,” the head of macro research for Asia at a European financial service company told AsianInvestor.

“Although the politburo again plans to roll out a raft of easing measures, we remain deeply concerned about growth, as we believe that the Omicron variant and the Covid Zero strategy represent the dominant challenges to growth stability,” Nomura wrote in its research published on Tuesday (May 3).

As China continues to suffer from the Omicron outbreak and lockdowns are still in place under Covid Zero, many foreign fund houses have lowered their forecast on China’s full-year GDP growth to below 5%. Nomura even downgraded its forecast to 3.9% on Tuesday. 

¬ Haymarket Media Limited. All rights reserved.
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