The coronavirus has created a command-driven economy
China’s financial system is highly centralised and authorities are now ‘encouraging’ banks to buy ‘virus-control bonds’, writes Shuli Ren
In times of distress, a centralised financial system can go a long way. Global investors, bruised by an ugly week of asset sell-offs, can perhaps consider buying the dip — but only in China.
In the past, if the US sneezed, emerging markets would soon be in the emergency room. Not this time. While the S&P 500 is heading for its worst week since the global financial crisis, China has been relatively Zen-like, despite being the epicentre of the coronavirus outbreak. The ChiNext index, in particular, is still up 16% this year, even after this week’s heavy selling.
When things get tough, stock prices become a tug of war between liquidity and fundamentals. The outlook for profits is bad, but if the central bank cuts interest rates and puts listed companies on life support, stocks may well brush off this black swan event.
This is where China is right now. There will be a bloodbath for corporate earnings, given that much of China remains at a standstill. Only one-third of small and medium businesses have had their workers return, according to a government briefing on Wednesday. China’s top medical expert doesn’t see the virus being contained until the end of April.
Enter the command economy. Whatever reforms Beijing has vowed to enact to give markets a bigger role, China’s financial system remains highly centralised and command-driven. Authorities are now forcing banks to lend and buy corporate bonds at yields that make no sense to private investors. For equity holders, this translates into lower risk premiums.
Take corporate bonds. While the US market practically froze up this week, Beijing is encouraging companies to issue so-called “virus-control bonds”. The issuance criteria are low: companies need only devote 10% of the proceeds to virus control; the rest could be all for refinancing. The interest rate is also low, with the average coupon only 3%, even lower than the People’s Bank of China’s benchmark one-year, medium-term lending rate.
It’s no surprise that these virus control bonds have been mopped up by banks, which are often called on to perform national service. Already, more than 120 companies have gone to the market, raising more than 100-billion yuan ($14.3bn) since the beginning of February. These are essentially large financial subsidies from the state.
It’s about the liquidity
Or consider bank loans. In China, the loan prime rate, or what banks offer their best corporate clients, is, in theory, a consensus figure derived from the central bank’s policy rate and the risk premium determined by lenders. Yet, miraculously, the loan prime rate has been moving in lockstep with the policy rate since the coronavirus outbreak. In other words, bankers don’t see a spike in credit risk at all. That shouts window guidance to outsiders.
Meanwhile, investors are looking to President Xi Jinping to re-open the sluice gates as promised in his vaguely worded speeches. This month, Xi repeatedly vowed to meet China’s economic growth targets, despite the virus. The only way for that to happen is to shower the economy with helicopter money. Inadvertently, Xi is now on the hook for a stock rally.
What Beijing is trying to do is to keep its “scale” companies, which are often publicly traded, afloat until it can contain the virus. The reasoning is that the ultimate demand is there: Chinese consumers will still want to buy cars, apartments and 5G phones, once they can roam about freely on the streets again. The government just needs to ensure that until then, China Inc doesn’t get any margin calls.
In China, earnings never mattered that much anyhow. Look at the historical performance of the ChiNext. The two recent rallies, in 2015, were triggered by a sharp slump in the 10-year government bond yield. The benchmark yield is now back at its 2016 low. Liquidity has always been what matters.
So as long as Beijing doesn’t blink and keeps the money flowing, China’s stock market will be a relatively safe haven.
• Ren is a Bloomberg Opinion columnist covering Asian markets.
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