Defiant leader: Xi speaks to the media in the Great Hall of the People in Beijing. He is banking on a vibrant sovereign bond space to defuse China’s municipal debt crisis. - AFP
UNLIKE Donald Trump, who slavishly sought validation from the S&P 500, China’s president Xi Jinping seems impervious to the ups and downs of financial markets.
Foreign investors have already come to terms with the fact that he doesn’t care about their billion-dollar losses.
Even the new year rout in domestic stocks, which is starting to become a political problem, doesn’t appear to bother him.
His technocrats are content with just enough policy tweaks to halt the market’s free fall.
The much anticipated two trillion yuan (US$279bil) stabilisation fund, which may spark a bull run, has not come about.
There is one market, however, that is perhaps dear to Xi’s heart.
He is banking on a vibrant sovereign bond space to defuse China’s municipal debt crisis.
Its health is also essential in his bid to dethrone the dollar’s dominance in global trade.
As of September, sovereign and quasi-sovereign issues accounted for close to half of China’s 133 trillion yuan inter-bank bond market.
How much debt is too much? Both Washington and Beijing have liabilities that exceed their entire economies.
Once we include off-balance-sheet borrowings local governments have undertaken, China’s government debt has ballooned to 122% of gross domestic product, according to International Monetary Fund estimates.
The United States is not shy about deficits either, notching the same number. But here is the key difference.
Foreigners own about 30% of the US$26 trillion US public debt, versus only 5% in 1970.
By comparison, this figure stands at just around 10% for China.
In other words, overseas governments and asset managers have been funding Washington’s pet projects such as pandemic stimulus checks, while Beijing is still figuring out who is ultimately footing the bill for its infrastructure spending.
Attracting foreign buyers
As far as Xi is concerned, the United States is in an enviable spot. He naturally wants to take a page out of the Americans’ playbook and lure in foreign buyers.
He might even be able to argue that Chinese government bonds are safe-haven assets.
They have outperformed volatile US Treasuries in terms of total returns.
As Beijing tries to defuse the local debt time bomb by bringing some leverage onto its own balance sheet, the health of its sovereign bond market is paramount.
The Finance Ministry needs strong demand for new issues, which means it has to make investors believe that they can continue to profit from their holdings.
And the timing may just be right for Xi.
In a stark reversal of recent trends, foreign investors are scooping up yuan bonds again.
Two reasonings drive this new-found enthusiasm.
First, now that the Federal Reserve has clearly ended its hiking cycle, global investors feel that the yield differential between the United States and China has peaked – or at least it is now within the People’s Bank of China’s (PBoC) control.
Second, the prolonged deflationary pressure in China will eventually drive yuan bonds to the same fate as the eurozone’s pre-pandemic issues.
Austria managed to raised a century bond in 2020 at only 0.85%.
The 10-year Chinese bond yield slipped to 2.47% this week, a level unseen since 2002.
Lower yield means higher prices for older notes.
Keeping the yuan firm
To nurture this slow bull, China’s policymakers must be responsible and keep the yuan firm and the yield differential narrow for largely dollar-based global investors.
Indeed, the PBoC has been gun-shy, disappointing analysts with no rate cuts in January.
The central government also needs to make sure its balance sheet is transparent, and its fiscal expenses are predictable and accountable, which perhaps explains why the stock stabilisation fund has not yet materialised.
Granted, Xi has made a lot of progress with the international use of the yuan.
It surpassed the dollar as China’s most-used cross-border legal tender last year, marking a major milestone.
But for the currency to truly go global, it needs to be traded in liquid global markets, and the country’s risk-free bonds have to be held by foreign sovereigns. China is obviously not there yet.
If there is any lesson to be learned from recent regulatory crackdowns, financial markets do not matter to Xi if their underlying assets and performance do not serve the greater good.
How the CSI 300 Index is doing is at most an afterthought, because the president’s high-end manufacturing ambition is being financed by bank loans.
But the government bond market is essential.
This is where he will prove China’s supremacy over the United States. — Bloomberg
Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. The views expressed here are the writer’s own.
