China’s Stock Market Soars on ‘Leaked’ Reform Documents as Bond Markets Seize Up

Following a sustained downdraft since September, China’s major equity benchmark, the seemingly sluggish Shanghai Composite index surprisingly jumped by 1.68% on Friday, allegedly on “leaked” documents that showed the intended reforms by the Chinese government from the recently concluded Third Plenum

From Malaysia’s The Star.com

A document purporting to detail reform plans by China's ruling Communist Party, including liberalising the prices of resources and reining in some state monopolies, circulated widely on social media on Friday, helping fuel the biggest stock market rally in two months.

The document appeared to be a scanned copy of part of a version of a policy statement with annotations on it.

It circulated on the Twitter-like social media service Weibo and was passed around widely on the social messaging service WeChat….

The proposed reforms…

The document said the government will push reforms on the pricing of water, oil, natural gas, electricity, telecommunications and transportation, and refrain from intervening in the market.

The government will push ahead with exchange rate and interest rate reforms, establish a market-driven bond market and open capital markets further, while speeding up moves towards full capital account convertibility, it said.

The government will also push reforms to limit various forms of state monopolies. State-owned firms must adapt to market changes, improve their efficiency and engage in fair competition, and exercise more social responsibility, it said.

China will encourage more state-owned enterprises (SOEs) to shift towards mixed ownership by bringing in private investors and allowing employees to hold shares in such companies, it added.

It included details on giving farmers more property rights and quickening reforms of the current "hukou" or residency system, which currently hinders rural residents from making a full transition to urban dwellers - something that in turn has impeded the country's urbanisation efforts.

Such restrictions will be lifted in small cities and townships and gradually removed in middle-sized cities, the document said.

Generally, the rumored reforms, which have been mostly liberalization based, seem promising over the long term. Some of the rumors above have now been official.

However, implementation will mark the difference from rhetoric

Yet the Chinese political economy and her financial markets will have to face vast immediate or short term challenges first. And the ultimate  challenge is how to deal with her overleveraged economy.

Allegedly due to the Chinese central bank’s (PBoC) suspension of cash injections (Reuters), overnight interbank shibor rates skyrocketed (Shibor.org).

Signs of liquidity squeeze even hit the Chinese government’s 10 year bonds which yield reached a “record” high of 4.6 on Friday. Yields of the 10 year sovereign closed at 4.43%, still up 16 basis points week on week.

What’s the implication of the surge of lending rates? 

The Chinese political economy has racked up the biggest private sector debt since 2008 compared to her emerging market and developed contemporaries

From another perspective, the ramping up of China’s debt markets has been from bank and non bank loans (including the Shadow Banking—China’s shadow banking industry posted one of the world’s fastest growth in 2012 according to the FSB). 

While debt growth has mostly been in the private corporate sector (a big segment of which has been due to Chinese local government financing vehicles or LGFVs), even households and the government has contributed to the substantial increase.

In the face of such huge debt levels, interest rate increases only means a larger share of debt servicing which should eat up on profits, delay planned expansions and possibly reduce overall demand. This also means greater risk of deterioration on credit quality or higher risks of credit default. The two charts above are from the Financial times

Should interest rates continue to dramatically rise (via China’s bond vigilantes), this will likely represent a “shock” to many establishments or even households who will be forced to respond drastically by adjusting to a “new” tighter money environment. 

Yet these precipitate adjustments will possibly be manifested, not only in China but on many international financial markets especially on economies whom has tightly connections or interactions with China. Again everything will depend on the bond vigilantes.

We live in interesting times.