PBoC wary of a hard landing in China

China slowdown concerns continue to drive sentiment in the commodities market.

The iron ore spot price has reached its lowest level since September 2012 and the September futures market is at a record low.

Funding issues, coupled with a slowdown in housing are fuelling the fears that the PBoC and the central government will continue to plough ahead with the fiscal reforms announced at the Third Plenum last year.

Lending standard in China exposed

The biggest concern comes around defaults - particularly shadow banking - and having seen a trust fund already go under at the start of the year, expectations for further defaults have only increased since it emerged that China’s 10 largest lenders saw bad and a doubtful debts in 2013 ballooning to CNY588 billion (US$94 billion).

With debt burdens increasing, cracks have emerged and the lending standard has been exposed. Collateral funding is a particular case-in-point; it emerged that one third of all stock piled iron ore is under a collateral agreement, when the norm is approximately 10%. Copper, a common collateral agent, has also been found to have elevated collateral levels, meaning the falling commodities prices over the past year have seen increased margin calls on the collateralised loans.

With industrial production and fixed asset investment growth falling to the lowest levels since May 2009 and home sales falling as questions around China’s property market mount, the central government’s target of 7.5% GDP and an inflation level of 3.5% look a distant possibility at best.

PBoC and the Chinese government forced into the market

The mounting economic slowdown has finally seen a reluctant central bank and central government being forced into the market, which was always a likely outcome. What is now coming to fruition is very targeted measures to prop out failings and reverse the first quarter GDP print of 7.2%.

The central government was the first to move by bringing forward the production of new railways, the regenerating of shantytowns and giving small and medium enterprises a more preferential tax policy. This was supportive and saw commodities stabilising through April. However, the bounce was short lived as the PBoC was unmoved and continued to soak up excess funds, which saw repurchasing rates flattening out.

Relaxed lending measures

However, the lending strain now looks to have prompted the PBoC to relax some of its measures on rural lenders. Unlike in 2008 where we saw aggressive stimulus on a broad-base scale, the new measures are targeted and could amount to something much more meaningful.

Support for industrial commodities

The two major examples of this include the disbursement of approximately CNY100 billion to the China Development Bank to facilitate the development of shanty towns. Nomura believes that this will be a monthly disbursement throughout May and June, meaning the PBoC will have injected CNY400 billion into targeted infrastructure spending – the assumption here that this will be a positive for industrial commodities.

Cuts to the RRR

The PBoC has cut the RRR (reserve requirement ratio) for country-facing rural commercial and co-op banks. The PBoC has cut rates by 200 bp (basis points) for commercial banks and 50 bp for co-ops. Nomura sees these two measures as equivalent to a 45 bp cut across the economy and again this targets growth and is investment positive.

Markets not responding

In the penultimate week of May, Premier Li Keqiang said the PBoC would 'fine tune' the economy, so this fits into PBoC’s narrative hitting the wires.

However, so far the markets have not responded to these measures; there has been no real pop in the AUD, or copper. The A50 has not moved on the news either, despite what looks like infrastructure planning which would see demand for copper in the home increasing.

However, given the concerns around housing and the slowdown in property prices, these measures must be supportive and should reduce the strain on corporate lending - which should directly and indirectly positively affect bad and doubtful debts.

Although the market is yet to respond, the other clear conclusion from the latest development is that the market’s concern about a China hard landing is now becoming a concern for the PBoC.

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