+++(BG) Xi’s Carrot Could Be Catalyst for an All-In China Rally: Gadfly

(Bloomberg Gadfly) — Call it the carrot and stick.
After the National People’s Congress repealed presidential
term limits, allowing Xi Jinping to rule beyond 2023, China’s
64-year-old leader is handing out some nice sweeteners.
Two major announcements in the past 24 hours show the pace
of financial reform is quickening. As Bloomberg News reported in
January, China will indeed merge its banking and insurance
watchdogs. At the same time, a $15.8 billion share sale by
Agricultural Bank of China Ltd. signals the process of shoring
up state-owned lenders’ balance sheets is underway.
The People’s Bank of China is the biggest winner of the
merger, which aims to prevent regulatory arbitrage — exploiting
loopholes in the system to avoid unwanted restrictions.
Functions previously performed at the two regulators, such as
drafting rules and prudential oversight, will now be handled by
the central bank.
As I’ve written, the combination really amounts to a
hostile takeover of the insurance industry.
More than political risk, ballooning state-owned-enterprise
and local-government debt is the key concern that has prevented
global investors from going all-in on China.
Beijing is nervous that deleveraging will spark a bond
sell-off. After last October’s party congress made curbing debt
a policy priority, the 10-year government bond yield briefly
topped 4 percent for the first time since 2014.
So here comes the cash-rich insurance industry to help with
an orderly unwinding of China’s massive corporate debt pile. The
industry’s fast-growing investment portfolios now amount to 15
percent of GDP. Only 35 percent of holdings are in bonds,
according to China Insurance Regulatory Commission data.
In other words, if a bond rout ever transpires, whether
triggered by local government financing vehicles retiring debt
or by global jitters, the PBOC can round up insurance companies
for some bond-buying national service.
With the 10-year yield having stabilized at around 3.85
percent after November’s wobble, that prospect should reassure
global investors.
Meanwhile, Agricultural Bank said it aims to raise as much
as 100 billion yuan ($15.8 billion) in what would be the
biggest-ever follow-on share offering by a Chinese company. It
will sell stock to seven state-linked entities including Central
Huijin Investment Ltd. and the Ministry of Finance, already
major shareholders of China’s third-largest lender.
The sale kills two birds with one stone. First,
Agricultural Bank has the weakest capital buffer of the big four
lenders (the others are Industrial & Commercial Bank of China
Ltd., Bank of China Ltd., and China Construction Bank Corp.) so
the cash injection underscores the government’s resolve to keep
the banking system safe.
Second, the private placement alleviates market concerns
that Chinese banks will tap the public market for capital, an
option that would add to supply and put pressure on their stock
prices. Agricultural Bank’s Hong Kong-listed shares surged 5.1
percent as of the midday trading break, the most in a month.
The benchmark MSCI China Index has recovered well since the
global market rout in early February, gaining about 9 percent
this year. Still, Chinese stocks could go a lot higher if
concerns over financial risks recede. After all, banks account
for about 15 percent of the index and remain inexpensive,
trading at an average of once book.
So where’s the stick? China may be trading short-term gain
for long-term pain, as Gadfly has noted previously. Away from
financial markets, the billions behind the Great Firewall may
see their freedom of expression further constrained.
But as long as bull spirits are in the ascendant, investors
on the outside have no reason not to cheer.