April 11, 2014 5:05 am

China bond auction failure reinforces slowdown concerns

A customer picks vegetables in a market in Hangzhou, east China's Zhejiang province on April 11 2014. Chinese inflation accelerated to 2.4 percent year-on-year in March driven by higher food prices, official data showed April 11, though economists warned there was still a risk of deflation. CHINA OUT AFP PHOTO©AFP

The Chinese government was unable to sell all the bonds offered at an auction on Friday, its first such failure in nearly a year amid concerns about slowing growth in the world’s second-largest economy.

The failed bond auction raises the stakes for Beijing as it tries to rein in debt levels, illustrating that even the state will have to pay a higher cost for funding as banks focus more on investment risks and demand improved yields.

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Traders said there was strong appetite for the government bond but only at rates above what the finance ministry was willing to pay to borrow money.

The bond failure followed inflation data that showed prices fell in China last month, reinforcing the picture of a sluggish economy weighed down in part by government efforts to squeeze leverage out of the financial system.

Consumer prices fell 0.5 per cent in March from the previous month, while producer prices remained mired in deflationary territory for a 25th consecutive month, according to figures published by the national bureau of statistics on Friday.

Weak trade figures and industrial data, junk bond defaults and big declines in property sales have also added to a disappointing first quarter for China.

Analysts have rushed to downgrade their forecasts for Chinese growth and predict that the economy will expand 7.4 per cent this year, its softest in more than two decades.

The downturn has fuelled expectations that the government will prop up growth, but Li Keqiang, the premier, on Thursday rebuffed calls for a stimulus. “We have the capabilities and the confidence to keep the economy functioning within a proper range,” he said.

But some analysts believe the government runs a risk of being too slow to counter the deterioration of China’s growth prospects.

“It’s high time for the government to ease fiscal and monetary policy. I wouldn’t think of it as a policy stimulus. Policy has been too tight since last year,” said Shen Jianguang, an analyst with Mizuho Securities.

In the bond auction the finance ministry had hoped to sell Rmb28bn ($4.5bn) of one-year bonds. However, it ended up selling just Rmb20.7bn, the first time since June that a government debt sale failed to reach its target.

Last year’s failure was a precursor to a cash crunch that roiled global markets when Chinese money market rates spiked to double-digits.

Bond traders said the situation was different this time, with liquidity conditions healthier and the central bank determined to avoid a repeat of the cash crunch. But with market rates climbing in recent weeks and traders expecting the tightening to continue, banks demanded a higher yield from the finance ministry.

“Rates have to stay relatively high to force deleveraging. Yields should be higher,” said a trader with a bank in Shanghai. “Everyone is suffering from the deleveraging process, even the finance ministry.”

Debt in China has risen to about 220 per cent of gross domestic product, compared with 130 per cent in 2008. The International Monetary Fund and global rating agencies have said such a rapid increase in debt can endanger a country’s financial stability.

Since the middle of last year, the government has taken increasingly aggressive steps to slow the build-up of debt, making it harder for banks to obtain cheap financing and clamping down on shadow banking activity. But these tightening measures have also taken a toll on growth, as highlighted by the subdued inflation.

Looking at price figures for the first quarter as a whole, the weakness is apparent. The consumer price index rose an average of just 2.3 per cent in the first quarter compared with the same period last year. That is down from 2.9 per cent in the final quarter of 2013 and it is also well below the government’s target of 3.5 per cent inflation this year.

For industrial companies, the trend is even grimmer. Prices of goods as they leave their factory gates fell an average of 2 per cent in the first quarter from a year earlier. Although producers have faced deflation for 25 months, the situation had previously looked to be improving with declines narrowing at the end of last year.

“These downward pressures are particularly pronounced in the sphere of heavy industry, which is both most exposed to lower raw commodity prices and also overexposed to overcapacity issues,” said Louis Kuijs, an economist with RBS.

The weak inflation data weighed heavily on Chinese markets on Friday. Shares in Chinese companies listed in Hong Kong fell 1.85 per cent, underperforming the wider market, which was down 0.8 per cent.

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