A couple of weeks ago China SCE Property Holdings, a company based in the coastal city of Xiamen, quietly redeemed an outstanding $350m dollar bond more than a year before it was due. I very much doubt that many among the elites crunching around in the snow at the World Economic Forum in Davos noticed this move. They have plenty of macro-level problems to distract them, with markets tumbling, the oil price sinking and geopolitical tensions sky-high.
But the fate of that little $350m bond points to a trend that helps to explain some of today’s market turmoil — and also highlights the headache confronting policymakers in China, Washington and elsewhere.
In recent years emerging markets companies in general — and Chinese groups in particular — have dramatically increased their dollar debts. The Bank for International Settlements calculates this now stands at $4,000bn for emerging markets as a whole, four times higher than in 2008. A quarter of this debt has emanated from China.
Until lately, using dollar-based markets to issue bonds or take loans seemed a smart strategy for Chinese groups. After all, the US Federal Reserve has kept dollar rates at rock-bottom lows and the renminbi has strengthened against the dollar in the past decade. But now the US interest rate cycle has turned and the renminbi has weakened. Moreover, contrary to assurances made in Davos by China’s most senior regulator that Beijing is committed to maintaining a stable currency, most delegates I have spoken to expect the renminbi to fall 10-15 per cent against the dollar in the next year.
A string of Chinese companies is seeking to get ahead of this trend by stealthily repaying dollar debts, often by raising funds in renminbi instead. While these repayments are tiny, estimated to be worth only a couple of billions of dollars so far, some Chinese and western government officials at Davos privately think this trend will fuel $500bn of capital outflows in the next couple of years. It looks like a case of a quasi-carry trade going into reverse.
This development is welcome from the perspective of many Chinese companies. After all, early redemption of dollar bonds may help them avoid default. If it also accelerates capital flight, however, it could deliver a destabilising jolt to the markets.
It looks as though this trend is gathering momentum: the Institute of International Finance estimates that almost $700bn of funds left China last year, considerably more than previously thought. That in turn illustrates an essential truth that Davos delegates (and everyone else) needs to remember: if you want to understand why global markets are in turmoil, there is no point looking at macroeconomic data alone. The forecasts released by the International Monetary Fund this week certainly do not explain, on the basis of the hard numbers, the scale of volatility we have seen.
The IMF expects a global growth rate of 3.4 per cent this year. And while the outlook for Brazil has been downgraded sharply, China is still slated to expand by 6.3 per cent.
Capital flows, fuelled by politics and policy change, are where the important action is taking place. Deep in the bowels of the system all manner of financial flows are switching course, creating unexpected knock-on effects for many asset prices.
Capital flight from China is one example. The energy sector is another. While the collapse in the oil price has prompted investors to stage a high-profile flight from the sector, oil-producing countries are furtively selling their holdings of US Treasuries and withdraw money from asset managers because governments need the cash. Meanwhile, the prospect of political fragmentation in Europe is causing many big asset managers to reassess their exposures there, too.
In some ways this is what we would expect: capital flows are fluid; but the real problem for investors and policymakers is that it is often fiendishly hard to track the scale and pace of these stealthy shifts since the data are so patchy. Indeed, the workings of China’s shadow banking system are as opaque as the US subprime mortgage sector was in 2007.
If you want to understand how global markets are behaving, do not just watch the economic data, let alone fret about whether Chinese growth is 6.3 or 6.4 per cent. In the next few months we all need to watch micro-level capital flows with renewed intensity and, above all, pay close attention to how the authorities are managing them — or not — in China and elsewhere.
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