A stabilization of Shibor in China is a necessary, but insufficient, condition for the market to rebound on a sustainable basis says David Cui, BAML analyst based in Hong Kong. Cui notes that ;ooking back to 2011, 7D Shibor in China peaked on Jun 23rd at 9.2% and then declined rapidly to 3.7% by July 13th; however, HSCEI didn’t bottom until Oct 4th and SHCOMP couldn’t find its footing until early 2012. PBoC’s action that drove up Shibor last week is equivalent to throwing a heavy stone into the pond and there will be repercussions. Until these are played out, we may not see any meaningful rebound in the market. He thinks are probably a few months away from seeing that: first, we are still in the midst of a liquidity crunch; once that’s over, potential growth and solvency risks (especially in highly leveraged areas including LGFVs and developers) may come to dominate market sentiment. Further details from BAML below.
China potentially on the verge of a vicious liquidity cycle
The sharp fall in SHCOMP yesterday and intraday today suggests forced liquidations in our opinion - some financial institutions probably liquidated some positions, including those held for WMPs, to satisfy regulatory, redemptions and other needs. The market reaction this time is much stronger than in 2011, indicating higher leverage in the system. It seems to us that we are probably on the verge of a vicious cycle getting established, i.e., forced liquidation – lower asset price – forced collateral sale – even lower asset price. That’s why we believe that, unless the government takes decisive measures to calm things down reasonably soon, market downside can still be substantial.
The morning after – focus on solvency risks
We expect the government to calm Shibor down over the next few weeks. Nevertheless, the latest shock should have made many shadow banking products buyers more aware of the hidden risks. As a result, credit should become less abundant and credit cost, higher. It’s quite likely that some projects may not be able to secure financing. Given credit-fueled low-quality investment growth has been behind the recent turnarounds in growth, we consider the risk of a hard landing much higher this time. Moreover, as credit growth slows, bad debts may surge – the weakest link is LGFV and property related trusts but stress can spread wide and quickly through the financial system. Once investors start to factor in solvency risks, the market may capitulate and reach a genuine bottom in our opinion. At this stage, we look to 1H 2014 as the potential period.
China Property market another potential catalyst
The hike in Shibor in China in mid 2011 contributed to a mini-collapse in housing demand in Sept and Oct that year. But it can also go the other way this time if rich people decide to leave shadow banks and park their money in property. Anyhow, we think the property market is fairly unstable and waiting for a correction as well.