Yu Yongding Speech Peterson

8/20/2019 Yu Yongding Speech Peterson

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China’s Financial Instability and

Recent Turbulence

Whitman Lecture

Yu Yongding

Presented at thePeterson Institute for International Economics

Washington, DCSeptember 29, 2015


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The topics of China’s financial instability and possible

triggers of a financial crisis over the years

• In 2012 – China’s housing market is on the brink

of collapse.

– China’s fiscal position will worsenrapidly because of massive localgovernment debt.

– the crash of underground credit

networks will lead to a broad financialcrisis across the county.

• In 2013 – Shadow banking activities

– LGFV

– Corporation debt

– Property bubble• Shadow banking activities attract

greatest attention

• Unexpected problem: liquidityshortage in Jun. and Dec.

• In 2014 – Shadow banking activities

– LGFV

– Corporation debt

– Property bubble

• High financing costs and

unavailability of credits to smallenterprises

• In 2015 – Stock exchanges crash

– RMB exchange rate depreciation

• No more discussion of property

bubble• Less attention given to shadow

banking activities


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Three important topics

• Corporate debt

• Stock price bubble

•

Exchange rate


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• The rise in China’s corporate debt-to-GDP ratio

imposes most serious threat to China’s

financial stability in medium and long term


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China’s corporate leverage

• Since the Global Financial Crisis broke out in

2008，China’s nonfinancial corporate debt

has been rising steadily and rapidly.

• According to Standard & Poor's, corporate

debt $16.1 trillion (2014), 160% of GDP

• According to CASS, 145% of GDP

• Will China’s corporate debt-to-GDP ratio

continue to rise until it blows up?


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The corporate debt-to-GDP ratio is

rising steadily: worrying? But…

IMF working paper


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What are the trajectories of those factors that determine the

trajectory of China’s corporate leverage until 2030

• Capital efficiency – low and falling (capital-output ratio rising)

• Corporate profitability – has been falling steadily

• share of finance via capital market – Very low

• interest rate on loans – High

• Inflation rate – producer price Index is falling

• growth target – Relatively high


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Trajectory of the capital-output ratio

0

1

2

3

4

5

6

1 9 5 2

1 9 5 5

1 9 5 8

1 9 6 1

1 9 6 4

1 9 6 7

1 9 7 0

1 9 7 3

1 9 7 6

1 9 7 9

1 9 8 2

1 9 8 5

1 9 8 8

1 9 9 1

1 9 9 4

1 9 9 7

2 0 0 0

2 0 0 3

2 0 0 6

2 0 0 9

2 0 1 2

2 0 1 5

2 0 1 8

2 0 2 1

2 0 2 4

2 0 2 7

2 0 3 0

Capital output ratio


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Trajectory of corporate profitability

(before interest payments)


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Equity finance to GDP ratio

(cannot be predicted)


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So far nominal interest rate resists to fall

(difficult to predict)

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

9.00

2 0 0 8 - 0 9

2 0 0 9 - 0 1

2 0 0 9 - 0 5

2 0 0 9 - 0 9

2 0 1 0 - 0 1

2 0 1 0 - 0 5

2 0 1 0 - 0 9

2 0 1 1 - 0 1

2 0 1 1 - 0 5

2 0 1 1 - 0 9

2 0 1 2 - 0 1

2 0 1 2 - 0 5

2 0 1 2 - 0 9

2 0 1 3 - 0 1

2 0 1 3 - 0 5

2 0 1 3 - 0 9

2 0 1 4 - 0 1

2 0 1 4 - 0 5

2 0 1 4 - 0 9

2 0 1 5 - 0 1

2 0 1 5 - 0 5

weighted average interest rate on loans

weighted average interest rate on loans


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Corporate debt-to-GDP simulation

(baseline scenario)

In 2020, the ratio will surpass 200%!!

the simulation

means that the

total debt service

cost is 43.7% of

GDP in 2021, andwill further

increase to

63.5% of GDP in

2027.


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The stock market turbulence

China’s stock price fiasco: “to save thecity, we bombed the city”

The implication on China’s financialstability is limited

But it bring authorities’ ability of crisis

managing into questionIndirect implication is serious


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The rise and fall of stock exchanges


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Three stages

• Stage 1 (Nov.24, 2014 –Jan. 19, 2015) – Shanghai Stock Exchange Composite Index (SSECI)= 2505，

– Fell to 3166, by 300 points and 7.7%

– China Securities Regulatory Commission (CSRC); clamped down on“Liang Rong”—margin financing (MF), stock collateralized lending (SCL)

• Stage 2 (Jan. 19 2015-Jun. 15, 2015) – SSECI peaked at 5178.19 on 12 Jun.

– It increased by more than 100% in less than 7 months

• Stage 3 (Jun. 15, 2015-present） – On 15 Jun. SSECI fell to 5062.99, by 103 and 2% over the previous day.

This was the day when the bubble started to burst – Now the index fluctuated violently, threat to break the threshold of

3000 point


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How was the bubble created?

• Government policy objectives

– To enable debt-ridden corporates to get funds

from the equity market

– To boost share prices to stimulate demand viawealth effect


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Measures taken

to boost share prices

• margin trading was encouraged andfacilitated

• Monetary loosening (lowering the RRR and

benchmark interest rates etc.)• Reform of IPO procedure: from the

examination and approval system to the

registration system• Shanghai-Hong Kong connection

• Expand quotas of QFII


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the seven channels via which margin

trading is financed

• The seven channels mentioned above are

margin financing (MF), stock collateralized

lending (SCL), umbrella trust (UT), stock

benefits swap (SBS), structured mutual fund(SMF), P2P and offline private fund matching


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The crash

• the China Securities Regulatory Commission

decided to restrict offline private fund

matching in the middle of June.

• On 15 Jun. The SSECI fell to 5062.99, by 103

points and 2% over the previous day

• Because the wide use of margin trading, the

fall in stock prices led to margin call, a

correction turned into a collapse


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The overnment rescue

• when stock price index fell to 4200, CSRCusher in rescue package includes

– stopping IPO

– discourage shorting – organizing a “national team” to prop up stock

prices

– Changing the rules of game

• The hope for reducing corporate leverage viathe capital market is dashed.


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Where did money come from

• High growth of bank credit, due to the PBOC’s

rather loosened monetary policy since the global

financial crisis.

• Low corporate profitability, clamp down on realestate investment and on shadow banking

activities

•In 2014, money flew into the share market, whichwas in a bad shape and share prices were still low

• Two bubbles have burst, what next?


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Exchange rater reform or devaluation?

• August 11 “reform”—Things happened rathersuddenly

• The episode rekindle an old problem that has

been debated since 2003• The implication of episode can be more

serious than the stock market fiasco, with

much large international consequences• The failure will have serious consequences on

China’s financial stability


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August 11 announcement and

devaluation

The daily fix and the closing price on previous day

Lower daily

fix by 1.9%

Closing

price

Daily

fix on

12 Aug


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Unexpected fall?

把收盘价下推，否则收盘价太低导致第二天的中间也太低。

看来没有真正想转浮汇

率

11

收

12

开


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Where does depreciation pressure come from?

China has been running capital account deficit since the

second quarter of 2014

-1,500.00

-1,000.00

-500.00

0.00

500.00

1,000.00

1,500.00

2,000.00

1 9 9 8 - 0 3

1 9 9 8 - 1 2

1 9 9 9 - 0 9

2 0 0 0 - 0 6

2 0 0 1 - 0 3

2 0 0 1 - 1 2

2 0 0 2 - 0 9

2 0 0 3 - 0 6

2 0 0 4 - 0 3

2 0 0 4 - 1 2

2 0 0 5 - 0 9

2 0 0 6 - 0 6

2 0 0 7 - 0 3

2 0 0 7 - 1 2

2 0 0 8 - 0 9

2 0 0 9 - 0 6

2 0 1 0 - 0 3

2 0 1 0 - 1 2

2 0 1 1 - 0 9

2 0 1 2 - 0 6

2 0 1 3 - 0 3

2 0 1 3 - 1 2

2 0 1 4 - 0 9

2 0 1 5 - 0 6

经常项目资本和金融项目:当季值(不包括外汇储备)

In the first quarter of 2015 China’s capital account deficit is larger

that than that of current account surplus.


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Causes of capital account deficit

• The Unwinding of Carry trade

• The diversification of financial assets by

households

• Outbound foreign investment

• Capital flight

•

In short, the currency structure of China’sinternational assets and liabilities are under

going adjustment


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How much ammunition China still

have


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Should China continue to defend the RMB

• What exchange rate regime China wish to

have?

– Carry though the 11 August reform

– Floating

– Quasi-Peg to USD

– Peg to a basket of currencies

• My view is that China should stopintervention and let the RMB to float.


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If China stops intervention, what will

happen?• Devaluation? Yes, but how large?

– Now one knows. But should not very large. 10%? 20%?

– China is still running current account surplus

– China still has capital control

• What will be the negative impacts of a large devaluation – Banks currency mismatch, if there is large borrowing in foreign currency by banks.

– Inflation

– Corporate debt, if there is large borrowing in foreign currency by corporates

– Sovereign debt, if there is large borrowing in foreign currency by the governments）（参见赖因哈特和罗格夫：245页）

• For China – Corporate foreign debt：According to BIS, 962 billion USD，70％ without hedging. China’s

own figure is much smaller, less than 500 billion USD

– Banks foreign debt: 300 billion USD, peanuts

– International condemnation: currency war

– What else?


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The significance of the RMB exchange

rate reform• Over the past two decades, the single most important market

distortion is exchange rate distortion. The reform of exchange rateregime has been delayed for too long.

• Without a flexible exchange rate, China will not able to implementindependent monetary policy without distortion

•Slow appreciation and slow depreciation encourage carry trade andshorting. In both directions, China suffers welfare losses

• Without making exchange rate flexible first, capital accountliberalization will become a dangerous adventure

• Without a flexible exchange rate, RMB internationalization will notgo very far. As soon as carry trade become unprofitable andshorting become a favorable game, de-RMB internationalization willbegin

• A flexible exchange rate will give great impetus to China’s economicreadjustment and growth paradigm shift


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Concluding remarks

• There will more turbulences to come

• Like in the past, China probably will muddle

through again

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Yu Yongding Speech Peterson