When rhetoric and simultaneous policy rate cuts failed to arrest the slide in Chinese equity markets late last month, Beijing resorted to threats, trading halts, and finally, to central bank intervention.
An unwind in official and unofficial margin lending channels had put immense pressure on the country’s stock market bubble and when it became apparent that the only way to arrest the slide was to prop up margin lending, the PBoC moved to backstop China Securities Finance and in the process created an $800 billion, state-controlled, margin lending Frankenstein.
For a few days, calm returned to Chinese equities but to those with a keen eye, it was clear that the relative tranquility would not last.
As we noted last week, China was apparently so confident that three week’s worth of unprecedented (and comically absurd) intervention had stabilized the situation and repaired what we still contend is irreparable damage to the collective psyche of the Chinese retail investor, that the PBoC was set to wind down the CSF’s plunge protection activities just days after several commercial banks pledged billions more in support for the margin lender. We got a good look at just how unstable the situation still was when, last Monday, Bloomberg (citing Caijing) reported that the CSRC was "studying [a] stock stabilization fund exit plan."
Here’s what happened next:
Fast forward exactly one week, and although it’s not entirely clear what actions the CSF has taken recently (i.e. to what extent more money has been funnelled to brokers), what is clear is that whatever respite Chinese investors enjoyed is now over.
As noted on Sunday and again earlier today, there’s still plenty of evidence to suggest that when one looks at official margin lending and the leverage that’s spread across at least six backdoor channels, the unwind has probably just begun and as BofAML notes, "most leveraged positions may suffer from losses likely in Rmb trillions."
That is unless Beijing moves to "take on substantially all of the leverage." This harkens back to comments made on July 18 by Finance vice-minister Zhu Guangyao who noted that "the key is what step the financial regulator should take after the stock market is stabilised, including the withdrawal of the intervention methods."
Here's a look at known CSF funding and spending so far:
If the CSF support dries up, the result could be carnage. Here’s BofAML with more on a potential unwind of China’s plunge protection program:
The balance sheet of CSFC, the vehicle the government has been using to stabilize the market after the crash, is unclear. Local media has reported that it had drawn down Rmb1.3tr from an Rmb2tr credit line provided by banks; the PBoC had also lent CSFC at least Rmb120bn and might have subscribed to Rmb80bn of its bonds.
In turn, CSFC had used the fund to buy A-shares directly or indirectly by lending to brokers to fund their proprietary desks (as discussed earlier), and subscribing to ETFs and mutual funds.
The equity base of CSFC, after the increase on July 3rd (most likely funded by PBoC), is only Rmb100bn while it may be carrying Rmb1tr+ stock positions by now (the size is likely still rising by the day based on our assessment). So unless the government will treat CSFC as another bad bank and allows it to carry the losses "indefinitely", at certain point, CSFC may sell to reduce its stock exposure.
An "indefinite" holding period is certainly possible – it’s how the government had dealt with the last round of bad debts in the banking system, i.e., by shifting them to bad banks and never crystalizing the losses. But even under such a scenario, there may be unintended consequences. For example, these loans to fund stock purchases have expanded RMB supply. Unless the government sterilizes elsewhere, particularly if the government has to buy Rmb trillions more stocks in the market going forward, property bubble risk may rise and RMB may come under pressure.
If it sterilizes, real business may suffer from less available credit as a result. Obviously the ideal scenario is if CSFC ultimately sells the stocks on its book at a profit, similar to what the US government managed to do with its capital injection into a few banks. However, we judge this outcome unlikely given the highly inflated valuation.
As you can see, there really is no right answer here and indeed the PBoC may now be in a position that's become all too familiar for DM central banks.
That is, an exit simply isn't possible.
Simply selling the shares now would be a disaster for obvious reasons (just look at Monday's action) while liquidiating the portfolio at a profit will likely prove to be impossible given the high prices paid for the stocks. Amusingly, Beijing may be forced to do exactly what the ECB has done to excuse the fact that Mario Draghi is buying €1 trillion in EGBs above par - classify the whole portfolio has "held to maturity." Only stocks don't mature, so China will need to invent a new bucket called "held to indefinitely" which isn't all that much different from forcing banks to perpetually roll bad debts in order to "manage" NPLs, something Beijing has been doing for quite sometime.
Clearly, this is has the potential to exacerabte capital outflows given the pressure it could put on the yuan. Nevertheless, "stabilizing" the market is likely to take precedence in the short-term which is why you should expect the plunge protection headlines to come fast and furious. And sure enough, just moments ago:
- CHINA TO CONTINUE STABILIZING MARKET, SENTIMENT, PREVENT RISKS
- CHINA SEC. FIN. CORP. HASN’T EXITED STOCK MARKET: CHINA’S CSRC
"[The turmoil] has come to an end."
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Full statement from CSRC (Google translated):
Q: Recently, some media reports, speculation, "national team" has been withdrawn, no bailout of. I ask whether it is true?
A: This is totally untrue . The SFC will continue to stabilize the market, to reassure, to prevent systemic risk as a working goal, to do related work. China Securities Finance Company did not quit, and will choose the holdings, continue to play a good function to stabilize the market.
Q: According to reports, the recent focus on selling large number of individual stocks, if the case of malicious short existence?
A: Do not rule out this possibility. SFC is the power of organization clues about verification, once verified, will be severely punished. Welcome to the community to report to us, to provide clues.