'Yuan Bear' warns of financial crisis in China

http://www.scmp.com/business/china-business/article/1858500/daiwa-analyst-known-yuan-bear-warns-financial-crisis-china

Daiwa analyst known as 'Yuan Bear' warns of financial crisis in China

True level of overseas debt raised by mainland entities closer to three times that of the official US$1tr figure, says bearish Daiwa economist

As economic growth slows in mainland China, policymakers are left with only two choices - hard landing or a financial crisis, Kevin Lai, Daiwa Capital Markets' chief economist for Asia ex-Japan, warned yesterday.

Lai said rounds of monetary easing, doubts over the true level of overseas debt held by domestic companies, and a strengthening US dollar on the horizon meant the world's second-largest economy was coping with thornier issues than headline figures suggested. His long-held pessimistic views on China have earned him the nickname "Yuan Bear" and, two years ago, he was among the first to predict the yuan's depreciation.

"The debate in the market now is between a soft landing and a hard landing," Lai said. "But I think the real debate should be either a hard landing or a possible financial crisis."

In his latest report - "Crowded entry, jammed exit" - Lai slashed his target for the yuan from 6.83 to 7.50 against the US dollar by the end of 2016.

That contrasts with more positive views in the market. on Monday, ING raised its yuan forecast against the US dollar to 6.40 from 6.55 by the end of the year, citing the recent firming trend of the currency, as well as Premier Li Keqiang's soothing remarks at the World Economic Forum in Dalian last week.

Analysts at Capital Economics also noted on Monday that signs were emerging that economic activity would improve, with more fiscal spending and credit growth on the cards. "While China is still undergoing a structural slowdown as part of its transition toward a more consumption-driven economy, we believe that the short-run downside risks are overstated," they said.

Lai said the People's Bank of China has followed the US Federal Reserve in easing monetary policy since the global financial crisis, with most of the additional US$3 trillion printed by the PBOC between August 2008 and July 2015 having been used to purchase US bonds, allowing companies and individuals to borrow US dollars at ultra-low cost.

The result of such leverage was that the true level of overseas debt held by mainland Chinese entities could be much larger than expected. Lai estimated the real US dollar debt raised by mainland entities should be close to US$3 trillion, rather than the US$1 trillion shown in Bank of International Settlement data on cross-border claims to emerging economies.

"Hong Kong and Singapore have amassed a large pile of dollar debt over the past six to seven years," he said. "Why would such small economies need so many debts? They are essentially raised by Chinese companies' offshore subsidiaries."

Beijing had been fighting capital outflows, as shown by record falls in recently released foreign currency reserve and forex purchase position data. The intervention was risking a credit crunch, Lai said, as the mainland's monetary base has been declining in recent months despite rounds of rate reductions.

Using foreign exchange to defend the yuan from depreciating called on the PBOC to print more money, which would in turn put more downward pressure on the yuan, he said. Letting the yuan slide would sharpen capital outflows and likely result in enormous defaults on US dollar debts. Lai said those were the trade-offs that Beijing had to consider.

"Policymakers are running out of ammunition," he said. "The end-game for China is either domestic debt deflation or a currency crisis. But China could also muddle through, which we think is the most likely case.

"In such a scenario, the government would try to manage an 'orderly' downward adjustment for the yuan, and in the meantime slow the pace of monetary easing. But this will also mean tightening capital controls."