Xi’s carrot could be a market catalyst

Call it the carrot and stick. After the National People’s Congress repealed presiden- tial term limits, allowing Xi Jinping to rule beyond 2023, China’s 64-year-old leader is handing out some nice sweeteners.
Two major announcements show the pace of financial reform is quickening. As Bloomberg News reported in January, China will indeed merge its banking and insurance watchdogs. At the same time, a $15.8 billion share sale by Agricultural Bank of China Ltd signals the process of shoring up state-owned lenders’ balance sheets is underway.
The People’s Bank of China (PBOC) is the biggest winner of the merger, which aims to prevent regulatory arbitrage—exploiting loopholes in the system to avoid unwanted restrictions. Functions previously performed at the two regulators, such as drafting rules and prudential oversight, will now be handled by the central bank.
As I’ve written, the combination really amounts to a hostile takeover of the insurance industry. More than political risk, ballooning state-owned-enterprise and local-government debt is the key concern that has prevented global investors from going all-in on China. Beijing is nervous that delevera- ging will spark a bond sell-off. After last October’s party congress made curbing debt a policy priority, the 10-year government bond yield briefly topped 4 percent for the first time since 2014.
So here comes the cash-rich insurance industry to help with an orderly unwinding of China’s massive corporate debt pile. The industry’s fast-growing investment portfolios amount to 15% of GDP. Only 35% of holdings are in bonds, according to China Insurance Regulatory Commission data.
In other words, if a bond rout ever transpires, whether triggered by local government financing vehicles retiring debt or by global jitters, the PBOC can round up insurance companies for some bond-buying national service. With the 10-year yield having stabilized at around 3.85% after November’s wobble, that prospect should reassure global investors.
Meanwhile, Agricultural Bank said it aims to raise as much as 100 billion yuan in what would be the biggest-ever follow-on share offering by a Chinese company. It will sell stock to seven state-linked entities including Central Huijin Investment Ltd and the ministry of finance, already major shareholders of China’s third-largest lender.
The sale kills two birds with one stone. First, Agricultural Bank has the weakest capital buffer of the big four lenders (the others are Industrial & Commercial Bank of China Ltd, Bank of China Ltd, and China Construction Bank Corp.) so the cash injection underscores government’s resolve to keep the banking system safe.
Second, the private placement alleviates market concerns that Chinese banks will tap the public market for capital, an option that would add to supply and put pressure on their stock prices. Agricultural Bank’s Hong Kong-listed shares surged 5.1% as of the midday trading break, the most in a month.
The benchmark MSCI China Index has recovered well since the global market rout in early February, gaining about 9% this year. Still, Chinese stocks could go a lot higher if concerns over financial risks recede. After all, banks account for about 15% of the index and remain inexpensive, trading at an average of once book.
So where’s the stick? China may be trading short-term gain for long-term pain, as Gadfly has noted previously. Away from financial markets, the billions behind the Great Firewall may see their freedom of expression further constrained. But as long as bull spirits are in the ascendant, investors on the outside have no reason not to cheer.

—Bloomberg

Shuli Ren is a Bloomberg Gadfly columnist covering Asian markets. She previously wrote on markets for Barron’s, following a career as an investment banker, and is a CFA charterholder