China’s Simmering Summer Repeat Woes

Summer, traditionally a time to slow down in the Northern hemisphere, has in recent decades ushered in some of the most challenging times for EM investors.  July 1997 was the start of the Asian Financial Crisis, Russia defaulted in August 1998, and China devalued the RMB in a shock move in August 2015.  The Southern hemisphere has also shown preference for summer crises: Mexico devalued the peso in December 1994 with ripple effects and several of Argentina’s defaults were also in December, the height of summer.   

This year China is at it again with a seismic seasonal selloff. After the Didi debacle and announcements that the Cyberspace Administration will now be in charge of policing overseas listings, regulators across the government are cracking down on the private sector. The shock announcement that the government is banning tutoring companies from making profit followed by the notice that online food platforms must earn at least a minimum wage has wiped billions off Chinese tech shares. In just three days the Nasdaq Golden Dragon China Index – incorporating 98 of the biggest Chinese firms listed in the US – sank nearly 20%, while the Hang Seng Tech Index plummeted 17% in the same number of sessions and has lost half its value since it peaked in February, according to Reuters.   

While a few investors may be bottom fishing, sustained selling is expected on regulatory uncertainty.  Although the tech crackdown began last November when giant Ant was forced to pull its Hong Kong/Shanghai offering, the acceleration of regulatory moves the past month will pressure both stock prices and the RMB. Despite continued trade and investment frictions with the US, the RMB gained almost 1.5% against the USD through June – and is still up marginally – as foreign inflows to local stocks and bonds topped USD 112 billion. The combination of share sales and USD 27 billion in dividend payments in August will pressure the currency, even if most of the tech sell-off is confined to listings in Hong Kong and the United States with an eye on which sector will be reined in next.

On the bond side, USD-denominated paper is also slumping, led by property firms as Beijing reins in prices and cracks down on leverage. The government has vowed to push ahead with government-subsidized rental housing and increase oversight on developers’ financing.  Giant Evergrande, the most indebted developer, is leading the way down.  Standard & Poor’s cut its rating 2 notches to B- just days after a court ordered a freeze on deposits at a regional bank and media reported that several large banks are restricting credit to the developer. The most shorted stock in Hong Kong, according to IHS market, Evergrande has issued USD 20.7 billion in offshore bonds. Evergrande’s share price fell 30% in H1, and in the past two weeks has plunged another 40%. Bonds have dropped below 50 cents to record lows in recent days.  While its offshore obligations have been met for 2021, Evergrande has more than USD 7 billion in bonds coming due next year and is funding itself onshore through non-transparent means on the shadow bank market, including wealth management products and trusts.

The crackdown on the private sector, coming the same month the Communist Party celebrates its centenary, will continue to expand. Last year the CPC’s Central Committee called for the United Front – a network of groups controlled by the CPC to advance its interests – to strengthen its control in the private sector. The billionaire founders of the large tech companies have clearly become a threat to President Xi. He will likely call for the “national team” to prop up stock prices as with market falls in the past. However, CBIRC, the regulator, has already warned that banks face the threat of rising bad loans with the current recover “unbalanced and lacking a solid foundation.”  The Chinese tech turmoil will drag down the EM MSCI Index further through the Northern hemisphere’s summer, as giant Tencent and Alibaba account for 10% of the index, and Chinese companies as a whole now account for more than 35%. Emerging markets investors face another August of managing waves of risk there instead of preferred beach vacation versions.

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