China Stocks, Currency, Corp Bonds Tumble After New Steps on Debt Risks

By Shen Hong in Shanghai, and Mark Magnier and William Kazer in Beijing 

        China notched its biggest market loss in five years after Beijing made a surprise move to rein in lending, fueling concerns about growth in the world's No. 2 economy.
        Tuesday's selloff came as policy makers convened in Beijing to plot an economic policy course for the next year--a meeting widely expected to yield a a drop in the 2015 growth target to 7% from 7.5%.
        China's leaders have struggled to find a balance between reducing the economy's reliance on government spending and boosting consumption to sustain growth over the longer term.
        Policies aimed at cutting down on debt--which economists estimated topped 250% of gross domestic product this year--could hold back growth in the short term if they choke off credit to industries such as steel and cement, where problems with overcapacity are widespread.
        The benchmark Shanghai Composite Index slumped 5.4% on Tuesday to record its biggest fall since 2009 after a regulator banned investors from using low-grade corporate debt as collateral to borrow cash. The bond market fell first, sending yields higher, before the turmoil spread to the yuan, which recorded its biggest two-day tumble ever against the dollar.
        The sudden moves served as a reminder to global investors about the country's risks, just as China has opened up stock investment to foreigners.
        The growth target isn't likely to be revealed until March, when China's legislature meets for its annual session. But in China, state media often indirectly signal policy shifts ahead of official declarations.
        On Tuesday, the Communist Party's flagship newspaper, the People's Daily, published a commentary from a government think tank saying that some stimulus measures may be needed but shouldn't be a substitute for reforms.
        "The important objectives are to adjust the economic structure and boost its quality," said Liu Shijin, vice president of the State Council's Development Research Center, in the commentary. The newspaper paired this with a front-page report bearing a headline that said an end to high growth was the "new normal."
        Tuesday's slump in the stock market was especially stark, though not entirely unexpected. A recent surge has made Shanghai the world's top-performing major index this year, a gain fueled to a large extent by retail investors using borrowed cash to leverage their bets. That has contributed to the market's wild swings in recent days and drawn warnings about the market's stability.
        "I was actually doing a presentation in my office during the last 10 minutes of trading, when my boss asked me to stop and asked everyone to look at stock prices. Then I saw the incredible fall of the Shanghai index and my stocks that have turned from black to red in just a few hours," said Wu Yunfeng, a Shanghai-based investor.
        The broad selloff was triggered when China's securities clearing house said late Monday it raised the threshold for corporate bonds qualifying as collateral for repurchase agreements, or repos, short-term loans with maturities spanning from overnight to 182 days. Bond investors such as insurers, mutual funds and brokerages use the repo market as a prime channel for short-term funding.
        "The new rule is to prevent risks from building up further as a result of high leverage in the market," said Xu Hanfei, analyst at Guotai Jun'an Securities. Mr. Xu also said that the combined outstanding value of repos on the country's two exchanges has surpassed 700 billion yuan ($113.5 billion).
        The securities clearing house said the new rule also applies to bonds issued by local-government financing vehicles. They have taken on huge amounts of debt in recent years to fund infrastructure projects around the country, but many are struggling to repay the money. Their revenue has slowed as a result of slower economic growth and a downturn in the property market.
        China's gross domestic product grew at 7.3% in the third quarter, its slowest pace in more than five years, while investment, industrial production, retail sales and industrial profit all posted weaker growth in October and new-home sales in November declined for the seventh consecutive month, albeit at a slower pace. "We haven't seen any significant pickup in any indicator recently," said ANZ economist Zhou Hao.
        Economists said they expect the leadership this week to set a stable monetary and credit policy stance for next year and to discuss key structural reform plans, such as interest-rate liberalization, reform of state-owned companies and land policy. In past years, the meeting's results have been disclosed at the National People's Congress, which is usually held in March in Beijing.
        "A lower GDP target for 2015 is almost certain," said Societe Generale Group in a research note, echoing others. "The new target is likely to be either 'around 7%' or 'a desired range of 7%-7.5%' "
        Industrial output, the most closely watched indicator of the economy's performance, is expected to slip to 7.5% year-on-year growth in November, from 7.7% the month before, according to a median forecast of 16 economists surveyed by The Wall Street Journal.
        China's leaders have worked to make the country's stock market more attractive after years of lousy performance. Measures they have taken have included a crackdown on insider trading, limiting the number of new share offerings, and most recently opening the stock-trading link between Shanghai and Hong Kong.
        Still, the rapid pace of the recent run-up is likely something policymakers don't like to see, especially given the leverage in the market. Even after the selloff, the Shanghai market remains up 35% this year, while the yuan is down 2.2% this year as the dollar has surged globally. Yields on China's 10-year benchmark government bonds have risen 0.25 percentage point this month to touch 3.799% on Tuesday.
        The selloff in the stock market was the top topic of conversation in the financial corners of microblogging service Weibo, as retail investors watched gains accumulated over a few days disappear in an afternoon.
        "The Chinese stock market is sick," said one post from the eastern city of Linyi.
        "It earned a lot in the morning, and it dropped deeply in the afternoon, " said another post on Weibo. "I don't know why this stuff dropped, and I don't know why it goes up either. There's almost no logic. It isn't as good as going to the casinos in Macau."
        Shen Hong contributed to this article.
        Write to Shen Hong at hong.shen@wsj.com
        (END) Dow Jones Newswires

        December 09, 2014 19:26 ET (00:26 GMT)

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