Will Xi Close the Dollar Window?

Bloomberg: China Deleveraging Is Going Into Reverse, New BIS Data Show

Chinese non-financial corporate debt is rising again as a percentage of gross domestic product following a year and a half of deleveraging from its mid-2016 record, according to new data from the Bank for International Settlements.

The ratio jumped to 164.1 percent in the first quarter of 2018 from 160.3 percent in the final three months of 2017, erasing more than half of the progress Chinese companies had made in reducing debt loads since the ratio topped out at 166.9 percent in the second quarter of 2016, the BIS data, published September 23, show.

...The government is also preparing measures on the fiscal side to boost domestic consumption and investment in the face of rising external risks, including tax cuts and infrastructure spending, Chinese officials told reporters Tuesday in Beijing. Lian Weiliang, vice minister of the National Development and Reform Commission, said "China is fully capable of hedging the impact by expanding domestic demand."

Chinese consumers finance consumption with consumer credit. Infrastructure development is funded by debt.

ECNS: China unlikely to follow further Fed rate hike: analysts

The People's Bank of China (PBOC), the country's central bank, is likely to leave its policy rates unchanged after the possible Fed rate hike and will manage liquidity through open market operations, said Wen Bin, a researcher with China Minsheng Bank.

Nomura analyst Lu Ting also expects the PBOC to maintain its rates, adding that low interest rates are needed to stabilize economic growth amid headwinds, while interest rate differentials between China and the United States given the PBOC some leeway in not following the Fed's hike.

As the exchange rate of the yuan remains generally stable against the greenback, there will be limited concern about a weaker currency if the PBOC does not follow suit with raising rates, Lu said.

Back in June I wrote Is China in Recession? Then It Isn't Deleveraging. Without a new source of economic growth, China cannot slow credit growth without suffering a major blow to nominal demand. If the economy isn't slowing and defaults aren't rising, the country is not deleveraging.

Economic reform could generate new growth, but the window for reform has all but closed. Aside from the growing evidence that the CCP isn't interested in reform, trade tensions create a new headwind for growth. China left itself very exposed to a "sudden" change in U.S. policy. It cannot cushion the blow without resorting to inflation.

Chinese FX reserves are stable, but the trade war hasn't hit yet. The yuan faces persistent depreciation pressure as long as the U.S. dollar remains strong. To this point, yuan weakness is entirely due to the stronger dollar, not a jump in depreciation expectations. What happens to FX reserves when the trade war fallout hits and dollar inflows slow? If FX reserves shift into net decline again, China will be inflating against a depreciating asset (FX reserves) that explicitly back the yuan. Maybe capital controls will hold, but even a modest outflow pressure could quickly burn through Chinese reserves. Chinese yuan depreciation/devaluation was never about trade. It's about protecting reserve assets, finding a sustainable level for the yuan and recognizing the true value of the yuan. China is unlikely to close the dollar window and float the yuan because there's no evidence the CCP is interested in letting the market set prices. The most likely outcome is still a large, one-off devaluation that balances reserves against a growing tidal wave of credit that the government has no ability or no willingness to contain.