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Heard on the Street: China's Broad Debt Crackdown Could Get Out of Hand -- WSJ

24 Jun 2017 6:32 am
By Nathaniel Taplin 

This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the US print edition of The Wall Street Journal (June 24, 2017).

China is poised for a once-in-five-years conference this fall, where the next generation of Communist Party leadership will be chosen. Nothing dramatic can happen before that, right?

Wrong. The winter of 2016 and spring of 2017 have already proven to be among the most volatile in memory -- particularly in the bond market where yields shot higher, but also in stocks, which felt the heat from the broad regulatory crackdown on debt in April and May. The latest victims are China's highflying overseas deal makers Anbang, HNA, Fosun and Wanda, whose widespread borrowing throughout China's banking sector are now under investigation.

As early as January, it was clear that the improving economic -- and particularly employment -- picture in China could give policy makers a window to deal with mushrooming financial-sector risks before the Party Congress in the fall made big political moves too risky.

That window, however, is about to close.

Although China's economy remains in reasonable shape for now, April and May data contained clear signals that growth has already peaked cyclically. And slowing industrial profit growth, which fell to 14% year over year in April from nearly 24% in March, will start to put pressure on the job market as well -- -the key to political stability that the Communist Party prizes above all else as the Party Congress approaches.

Although some independent surveys paint a brighter picture, China's official purchasing managers indexes show the job market moving back into contraction in recent months: nonmanufacturing, which includes construction, peaked in November while manufacturing peaked in March. Tightening financial conditions could accelerate this trend -- after falling continuously since late 2015, real borrowing costs for Chinese firms probably started rising again in the second quarter. Chinese factory gate inflation peaked in March -- the same time as industrial profits.

The early warning signs of a slowdown in the economy, and particularly the labor market, means that the pressure from President Xi Jinping and other top cadres to keep raising the heat on financial-sector leverage will probably start easing soon.

That may be easier said than done, however.

Regulatory crackdowns can take on a life of their own -- part of the reason that the volatility in April was so intense, as different regulators all competed to show the top leadership they were heeding Mr. Xi's direct call to tackle financial risks. The 2015 stock crash, which was triggered in part by regulators' belated crackdown on margin borrowing, was a classic example of the danger of too little action, taken too late.

Chinese regulators may yet succeed in tamping down just enough on leverage, at just the right time, to postpone a debt reckoning once again. But that is a tricky needle to thread -- and the consequences of failure large indeed.

Write to Nathaniel Taplin at nathaniel.taplin@wsj.com

(END) Dow Jones Newswires

June 24, 2017 02:32 ET (06:32 GMT)

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