China’s curbs on bank lending, Pioneer’s Ratto comments

Mauro Ratto, head of Emerging Markets at Pioneer Investments, answers questions on the real implications of China’s curbs on lending for the world economy.

China’s stock market was down very sharply in June, with banks under severe pressure. Are investors right to fear that growth is at risk?
Banks are by far the top-weighted sector group in China, so there’s little chance for the broad market to buck the trend. Indeed the problem is sector-specific at first glance. Policy makers want to curb excess bank lending in an effort to make the industry better managed and more selective. The People’s Bank of China’s attitude suggests that banks are short of money after lending too much and thus deserve punishing interest rates to cover the shortfall. That’s very draconian and so different from developed countries’ way to regulate banks.

What’s the main difference in bank regulation?
Regulators in developed countries tend to combine changes in interest rates and mandatory reserve requirements. They can also set credit quotas but that’s a rare occurrence in modern times. Liquidity crunches happen, but they’re mostly explained by temporary glitches and are promptly covered by banks’ treasurers albeit at expensive rates mainly in the overnight market. Broad liquidity crunches, such as those following the demise of Lehman Brothers and the euro debt crisis more recently, have elicited a different reaction from regulators, who provided emergency funds to avert a recession.

That may just be a different approach, with few implications for the whole Chinese economy, let alone the global economy. Can we say markets are too concerned ?
The reaction may look overdone, but we shouldn’t forget the current uncertain climate. Investor fears over monetary tightening were raised by the prospective end to overly loose policies in the USA. This sentiment made the U.S. Federal Reserve’s (the “Fed”) gradual time-line for policy normalization (the “tapering” of quantitative easing) appear an abrupt change. China has never embraced overly loose policies but there, too, investors called for some stimulus measures to revive a slowing economy and they are getting tight curbs on bank lending instead.

How important is the change of political leadership in China?
The new leadership, notably the Prime Minister who is in charge of economic policy, has openly talked against things like “stimulus” and “excess”. Property prices are a case in point. Officials are concerned about property-related loans, which are said to fuel a speculative rise in home prices. The way they’re cracking down, however, leads us to believe they want to “prick” the market bubble and trigger a collapse in prices, which may hurt not only banks but also private home-owners with bad consequences on consumer confidence and spending.

Are you changing your portfolio allocation in this uncertain climate?
Our global asset allocation strategy has closed the overweight position to emerging market in an effort to stem the volatility induced by Fed’s tapering process. We didn’t decide this on the basis of fundamental valuations, as we maintain that emerging markets are cheaper than most developed markets and still have a long-term growth story. However we acknowledge that the prospective end to quantitative easing may stem investor flows into emerging markets to some extent. China’s own problems have compounded the case for a more defensive stance. And last but not least, we should ponder the increased political risk (real or perceived) that may ensue from specific situations in key EM countries such as Brazil and Turkey.

Does it mean our strategy wants to hedge against global implications from less quantitative easing?
Actually, we’re not switching into a “risk-off” mode as we don’t believe the Fed will drain away its abundant liquidity too quickly. The “tapering” process is meant to be slow and gradual and is also made conditional on an improving economy. The commitment of major Central banks to economic growth will not be diverted by the Fed’s plan for normalization.

Is there still an investment case to be made for China, maybe in the longer term?
That should not be disputed. We believe that Chinese officials are committed to making economic growth more reliant on household spending and consumer-goods stocks stand to gain from the change. What surprised us (and most other investors) is the way Chinese officials want to force a change in the banking sector’s practices. Bank loans to businesses account for a disproportionate share of the whole lending industry. However it would make more sense for the new leadership to follow up on the former Prime Minister’s call for a break-up of the largest banks’ near-monopoly and let them be run like most privately-owned banks in developed as well as in developing countries.

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