UBS say Worries on China’s Debt are Overblown as it Sets Up Exclusive Investment Fund

by | 22 Nov, 2017

Swiss banking giant UBS is introducing a new private fund for institutional and high net-worth individuals interested in investing in China’s booming equity markets.

Having obtained a new permit granting them increased access to stock markets in the country, UBS is introducing the first mainland China stock fund owned by a company outside China. The UBS China Equity Private Fund Series 1 has completed it’s initial offering, and will help its members to invest in China’s thriving stock markets, which for many years were available only to Chinese citizens.

China’s markets are dominated by state-owned businesses, but private companies are starting to make headway too, particularly in sectors like healthcare. Not only this, but the central government has made reforms in order to let foreign investors trade on more-restricted stock exchanges like the Shenzhen and Shanghai exchanges (which contain so called ‘A-Shares’ – the stocks that this new fund from UBS is mostly interested in).

Historically, these shares were only available for purchase by mainland citizens, due to China’s skepticism about foreign investment, but the country is continuing to open up its markets to overseas wealth.

UBS has a long history in China. UBS AG was China’s first qualified foreign institutional investor, as approved by the China Securities Regulatory Commission in 2003 – a massive deal for a foreign bank!

The fund’s manager, Zizhen Wang, said “From a long-term perspective, UBS sees sustainable growth in the Chinese economy and opportunities in the A-share market,” he added, “Blue-chip stocks are fairly valued and leading companies across numerous sectors are enhancing their international competitiveness.”

In another vote of confidence for the economy, UBS also said they were less worried about China’s debt burden than other banks. Speaking to Bloomberg, Jason Bedford, a Hong Kong-based UBS analyst, said a financial systemic credit event in China is “very unlikely”. He added that a lot of the items on China’s balance sheet were less risky than many thought, even the asset-backed securities.

He said “A significant portion of off-balance sheet exposures are composed of benign, no-risk or low-risk items.” He added, “The failure to distinguish the risk between these items has often led to an exaggerated risk perception among many market watchers.”

It’s no secret that the Chinese economy is hooked on debt, especially in its state-owned enterprises. Lending in the country has grown rapidly over recent years, as household and corporate wealth has ballooned. China’s citizens and businesses have been looking for higher returns in a system where bank interest rates have been held down. 

The government is aware of this, and looks to be taking steps to deleverage the economy by cracking down on certain problem-areas, including the booming online lending market.

Just this week, CNBC reported that a top-level Chinese government body issued an urgent notice on Tuesday to provincial (local) governments, urging them to suspend approval for the setting up of new internet micro-lenders. They also apparently told local regulators to restrict granting new approvals for micro-loan firms to conduct lending across regions. 

These kinds of businesses have grown massively in popularity over recent years, by giving credit to people who couldn’t get loans at state banks, which tend to favour bigger corporate clients instead. 

Xi Jinping has made clear that he backs the idea of deleveraging so as to ‘cleanse risk’ from China’s financial system, and the governments actions so far have been applauded by analysts. But though reforms are clearly in motion, whether this will be enough to offset China’s already hugely leveraged economy is less certain. 

As we saw in the case of the financial crisis in 2008 where top Wall Street firms were leveraged (indebted) to an obscene degree, a high amount of total debt can signal systemic financial fragility. When everyone owes everyone else money, a negative shock to the economy, or even just a spontaneous panic can upset the system, by causing a lot of borrowers to default at the same time. When financial firms are highly leveraged, it also makes it easier to have a bank run or a similar liquidity crisis. During the financial crisis, this was certainly the case. China must avoid this kind of situation at all costs. 

Though UBS are bullish, other data shows the future looks bleak for the world’s second largest economy. Bloomberg economists Fielding Chen and Tom Orlik estimate that China’s total debt will reach 327% of GDP by 2022, a staggering level which could make it harder for the country to avoid a financial crisis, especially considering actual economic expansion is set to slow to 5.8% in 2022 from 6.7% in 2016, compounding matters further, and as growth continues to slow while debt continues to rise, the risk of a collapse in asset prices looms. This would spell big trouble for an economy that the world depends on for so much.

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ALL RIGHTS RESERVED © INVSTR LTD. 2017

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