China: Political And Economic Developments

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Includes: CNY, FXY
by: Marc Chandler

Summary

Balance of power in China between "princleling and youth league may be at risk.

Foreigners have stopped up their purchases of onshore CNY bonds.

Tensions are rising between China and Japan and China and South Korea.

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This is the period in the monthly cycle that China releases most of its high frequency data. The process is well under way. Over the weekend, China reported its reserve figures that suggested capital outflows have slowed. Earlier today China reported its largest trade surplus (in dollars and yuan) since January.

With the help of a lending spree, Chinese officials have managed apparently to stabilize the economy. Data due out over the coming days is likely to confirm this signal.

There are several notable developments outside of the immediate economic data. First, it appears that the anticipation of the yuan formally joining the SDR has begun increasing the demand for onshore yuan bonds. Preliminary data suggest that foreign investors increased their onshore yuan bond holdings in June by the most in two years. Foreign investors boosted their holdings by CNY47.7 bln (~$7.2 bln) to CNY764 bln. The breakdown of officials and private sector holdings is not clear.

In addition to SDR considerations, there has been some liberalization in terms of access. When China was experiencing strong inflows, officials liberalized outflows. More recently, capital outflows challenged officials and they moved to liberalize inflows. Specifically, in February, officials have allowed medium- and long-term investors easier access the onshore interbank bond market. Registration is required, but applying for permission or a quota is no longer necessary. June was the fourth consecutive month that foreigners were net buyers of onshore yuan bonds.

There are two other considerations. First, there was the quest for yield. The premium China offered over the US on 10-year money gradually rose in H1 from about 65 bp to start the year to nearly 150 bp by early July. It was the most in nearly a year.

Second, although MSCI decided not to include China's A-shares in its global indices, China is still pushing for its bonds to be included in global indices that Citi, JP Morgan and Barclay's have created. These indices are important because they serve as the benchmark for many fixed income managers.

Political events have become more important for investors, and just because China does not a representative form of government, does not mean that it does not have politics. Over the weekend, senior Chinese officials met. A key issue was the political changes in a year's time. Of the seven-member Standing Committee ( a key decision-making executive committee) five will hit the mandatory retirement age (68). The new configuration will not only shape President Xi's second term but also indicate the succession process.

As we have noted previously, President Xi has consolidated power to such an extent that the balance of power in China between the "Princelings" and the Communist Youth League may be at risk. President Xi has been particularly critical of the Communist Youth League, and many economic problems, including the stock market's performance, has been blamed on them. Premier Li, coming from the Communist Youth League, served as a lightning rod. Some reports suggest that President Xi anti-corruption campaign was aimed primarily at members or sympathizers of the Communist Youth League.

Last week, before the weekend confab, President Xi took what appears to be the most aggressive move to date. Under his direction, the Communist Party control over the Youth League will be increased. Xi is demanding the Youth League are fully committed to his political views. The League's ability to reward loyal supporters through promotions in its large bureaucracy, and then the government will be undermined.

Meanwhile, China's tensions with Japan and South Korea have flared up. Reports indicate that hundreds of Chinese fishing boats and more than a dozen coastguard vessels have been spotted near disputed islands. Japan is formally objected, and is protesting what it claims is the installation of military-grade radar on a gas platform near its territorial waters.

Last month's decision South Korea to install a US missile defense system irks Chinese officials. The US and South Korean officials argue that the "Terminal High Altitude Area Defense System (THAAD) is aimed solely at North Korea's missile threat. Several South Korean legislators are visiting Beijing this week, and it is causing some consternation in local Korean politics.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.