The bullish case for China

A bullish case for China is given by one Western fund manager who can claim something most of his counterparts can't: having actually lived there for a long time. His key takeaways:

- China may be overloaded with debt, but it seems to be making progress shifting more of it to securities markets, where their risks can be priced more accurately than traditional bank loans thanks to exposure to the investing public
- Beijing will continue to prioritize a stable currency and can fend off the downward pressure for a large devaluation of the yuan
- Cooperation with its trading partners, especially the US (even under a Trump presidency), ensures a favorable external environment for the transition and rebalancing

In a nutshell, despite all the naysayers, China's at least trying to get the reform ball really rolling along.

A fertilizer maker in north China has become the latest company to default on its bonds, as confidence in Beijing's implicit guarantees of bailing out debt securities, even of SOEs, appears to be flailing as never before. With some $571 billion of local corporate notes maturing by year-end 2016, companies are under ever greater pressure to streamline their operations.

Of course, Chinese bond markets are nowhere close to Western standards in terms of credit stringency. But some context is important here. In the past, many of them didn't even have access to reasonable local bond financing at all - these less favored, typically private firms had to get repayment-heavy bank loans or, if they were good enough, could actually raise capital more easily in dollars, i.e. in the Eurobond market. Now things have swung around: local RMB-denominated bond issuance has gotten much cheaper even as foreign debt costs - especially Eurodollar (i.e. offshore dollar) wholesale financing - have soared.

This means that for the first time, Beijing wants public investors to be the driver of debt pricing discovery. True, it's an opportunistic move to clean up the horrid balance sheets of its state banks, but it also makes those cushy government outfits less dominant and privileged in the long run. It may be a while yet until Chinese corporate debt is priced correctly, but the first baby steps have been taken. We have to cross our fingers now that the bond market will gradually require higher and higher yields for risky debt, so it doesn't seize up quickly and violently from (il)liquidity events.

It helps China that all the world over, debt holders are already (grudgingly) entering something of a "Jubilee" mode of liability forgiveness, i.e. "haircuts" on what they're owed. A general recognition is gradually dawning on investors that they've simply dumped too much money into already crowded investments and assets. Donald Trump is openly gloating about how he'll reduce the national debt if elected president by writing some of it down.

Investors are also slowly acquiring more appreciation of the nuance of China's transition. They're coming to learn, for instance, that the latest burst of stimulus-induced fixed asset investment (FAI) is more driven by infrastructure not property, and this more so in the underdeveloped hinterland and periphery than the wealthy coastal provinces. It's too simplistic to say, as here, that China's economy is still essentially one giant property bubble - even allowing for legitimate concern that it's building more roads and bridges to nowhere.

That last link cites an IMF metric that 14 percent of publicly listed Chinese companies can't meet their interest payments with their earnings - and another 14 percent that can meet them at best twice over. In any Western country, far lower thresholds would have sparked a financial crisis by now. The scale of the mess is undeniable. But the way out is just as clear: struggling firms should be given haircuts and grace periods to get their acts together, else be allowed to fail so long as regulators determine the fallout will be containable. 2016 should be the year that the world finally sees a China in which financial market discipline starts to take root - else it can only be the year that signals an outright retrogression which nobody wants to contemplate.