China’s Gray Rhino Financial Risks

In the financial sector black swan events are those which are unlikely to happen but, if they did, would have a huge impact on the country and they are nearly impossible to predict. The elephant in the room is an event that everyone is aware of but no one wants to address. A new animal has recently been added to the list of financial risks – the gray rhino. A gray rhino risk is an event that is highly probable and high-impact that officials have neglected to address. China is currently facing just such a risk as debt has built up in Chinese banks and firms due to the unregulated shadow banking system.

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China’s economic growth is founded on a system of credit and the growing debt levels have surged China’s non-financial debt-to-GDP ratio to over 250%. Having neglected to curb bank borrowing previously, President Xi has now begun efforts to prevent a financial crisis which could negatively effect the domestic economy and result in social unrest. However, the current situation presents somewhat of a catch 22. Tackling debt levels would result in a sharp drop in growth, meaning a large portion of the population could find themselves without employment. If left as it is with no attempts to solve the issues, the financial situation could lead to the banking system crashing.

As the government begins to address this long-standing issue, investors are worrying that risky assets, such as small stocks, may bear the brunt of the damage, as many of them are purchased using credit. The Shenzhen, China’s small-cap index, fell by 4.3% on the 17th July while the tech-focussed ChiNext index closed the day at 5.1%, its lowest point since 2015. The government’s expansion of regulation into more aspects of the economy, rather than just financial sector excesses as before, has prompted many investors to sell off their domestic stocks. If Chinese stocks suffer as a result of efforts to rectify the gray rhino risk, the effects could be felt in other countries. In a global market, if a country as influential as China experiences problems other areas will follow.

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Despite the issue of bank debt finally being addressed by the Chinese government, the country’s growth in the second quarter of 2017 was still 6.9%, a faster rate of growth than predicted. While this puts China back on track to meet its growth target this year, it means that the country is still heavily relying on debt-fuelled investments to develop GDP. To target the gray rhino risks, China should address problems that could arise from liquidity, shadow banking, credit, and avoid falling victim to price bubbles in the insurance and property markets. The outcome otherwise could be negative for China’s economy.

Market Overview: Asia

This week we are focusing on activity in Asian markets. We will be highlighting changes in Singapore, and China, as well as looking at the impact of the recent missile strike in Syria on Asian markets, and stock prices further afield. The attack had some immediate effects on markets, however, most stocks seem to have re-stabilized.

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Singapore

It has been announced that the Singaporean government will increase spending on public infrastructure from SGD18.3 million to SGD30 million by 2020. This comes as they fell in the rankings of the World Economic Forum’s Global Competitiveness Report from number 2 (2012-2013) to number 5 (2014-2015). Projects will be carried out in the areas of land transport, air and sea transport, utilities, and healthcare with planned building of four new state hospitals between 2020 and 2030.

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China

In the week ending April 2nd property prices rose 27% from the same time last year in 26 major Chinese cities. Leading this increase were Shanghai, with a rise of 72%, and Guangzhou with a rise of 77%. Moreover, 17 major property developers saw sales growth of 82% in March, similar to that of 91% in the January-February period (Source: Barrons).

The Effect of Air Strikes on the Markets

Last week saw the US fire dozens of missiles at a Syrian airfield, damaging infrastructure including the runway. The strike was carried out in retaliation to a chemical attack that occurred in a rebel-held area of Syria earlier. Several stocks have experienced increases and decreases as a result of the strike. US futures fell, with S&P 500 futures off 5 points and Dow Jones futures down by 44 points. Asian shares also experienced an initial drop before re-stabilizing.

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However, not all markets saw drops. The Yen saw an increase against the Dollar, and commodities such as gold and oil saw a rise in prices. London spot gold prices were 1.3% higher recently while Brent crude futures rose more than 2% before levelling to a gain of 1.42% at $55.67 per barrel. US crude increased by 1.61% taking it to $52.53. The reason for increases in the prices of these goods is because investors switched over to them, moving out of riskier investments. In the case of oil the price rose due to investors’ concerns that supply might be disrupted by the military in the region. However, despite these fears, CNBC says that it is unlikely that oil supplies will be restricted by Syrian military forces as it would be equally disadvantageous for them.