China’s vulnerability sentiment improved notably in May: BBVA

HONG KONG – BBVA Research says its China Vulnerability Sentiment Index (CVSI) has improved notably over the past month, led by the Housing, SOE and Shadow Banking components, which together offset a marked deterioration in the Exchange Rate Vulnerability Index.

“In the context of China’s sovereign ratings downgrade by Moody’s, the improvement in CVSI is a harbinger of underlying investor confidence that macro-financial headwinds facing China remain manageable, still, as anchoring financial stability assumes top policy priority,” BBVA says.

Robust SOE earnings, policy prudence, underpinned China’s vulnerability sentiment, it adds.

“The sharp jump in the CVSI can be attributed to two key factors – 1) Solid earnings growth revealed by China’s State Owned Enterprises and 2) A step up in policy efforts to quell financial stability risks.

“China’s State Owned Enterprises reported a solid 59% y/y profit growth in the first four months of 2017, led mainly by gains in oil, petrochemical, coal and steel industries. However, in a word of caution, such gains in SOE Vulnerability index aren’t likely to sustain over the next month.

“The recent decline in commodity prices and tighter policy oversight will show slower SOE profit growth for May (data is released with a month’s lag).

“Meanwhile, Housing Bubble Index for China improved as authorities expedited efforts to stem speculative house price increases and stabilise the property market. Improvement in Shadow Banking Vulnerability Index reflects a step up in efforts by regulators to enhance regulatory oversight in the sector.

“The CBRC recently introduced a stringent unified regulatory framework to quell asset management risks, while the PBOC maintained its “prudent” monetary policy stance and implemented a new regulatory framework of Macro Prudential Assessment, enforcing banks to include many previously off-balance-sheet activities into their books.

“April credit data confirmed that ‘entrusted loans’, a shadow financing proxy, contracted for the first time in a decade (by RMB4.8 billion on-year).

“The deterioration in Exchange Rate Vulnerability Index suggests that, despite a relatively stable Yuan, and incremental improvement in China’s FX reserves, risk of capital outflows remains an overriding concern for China.

“To underpin financial stability, PBOC last week added a ‘counter-cyclical adjustment factor’ to its model guiding daily USDCNY midpoint fixing. We believe that by leaning towards an overvalued exchange rate, authorities have, in effect, raised their stakes on the effectiveness of ongoing deleveraging campaign. www.bbvaresearch.com (ATI).