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A TV screen in Shanghai shows a live news broadcast of Chinese President Xi Jinping speaking after the Communist Party congress on Oct. 25.   © Reuters
Economy

Chinese long rates surge as stimulus turns to discipline

More oversight for shady financial products could rattle debt-heavy banks

SHANGHAI -- China's long-term interest rates marked a three-year high Monday amid speculation that the government will ramp up oversight of interbank trading and shady investment products in a campaign against financial risk.

Yields on benchmark 10-year government bonds topped 3.9% in trading Monday, reaching their highest level since October 2014. This may be because certain investors "believe holding government bonds in excess entails political risk" and so "are selling at full force," according to a fund manager for a bank here.

In a speech at the twice-a-decade Communist Party congress Oct. 18, President Xi Jinping called it important to "forestall systemic financial risks." With his second term as party leader now secure, Xi is in a strong position to do so via such means as cracking down on interbank lending and the issuance of shady, uninsured financial products.

Some banks have in recent years padded their balance sheets with long-term bonds purchased with funds borrowed on the interbank market. Institutions also use government bonds as collateral to borrow additional funds and invest them in riskier assets, which are bundled into so-called wealth management products sold as higher-yielding alternatives to savings accounts. A rapid rise could put these highly leveraged banks in a fiscal crunch and lead them to default on these offerings.

New priorities

Long rates have in fact been on the rise since late 2016, when the authorities moved toward tighter monetary policy, and have only picked up speed since the party congress wrapped up Oct. 24. Those directly affected will mainly be Chinese institutional investors, as foreign participation in the country's bond market remains limited. But should market disruptions market bleed over into the real economy, the impact could be global.

A continued rise in interest rates, for example, could put even more strain on heavily indebted companies. Investors are already showing some concern about the outlook for corporate earnings and the economy overall. The benchmark Shanghai Composite Index ended Monday down 0.77%. Trading was rough for companies heavily exposed to shifts in the broader economy, including ocean shippers and producers of such metals as steel.

In a sense, tighter financial oversight aims to rein in the excesses born of economic stimulus. Such bad behavior as risky trading by banks was tolerated to an extent when the Xi administration's primary goal was to ensure ample funding needed to keep the economy stable until the party congress. But priorities seem to have shifted, and market players are waiting to see what could befall the economy as discipline becomes the goal.

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