China’s hot money crackdown is spooking markets
Financial markets are on high alert, as they wait to see whether Beijing’s move to crack down on “hot money” inflows will trigger further steep falls in commodity prices.
The nervous state of markets has made them fertile ground for rumours. Overnight, the copper price dropped sharply on speculation that a hedge fund that had borrowed heavily to amass a large copper position was being forced to unwind its position and that another Chinese corporate could be about to default.
The latest bout of nervousness was triggered after the Chinese central bank last month issued a stark warning to speculators and Chinese borrowers not to count on a continued appreciation of the Chinese currency, the yuan (or renminbi). So far this year, the People’s Bank of China, which keeps a tight grip on the currency, has pushed the yuan down by 1.4 per cent, a stark contrast to the 2.9 per cent rise it saw in 2013.
The PBOC’s move has sent ripples through global financial markets. In recent months tens of billions of dollars that have flowed out of troubled emerging markets has headed to China, which was seen as largely immune from currency risk. For Chinese firms, it made huge sense to borrow in a currency that was likely to drop, such as the Japanese yen, and to use the proceeds to buy high-yielding Chinese assets.
Riskier borrowers, such as small property developers, which were shunned by the major banks used copper and iron ore as collateral for their loans from China’s “shadow banks”.
Typically they would buy copper or iron ore abroad, using US dollars or yen, and store the commodities in China for use as collateral for yuan-denominated loans.
TWO COMMODITIES TAKE PLUNGE
But the yuan’s fall has choked off some inflows of foreign funds into the shadow banking system. And this, combined with mounting concerns over Chinese growth, has caused the prices of these two commodities to plunge. This week, the copper price has tumbled to its lowest level since July 2010, while the iron ore price hit its lowest level since October 2012.
These falls have prompted growing margin calls from nervous lenders, worried that the value of their collateral is falling. The fear is that an increasing number of borrowers could be forced to liquidate their stockpiles of copper and iron ore in order to repay their loans, and that this could drive the prices of both commodities even lower.
Tensions were further exacerbated last week by the first default on a publicly traded corporate bond in China, of solar-panel maker Chaori Solar.
Analysts said that although it was important for Beijing to show that it did not intend to bail out reckless lenders, the default could be merely the tip of an iceberg as the Chinese credit bubble bursts.
In particular, they warn that loss-making steel mills could be forced to cancel iron ore orders as their funding dries up in the wake of last week’s bond default.
Source :Financial Review