Thursday, February 11, 2016

Kyle Bass Steps Up Attack on China’s Currency

Investor Kyle Bass said Wednesday that China’s liquid foreign reserves are “already below a critical level,” intensifying a debate over China’s ability to keep its currency from falling.
Mr. Bass, whose Hayman Capital Management LP has a multibillion-dollar bet that the yuan and Hong Kong dollar will fall, told clients in a letter that his firm estimates that China’s liquid foreign reserves are $2.2 trillion at most. That compares with the $3.23 trillion reported by the People’s Bank of China, the central bank, for the end of January.
The comments from the Dallas hedge-fund manager highlight mounting investor unease about the degree to which the official Chinese number reflects reserves the nation can quickly use to prop up the value of its currency.
Market sentiment about China has turned sharply negative in recent months amid a torrent of capital outflows from the world’s most populous nation. Investors fear that development presages a sharp devaluation of the yuan that could threaten to intensify the currency wars encircling the globe and send a wave of deflation that would further enfeeble economic growth. China devalued the yuan in August, but officials have said they would like to maintain it at a stable level.
China hasn’t fully disclosed the composition of its foreign reserves, making it a contentious point between bulls and bears. Official data showed that China’s foreign reserves had dropped 19% from its peak in mid-2014. But questions have been raised as to what comprises the reserves and how quickly China can liquidate the assets, if needed, to meet the demand for foreign currencies.
“The view that China has years of reserves to burn through is misinformed,” Mr. Bass wrote. “China’s back is completely up against the wall today, which is one of the primary reasons why the government is hypersensitive to any comments regarding its reserve levels or a hard landing.”Mr. Bass said in his letter that some of China’s reserves already are tied up in institutions such as policy banks and one of its sovereign-wealth funds.
Last month, a spokeswoman of the State Administration of Foreign Exchange said China has ample foreign-exchange reserves as measured by the absolute amount and against other adequacy ratios such as imports and external debt.
“It’s a robust foundation for the country to withstand any external shocks,” said Wang Chunying, the spokeswoman.
China’s reserve holdings include U.S. securities—government bonds, agency debt and stocks—that totaled $1.76 trillion as of last October. China also held about $100 billion in bonds in Japan and $60 billion in German securities, according to Goldman Sachs GroupInc.
Beyond that it isn’t clear whether China’s total includes capital injected into China’s policy banks, foreign-currency loans to other countries and its commitments for multilateral initiatives, such as the Asian Infrastructure Investment Bank.
It also isn’t known whether China’s sovereign-wealth fund, China Investment Corp., is counted. In 2007, China’s Finance Ministry issued 1.55 trillion yuan in specialty treasury bonds and used the proceeds to purchase $200 billion in foreign-exchange reserves, which was injected into CIC. Though the initial capital infusion came from a reduction in the reported reserves at the time, it is unclear whether any of the subsequent injections were taken from the same source. Total assets at CIC were at $652.7 billion as of 2014, according to the company.
The letter from Mr. Bass marks the latest effort by hedge funds and other investors to raise doubts about the underlying health of the Chinese economy, which has slowed sharply in recent years amid a global commodity bust, and whether officials in China will be able to avoid devaluing their currency, the yuan.
The 11-page letter, Mr. Bass’s first to his investors in more than two years, contains some of his most-detailed comments yet on the thinking behind his fund’s China short. Hayman, starting last year, sold off the bulk of its investments in stocks, commodities and bonds to focus on shorting Asian currencies in the biggest concentrated wager it has made since its profitable bet years ago against the U.S. housing market, The Wall Street Journal reported last month.
Hayman began repositioning its portfolio after studying China’s banking system and being stunned at its rapid expansion of debt. The firm’s analysis suggested that past-due loans would rise sharply and eventually require a huge injection by the central government to recapitalize the banks.
In the letter, Mr. Bass wrote that the assets in China’s banking system are equivalent to 340% of the country’s gross domestic product and that the PBOC would need to print more than $10 trillion worth of yuan to recapitalize its banks. The magnitude of losses by China’s banking system “could exceed 400% of the U.S. banking losses incurred during the subprime crisis,” he wrote.
China has several levers to pull, including cutting interest rates to zero and using reserves to recapitalize its banks, the letter said, but “ultimately a large devaluation will be a centerpiece of the response.”
Other investors say they are more focused on the speed of reserve drainage. “The number we’d look at is more the pace than the absolute level. If we have many more months of $100 billion-plus outflows, that starts to become worrying,” said Maziar Minovi, a managing director at Goldman Sachs.