China’s Crashing Stocks And Creaking Politics

THERE WAS A time when even financial markets in China were believed to be responsive to firm instruction and Party discipline. Yet China has become much more market driven in many spheres than it once was, even, incongruously, as President Xi Jinping has sought to exert greater control over every aspect of the body politic.

The trouble with markets, as has been seen in the Shanghai and Shenzhen exchanges in recent weeks, is that they have a mind of their own. Stock markets, in particular, can express it in stark and cantankerous ways.

July’s attempt to prop up stock prices that had started to blow off a lot of excessive froth — by cajoling 21 securities firms to hold stocks — was brushed aside like a mistress’s hair from a jacket; so, too, was the more recent directive to the country’s massive pension funds to act as the buyer of last resort.

This was not markets just thumbing their nose at any old government intervention. This was a direct challenge to the proposition that the Party leadership could be trusted to stop the stock markets fall. By extension, it could also be trusted to keep the real economy from slowing too quickly even while making the transition from the old model of infrastructure investment- and export-led growth to one driven by domestic consumption.

That transformation is a Herculean task of macroeconomic management demanding extensive structural reforms, although a task that both Japan and South Korea have earlier undertaken, if not on the scale required in China. It is one, though, that challenges many vested interests that profited richly from the old ways and stood to lose much from the reforms needed.

One thing that this recent stock market crash has inadvertently advertised is how deep and widespread are the pockets of opposition to reform — a contrast the the narrative of inevitability and Xi’s expanding control portrayed in state media.

The arguments of what countermeasures to take against falling stocks, the currency, and slowing growth have become a proxy battle for the bigger one over reform. Xi has championed reform as necessary to ensure the Party can continue to deliver economic wellbeing for China’s population and thus retain its mandate to rule.

He, correctly in the view of this Bystander and many other outside observers, believes that the old growth model is unsustainable if China is to continue to develop as a wealthy economy. If there turns out to be any substance to the gossip the Prime Minister Li Keqiang is to be a scapegoat for the slowing economy and stock market fall — then that would indicate deep divisions over the path to rebalancing on a scale that would rattle global markets.

The precipitousness of that path, which we have frequently referred to here as a glide path to slower growth, is what is now so concerning. We have always regarded its trajectory as being the object of the leadership’s management, but equally have cautioned that it would not, inevitably, be as smooth as the leadership would like.

There are many potential bumps: property bubble, equities bubble, shadow banking crisis, and local government debt bomb. All remain manageable, but the stock market’s fall raises the risk of a credit crunch.

What is now at stake is trust in the government’s capacity to manage the markets and the economy more broadly.

Ever since Deng Xiaoping started to open up the economy at the end of the 1970s, the government has been able to marshal the capital needed to direct the economy and absorb the external shocks to distorted markets. The assumption that that will continue to be the case is now being tested.

The banking system as a closed conduit of state-disposed capital is under stress. The Catch 22 is that it has to be if the financial system is to be opened — as, in turn, it has to be if rebalancing is to be successful.

All of which brings this Bystander back to a fundamental question: can China do something that no other developing economy has ever achieved, liberalise its financial system without doing the same with its politics.

Last October we said:

The trick for Xi remains to align the political realities he faces with the underlying structural slowing of economic growth, but without getting too close to the feared hard landing of the economy that would undermine his political position. As we have noted before, every mini-stimulus ratchets up a notch the difficulty of introducing the policies needed for rebalancing because they don’t address the underlying causes of unsustainable booms and the vested interests that benefit from them. And that needs a political solution before it can get an economic one.

That remains the case.

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Chinese vs US Equity Markets: A 5-Year View

Shanghai Composite Index vs S&P 500, 5-year view. Source: Bloomberg

ONE PERSPECTIVE ON the recent slump in equity prices on the Shanghai exchange (chart courtesy of Bloomberg). Where’s the real bubble?

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Tianjin Blasts Likely To Cause Pain To China’s Insurance Companies

Cars burned in the Tianjin chemical explosions, August 13, 2015. Flickr/Karl-Ludwig Poggemann. Licenced under Creative Commons.

INSURANCE COMPANIES FACE the prospect of picking up at least a $1 billion-1.5 billion bill for the fatal Tianjin chemical explosions, according to an early estimate by Fitch Ratings. Regardless of the final number, the disaster is shaping up to be one of the most expensive recent man-made disasters in China for insurers.

By comparison, the previous largest claim on insurers resulting from a natural rather than man-made disaster in China was for the havoc wreaked by Typhoon Rammasun. The storm made landfall in July 2014, killing 202 people and injuring a further 125 — a similar human toll to Tianjin. Rammasun caused damage estimated at $5.15 billion, of which only 250 million was covered by insurance.

The coverage to loss ratio will be less favorable to insurers in Tianjin. For one, a reported 10,000 vehicles were damaged, as the photo above shows. Mainly foreign marques such as Volkswagens, Renaults, Hyundai and KIAs, they could be worth as much as $300 million and all likely to be insured. Other claims will be under cargo, liability and property insurance.

In general across China, an estimated 90%-95% of properties owned by enterprises are not insured except for cars. Nonetheless, the industry regulator, the China Insurance Regulatory Commission, says non-life premiums written in Tianjin amount to 11 billion yuan ($1.7 billion). This figure leads Fitch to conclude that the explosions will cause some stress to the insurers who wrote business in the city.

That will bring back the painful memories for insurers of the losses they suffered in 2008 as a result of the Sichuan earthquake and the southern snowstorm of that year.

The insurance companies most exposed in Tianjin will be the property and casualty arms of PICC (China’s largest property and casualty insurer with a one-third market share overall), Ping An, China Pacific, China Continent, Sunshine and Taiping General. These six account for more than three-quarters of the non-life insurance premiums written in Tianjin, according to Fitch.

Some of the risks will have been laid off to re-insurers; 10%-15%, we are told but suspect that number is a guestimate. The government will likely cover much of death and injury claims. However, balance sheets will feel pain, and especially as fierce premiums competition has been squeezing profitability for some time.

China’s insurance markets have been among the world’s fastest growing in recent years. Coverage is still low by international standards, given the size of the Chinese economy and its increasing exposure to natural and man-made disasters.

In 2013, the latest year for which the National Bureau of Statistics has published comprehensive figures, total premiums amounted to 172.2 billion yuan ($27 billion). Life insurance accounted for 110.1 billion yuan and property and casualty for 62.1 billion yuan.

The property and casualty total accounts for barely 5% of the world’s total premiums for that line of business. However, that was up from 1% a decade earlier.

Premiums are forecast to grow at an average annual rate of 11% to 2018. That would likely let China leapfrog Japan to become the world’s second largest insurance market behind the United States. It would still take it to only a 9% world market share, though, still out of proportion with what would be expected of an economy that accounts for more than 15% of the world economy.

Geographical differences in insurance penetration within China are also great. The prosperous provinces of the eastern seaboard are the most insured.

P&C Lines of Business, 2013

Motor insurance (commercial vehicle and compulsory car) account for almost three-quarters of the property and casualty premiums, making China the world’s second-largest market for that line of business. It does not make the world top five in either property or liability insurance written, however — although China’s are still $20 billion and $15 billion markets respectively.

Crop insurance is a small but significant market, at $3 billion (out of a global total of $22 billion; and second only to the United States in raw size). It is one that is fast growing and spawning specialist insurers, one of the objectives of the current five-year plan that concludes this year. It is also a line of business that the government has prioritized as part of its campaign to shore up rural incomes.

Catastrophe insurance is another sector thought poised for rapid growth given China’s familiarity with flood, drought and earthquakes. Pilot programmes were approved in 2013 for Yunnan and Shenzhen as precursors of a possible national scheme. Should that happen, the business would experience rapid growth for some years.

The five-year plan’s replacement is expected to include goals to sustain the expansion of the market, including further development of specialist companies, international expansion of Chinese insurers, and an expansion of their role as institutional investors at home.

The market gradually opened to foreign firms between 2004 and 2012 and is now fully unrestricted. The foreign presence is growing, usually by joint ventures to overcoming the considerable challenges of distribution. Of the 67 insurance companies in total, 22 are foreign funded.

Zurich Insurance and Allianz are among the foreign insurers who have reportedly already received Tianjin-related claims. Swiss Re, Hannover Re, Munich Re are among foreign reinsurers active in the market.

However, foreign-funded companies still only write around 1% of non-life business and are largely consigned to specialist areas within the property and liability sectors. PICC, Ping An and China Pacific, China’s three largest insurers, have a firm grip on their 65% market share. The top 10 companies, all Chinese, have 85% of the market.

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China’s Small Firms Bear Brunt Of Slowdown

China PMI by Enterprise Size

INTERESTING BREAKDOWN OF the Purchasing Managers Index from the National Statistics Office showing who most has been at the sharp end of the economic slowdown over the past year.

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Clean Air And Safety First At War Parade

THE CELEBRATION IN in Beijing on September 3rd to mark the 70th anniversary of the ending of World War Two in Asia will be a breath of fresh air.

Heavy industry, power plants and construction sites in the capital, along with more in Hebei, Tianjin, Shanxi, Inner Mongolia, Shandong and Henan, are being shut down or curtailed between August 28th and September 4th to make the air less polluted. Some 10,000 factories and 9,000 construction sites will be affected, state media say.  The goal is to cut pollution on the day by 40% in the capital and 30% in the surrounding region.

The measures are similar to those taken during the 2008 Olympic Games and last year’s the Asia Pacific Economic Cooperation (APEC) meetings so that visitors wouldn’t have to breathe in the filthy atmosphere residents have to suffer the rest of the year. The tail end of the Athletics World Championships due to start in Beijing on August 22nd and run until September 6th will also get some benefit from this year’s effort.

One difference this time is that Beijing authorities have also ordered a complete halt to production at explosives plants and the sealing under guard of all toxic chemicals in the city. In the wake of the Tianjin disaster, Beijing wouldn’t want the 70th-anniversary parade going off with the wrong sort of bang.

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Tianjin Blasts: Shaking Up Environmental Disaster Denial

THE CITY OF Tianjin is facing an environmental disaster of unknown proportions following the double explosion at the Ruihai International Logistics warehouse on Wednesday. The presence of sodium cyanide, which combines with water to form deadly hydrogen cyanide gas, has been acknowledged along with calcium carbide, potassium nitrate and sodium nitrate — all industrial chemicals whose impact on the population of the northeastern port city may be felt through illness and shortened lives for generations to come.

For the leadership, failure to deal with the aftermath of this tragedy that has cost at least 112 lives with hundreds more injured could be just as toxic. At risk is public trust in the Party to look after the people.

Industrial accidents are commonplace in China, even in large cities. Yet the power of the second blast in particular and the amount of dramatic video footage seen on social media before the inevitable media clampdown puts this one into a class of its own.

By way of comparison, the Jilin chemical plant explosion in 2005, one of China’s worst comparable man-made disasters, killed six and the injuries were in the dozens. However, pollution of the Songhua River was severe. Harbin, 400 kilometers downstream, had to cut off the public water supply to avoid poisoning its residents. Environment agency minister Xie Zhenhua was eventually sacked.

The initial official response to Jilin was to cover it up. That has been the go-to response for authorities to any environmental disaster until the evidence can no longer be ignored. Officials did not admit to the Bohai Bay oil spill in 2011 until a month after it had happened.

A nationwide check ordered on dangerous chemicals and explosives following the Tianjin blasts and a blanket order to officials to enforce safety regulations seems like bolting the stable door after the horse has bolted. Even worse will be if authorities react in their customary way and pursue a carefully managed information blackout.

Signs are not encouraging. Social media accounts and websites are already being closed down; state media is starting to craft a narrative around the laxness of businesses and workers that officials will address.

Even in these early days a finger is being pointed at Ruihai for keeping inadequate records of what was on site, following inadequate storage procedures or turning a blind eye to what safety regulations there are. Regulations keeping public transport and housing at a specific distance from dangerous industrial sites were ignored or flouted by officials.

The first-responder firefighters were ill-informed, inadequately trained and equipped, or all three. Suggestions that attempts to put out an initial fire with water inadvertently caused the chemical reactions that produced the subsequent blasts seem well founded, though, again, this Bystander cautions against early judgments on limited information. Whatever the circumstances turn out to have been, firefighters have paid a heavy toll in human life.

Assurances by officials that air and water quality levels in Tianjin are safe have been met with incredulity by residents. The 3-kilometre evacuation zone imposed on Friday will have done nothing to diminish concerns, any more than the earlier shutting off sewers to stop discharge into Bohai Bay. Many residents already know the water they drink and the air their breathe are polluted enough.

China has long disregarded environmental and public health whenever untrammelled economic development was at risk. Pockets of populations with abnormally high cancer rates in some of the most polluted areas bear silent testimony to that. The Party has seen the delivery of ever higher living standards to the broad population as the basis of its claim to a monopoly on political power.

For most Chinese, higher living standards increasingly include quality of life, not merely the quantity of material well-being — simple things like clean air and water and neighbourhoods that don’t explode.

This Bystander would like to think that the legacy of the Tianjin disaster would be that it was the one that caused that penny to drop for the authorities. That is likely wishful thinking. Scapegoats will again be found; rescue efforts will be lionized; online critics will be silenced. The policy and institutional reforms needed to ensure there is no repeat will not be carried out with the same vigour.

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Beside The Seaside, Beyond The Grave

Mystery surrounds this year’s annual Beihaide meeting. Mystery surrounds every Beihaide meeting. It is a secretive, closed-door gathering of past and present senior officials who turn up at the salubrious Hebei seaside resort around August 10 each year.

There are unconfirmed reports that this year’s meeting was cancelled or that it was held early, ostensibly to accommodate preparations for President Xi Jinping’s visit to Washington next month. Most likely it has been scaled back and downplayed in importance this year.

The traditional significance of the meeting is that it allows the leaders of the factions and interest groups within the Party informally to discuss policy in a way that both ensures collective buy-in and brokers the constraints on the actions of both the top leadership and those not supporting their policies.

Beihaide meetings can bring final consensus to thorny policy questions. The ending of the one-child policy followed a Beihaide meeting and, our man on the seashore assures us, a lot of the questions about the public face of dealing with the disgraced Bo Xilai were fixed there.

This year’s agenda, as far as anyone knows, was meant to include approval of the draft 13th five-year plan. That would already have been agreed in outline by the Politburo but the Beihaide meeting would set the tone for the priorities and pace of implementation that will be contained in the final draft to be presented to the Party Congress plenum in October for rubber-stamping.

Similarly, discussions would likely be held on how to deal with the economic slowdown, reforming state-owned enterprises (and their embedded vested interests), and how far  Xi’s crackdown on corruption should be allowed to run in the current economic circumstances.

However, most critically, Beihaide has provided an effective forum for former leaders to continue exerting power and influence long after they have retired from office. Former President Jiang Zemin would be a prime example, and one who the very pinnacle of official mouthpieces, the People’s Daily, obliquely suggested should stay retired from active politics.

It is an open secret that Xi has found Jiang an obstacle to his extension of control over every aspect of the party, government, and state. Xi is said to be annoyed that the excesses of Jiang’s drive for untrammeled economic growth when he was president are having to be cleaned up on his watch, from corruption and cronyism to environmental degradation. It is no accident that many of the biggest tigers snared by Xi’s anti-corruption campaign have connections to the Jiang faction.

Bringing down a former president would be a reach too far, even for Xi, who may also be betting that time will do the job for him. Jiang is 88, and indeed rumoured on more than one occasion to have died.

Much of the political turmoil that seems to be churning at the top of Chinese politics despite the official narrative of Xi’s consolidated grip on power may best be explained by Jiang trying to secure the legacy of his Shanghai faction come the day when he has to wield his influence not from beside the seaside but from beyond the grave.

The loyal Politburo members Jiang had left in place after he left office in 2002 were certainly an impediment to scaling back of the state-owned-enterprise-led model of infrastructure investment when Xi’s predecessors, Hu Jintao and Wen Jiabao, first tried. Their influence has since waned and Xi has sought to diminish it further. The question is whether it will survive at all once Jiang is gone.

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