The Chips Are Down

BY VALUE, CHINA imports more semiconductors than oil. For the past two years, chips have been the country’s most valuable import.

That, in itself, tells this Bystander how much of a foundational challenge China still faces in becoming a technological rival to the United States until it is the leading provider of chips, the bricks of the digital economy, and especially the most advanced designs.

The national drive for self-sufficiency in the design and fabrication of semiconductors is long-standing. Domestic production is being ramped up rapidly, and the pace has accelerated since the US imposed sanctions to deny it access to US chipmaking technology.

Domestic output rose by one-third last year over 2020’s level, to reach 359.4 billion units, according to data newly released by the National Bureau of Statistics, having grown by 16% in 2020 over 2019.

However, last year’s production was still less than imports, which reached 432.5 billion units.

More significantly, China still does not yet produce the most advanced chips. The indigenous chip industry is still only nibbling at the edges of the leadership of foreign chipmakers like TSMC, Samsung, and Intel in cutting-edge chips. It is also an industry in which economies of scale favour the market leaders.

That adds to the risk of China’s strategy to leap-frog to compound semiconductors or ‘third-generation’ chips. Chipmaking is an industry ill-suited to decoupling.

Investment of some $26 billion in production facilities in 2021 — and the mobilisation of state planning resources on the scale of the development of the atom bomb in Mao’s time — is moving China’s chip makers up the technological ladder and reducing the country’s vulnerability to sanctions and external shocks.

The Covid-19 disruption to supply chains was a further wake-up call in that regard if any was needed. However, supply chains in the sector are complex and transnational, making self-sufficiency in chips beyond China (and indeed any country) for the foreseeable future.

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China Resumes Freight Rail Link To North Korea

CHINA AND NORTH KOREA have reopened the railway across the Yalu River, separating the two countries.

A freight train crossed from North Korea into Dandong on Sunday, returning the next day laden with supplies, according to reports from South Korea subsequently confirmed by foreign ministry spokesman Zhao Lijian:

After friendly consultations between the two sides, freight in goods in Dandong has resumed.

Japanese reports say a Chinese locomotive went to Sinuiju in North Korea. It picked up a dozen boxcars, took them to Dandong and then hauled them back to Sinuiju laden before returning with the same number of empty boxcars.

Pyongyang cut the rail link about a year and a half ago when it closed the country’s borders due to Covid-19 fears. Since then, only a tiny volume of trade has been conducted, via sea. There have been several reports since that the rail link was about to reopen.

The border closure exacerbated North Korea’s most severe economic contraction in more than two decades, with reports emerging of widespread hunger and North Korea’s leader, Kim Jong Un, making rare admissions of the country’s difficulties in recent months.

The suspension of trade with China, which has long provided a lifeline to its neighbour, probably dealt a greater blow to Kim than the international sanctions to deter his nuclear weapons program.

The question now is whether the restarting of the trade, albeit on a small scale, will ease the pressure on Kim to return to the stalled disarmament talks. The Biden administration has just imposed additional sanctions on Pyongyang, which has stepped up its ballistic missile testing in recent weeks.

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Rate Cuts Highlight Tricky Growth Balance China Has To Strike

Chart showing China's quarterly GDP growth year-on-year from Q1 2019 to Q4 2021

CHINA HAS CUT interest rates for the first time in two years as the property sector debt crisis and a resurgence of Covid-19 weigh on the economy.

Fourth-quarter GDP growth came in at 4.0% year-on-year, its slowest pace of growth in 18 months. Quarter-on-quarter growth was 1.6%, up from the third quarter’s 0.7% but still far from robust.

While both the y-o-y and q-o-q numbers slightly exceeded consensus expectations, they confirm the return to the trend slowdown in growth seen before the distortions of the pandemic.

Year-on-year growth slowed in each quarter last year, although the economy expanded by 8.1% for the full year as it bounced back from 2020’s initial outbreak of Covid-19. The official target for 2021 was ‘over 6%’.

Retail sales rose by only 1.7% in December, much less than forecast, as new Covid-19 outbreaks forced new lockdowns in several cities. Investment also slowed, although industrial output rose.

The interest rate cuts by the People’s Bank of China signals a more assertive monetary approach than the easing already seen in the third quarter with the lowering of banks’ reserve requirement ratios.

Today’s cut in the benchmark one-year loan prime rate by ten basis points to 2.85% and the rate on seven-day reverse repurchase agreements to 2.1% follows December’s five-basis-points cut in the one-year policy loans rate. The five-year loan prime rate, the benchmark rate for mortgages, was left unchanged, but a reduction in that sooner rather than later would not be a surprise.

The reverse repo rate cut is the more unexpected of the latest cuts. It reflects authorities intention to stabilise the economy well ahead of the Party congress later this year when President Xi Jinping will likely be anointed to a third term.

A managed slowing of growth to rebalance the economy is politically tolerable, providing it comes with no social disruption. However, a property sector collapse with widespread developer defaults and the financial and social risk that would bring would not be.

The debt overhang remains serious. Corporate debt was still 156.8% of GDP in the second quarter of 2021. That is down from 163.4% a year earlier but still high enough to complicate the way forward for policymakers aiming to stimulate growth while reducing the economy’s reliance on debt-fuelled infrastructure investment and export-oriented manufacturing.

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Reining In All Round

Screenshot of China Cinda Asset Management web site captures on January 16, 2022

IT TAKES SOME deft reading between the lines to understand the unexpected decision by China Cinda Asset Management, a bad-debt manager controlled by the finance ministry, to drop its backing for the restructuring of Ant’s consumer finance business.

The only public reason that China Cinda has given for backing out late last week from its announced 6 billion yuan ($940 million) participation in a 22-billion-yuan funding round for the reformulated version of Ant’s consumer finance business is “further prudent commercial consideration and negotiation.”

As part of the ‘rectification‘ of Jack Ma’s Ant Group that commenced with regulators pulled the rug from under the group’s planned blockbuster $37 billion initial public offering in November 2020, Ant’s two consumer finance businesses, Huabei and Jiebei, were to be consolidated as Chongqing Ant Consumer Finance, in which Ant’s stake would be capped at 50% and regulatory oversight extended.

Authorities are pruning back the growth of China’s tech platforms for various policy reasons, from reining in financial risk to concerns about misuse of consumer data, overweening market power and a feeling that the platforms and their billionaire owners are just getting too big for their boots.

Yet authorities also have concerns about the four bad-debt managers straying from their core mission, especially now their cash flows are being squeezed and debt ratios rising. After all, there is still a potential real-estate sector meltdown to worry about. There is no appetite to repeat the bailout of China Huarong Asset Management, the largest of the four state-backed bad-debt managers established in the late 1990s to clean up the ugly parts of the large state-owned banks’ loan books.

The China Banking and Insurance Regulatory Commission (CBIRC) recently instructed the bad-debt managers to return to their core businesses of managing bad loans and distressed assets.

China Cinda already owns 15% of Chongqing Ant through its wholly-owned subsidiary Nanyang Commercial Bank. Expanding that to become the second-largest shareholder in China’s largest consumer finance company does not fit CBRIC’s mandate.

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World Bank Trims China Growth Forecast, Frets About Real Estate

World Bank estimates and forecasts of China's economic growth

THE WORLD BANK has trimmed half a percentage point off its estimate for China’s GDP growth last year and three-tenths of a percentage point off its forecast for this year and remains concerned about the risk of a prolonged downturn in the property market.

In the latest edition of its Global Economic Prospects, the Bank estimates China’s economy grew by 8.0% last year, down from the 8.5% forecast in June 2021. It forecasts 5.1% for 2022, down 5.4%, reflecting the lingering effects of the pandemic and additional regulatory tightening. It is holding its 2023 forecast unchanged at 5.2%.

Its forecast for this year is in line with China’s slowing trend growth.

In its commentary, the Bank says that manufacturing activity has been solid despite supply disruptions and electricity shortages, and export growth has accelerated, even as Covid-induced lockdowns and curbs on the property and financial sectors have restrained consumer spending and residential investment.

For now, macroeconomic policy measures have forestalled a sharper economic slowdown and mitigated financial stress. The People’s Bank of China has reduced reserve requirements, lowered its one-year loan prime rate and implemented significant short-term liquidity injections. The government has accelerated infrastructure investment, supported homeowners and creditworthy developers, and accelerated local government bond issuance.

However, looking ahead into this year, the Bank expects the effects of the pandemic and tighter sector-specific regulations to linger, with policy support only partly offsetting that. It also remains concerned about the possibility of a marked and prolonged downturn in the property sector—and its potential effects on house prices, consumer spending, and local government financing. It describes this as ‘a notable downside risk’ to its forecasts.

In China, financial stress could trigger a disorderly deleveraging of the property sector. Property developers such as China Evergrande have collectively accumulated financial liabilities approaching 30 percent of GDP. Moreover, corporate bonds issued by property developers accounting for a third of the sector’s liabilities have recently been trading at distressed prices. A turbulent deleveraging episode could cause a prolonged downturn in the real estate sector, with significant economy-wide spillovers through lower house prices, reduced household wealth, and plummeting local government revenues. The banking sector—local banks in particular—would be significantly impaired, raising borrowing costs for corporations and households.

Should that come about, the impact would be felt well beyond China. The financial stress would quickly reverberate across the region’s emerging markets and developing economies. The knock-on effect would be the risk of capital inflows suddenly drying up, triggering currency crises, especially in any country dependent on short-term inflows to finance its current account deficit.

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Hong Kong Turns To Boosters To Battle Omicron Threat

As Beijing battles in Xi’an the most severe Covid-19 outbreak since Wuhan two years ago, Hong Kong is starting booster shots for all adults in the city.

Previously, only those in high-risk groups or who had taken the less-effective Sinovac shot were eligible for boosters. Studies in several countries have shown that boosters significantly aid in the fight against the more infectious Omicron variant.

Hong Kong has proved effective in keeping out the Delta variant; it is one of the few places in the world to have avoided a Delta outbreak. There have been no locally transmitted cases of Covid for more than six months.

However, this has led to complacency over vaccination, with less than 70% of the city’s population being inoculated with at least one dose. One-third of those have had the Sinovac vaccine, which provides insufficient protection against Omicron even with three shots.

Hong Kong would be vulnerable if Omicron took hold, and it is increasingly being detected in travellers. As of January 4, 114 cases of Omicron have been detected at the airport, all arriving passengers or directly linked to them. On December 23, the government said an airport cleaner was suspected of having been infected with Omicron, the first time the variant appears to have evaded the city’s strict border controls.

Hence the expansion of boosters. The government has also started making second doses of the Pfizer-BioNTech vaccine available to 12-17-year-olds. Younger people had previously been restricted to one shot due to concerns over the side effect of myocarditis.

Hong Kong’s booster programme will be watched in China and much of the developing world, where millions of doses of Sinovac’s vaccine have been administered. That is especially true for the mainland, where the Lunar New Year (February 1) and Beijing Winter Olympics (February 4-20) pose particular opportunities for Omicron to take hold.

Plans to reintroduce limited quarantine travel between Hong Kong, Macau and the mainland ahead of February may now be scaled back or postponed. Or Hong Kong may have to adopt the tight monitoring of its citizens commonplace on the mainland, which has used all the tools of its surveillance network to tackle the outbreak.

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Xi’an Tests Beijing’s Zero-Tolerance For Covid

Ariel view of Xi'an under lockdown, taken on January 1, 2022. Photo credit: Xinhua/Tao Ming

THE MANAGEMENT OF the lockdown of Xi’an to control the outbreak of Covid-19 has not gone smoothly, highlighting the challenge each new resurgence of the virus poses to China’s zero-tolerance policy towards Covid-19.

The lockdown imposed on December 23 suggests that authorities have no intention to give up on their zero-tolerance approach. However, Vice-Premier Sun Chunlan said late last week that local authorities need to adopt more ‘targeted and forceful’ measures and improve quarantine controls to deal with the outbreak in the city of 13 million people.

For example, multiple reports talk of infections being transmitted by residents mingling while waiting to be tested for Covid.

The Party secretary of Yanta district in the southern part of the city and one of the areas worst-hit by the outbreak has been fired along with another official — far from the first local bureaucrats to take the fall for mishandling Covid flare-ups.

This came as reports emerged of midnight evictions in the district’s Mingde 8 Yingli housing compound on January 1 when residents were instructed to leave their homes and go to quarantine facilities with some waiting for hours outside in the winter cold for the buses taking them there.

To restrict the outbreak regarded as the most severe since the virus was first observed in Wuhan two years ago, residents were already required to remain indoors. Shops are closed. Entry to the city is heavily restricted and driving within it is banned, as the empty roads in the picture of the city above, taken on January 1, testifies.

A few dozen cases in early December increased to more than 150 a day. However, the latest data reported by state media suggest the numbers of new locally transmitted infections have peaked with new infections around the 100 mark on both days of the weekend.

A total of nearly 1,600 cases were confirmed in the city as of January 1. The number is tiny by international comparisons, but the highest in China since March 2020.

The outbreak, which is of the Delta, not the Omicron variant, was traced to a flight from Pakistan but initially evaded detection by contract tracers for some days. As well as instituting a lockdown, authorities say they have conducted six rounds of city-wide testing.

Reports speak of citizens being punished for evading lockdown restrictions by fleeing the city and shortages of food. There have also been complaints about the lack of access to medical services and the availability of heating in the midst of winter in the northwest of the country.

It is thought this was due to recent reported infections in the community. Multiple Chinese outlets reported that locals had mixed while getting tested for Covid.

Authorities say that supplies of groceries and household essentials for residents have improved and that free food deliveries have been made to residents since December 28.

However, the build-up of public frustration in Xi’an directed towards the local government that has ensued — and its expression on social media despite attempts to censor it — points to the increasing difficulty authorities may face in continuing with severe lockdowns to snuff out resurgences of the virus.

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Walmart Put On Notice In China

THERE IS NO ambiguity in the message the Central Commission for Discipline Inspection, the Party’s anti-graft watchdog, has sent to US retailer Walmart: put products from Xinjiang back into its Sam’sSam’s Club stores in China or face a consumer boycott.

The need for foreign multinationals to choose which of their major markets to prioritise — China or the United States — is being ratcheted up another notch by Beijing.

In late December, Chinese social media lit up over allegations that Walmart had stopped selling items from Xinjiang at its members-only Sam’s Clubs, which, unlike their US incarnation, are upmarket hypermarkets in China. Netizens claimed they could no longer buy Xinjiang-sourced items such as apples and dates on the Sam’sSam’s Club app that were previously available, and that the groceries had been de-stocked by Walmart. Typical Xinjiang produce such as cantaloupes and apricots were available, but they were not from Xinjiang.

The flare-up emerged two days after US President Joe Biden signed into law a bill banning companies from selling goods from Xinjiang or containing Xinjiang-made components unless they can prove forced labour was not involved.

The Central Commission for Discipline Inspection’s statement pulls no punches in dismissing suggestions that this was the result of inventory management:

Removing all products from a region without a valid reason hides an ulterior motive behind it, exposes stupidity and short-sightedness, and is bound to suffer its own evil consequences…Suppressing and boycotting Xinjiang products is another “card” played by Western anti-China forces, which is doomed to failure… From H&M Group’s boycott of Xinjiang cotton, to Intel’s letter to suppliers demanding that Xinjiang labour and products be banned, to the removal of all Xinjiang products from Sam’s Club, these Western companies that once flaunted no political interference have punched themselves in the face with their own actions.

The anti-graft watchdog also noted the expected patriotism of consumers in such circumstances:

Chinese consumers expressed strong dissatisfaction and resisted with the action of returning cards, expressing their position of resolutely safeguarding national interests.

If the remedy required of Walmart — to back down — is not forthcoming, then, the Commission says, Chinese consumers will ‘respond resolutely with practical actions’.

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RCEP Arrives

THE CHINA-STEERED Regional Comprehensive Economic Partnership (RCEP) will come into effect on January 1, bringing together China, Japan, South Korea, Australia, New Zealand and the ten ASEAN nations in the world’s largest free trading agreement (FTA).

The 15 nations account for more than half the world’s exports and almost one-third of its GDP and its population. More significantly, they will likely account for most of the world’s economic growth in the coming decades.

RCEP was signed on November 15, 2020, having been hurried forward by Beijing. Ratification by the required nine signatory nations was achieved on November 2, and the agreement will come into effect in the minimum stipulated 60 days. Indonesia, the Philippines, Malaysia and Myanmar are the only four nations left to ratify it.

About 90% of goods will be traded tariff-free within RCEP, although that is largely the case already as ASEAN has FTAs with Australia, Japan, New Zealand and South Korea. The bigger benefit will likely come from dismantling non-tariff barriers.

This will bolster China, Japan and South Korea by strengthening their supply chains in the region. Regional supply chains are likely to become more China-centric, and, as the largest economy, China will be well-positioned to dictate terms and technical standards.

RCEP’s less industrially advanced nations such as Cambodia and Laos will benefit less substantially and have been given extensive phase-in periods to ease the transition. (Long transitions, exceptions, exclusions and non-enforceability of many of its 20 chapters are quite a feature of RCEP.)

The raw materials, machinery, motor vehicles and consumer products sectors are likely to benefit most, but trade in agricultural products, always contentious, is not covered under RCEP. RCEP also ducks other controversial issues such as subsidies for state-owned enterprises and labour rights.

Trade in services will be liberalised along two tracks. One group of countries — China, Myanmar, Thailand, Cambodia, Laos, Vietnam, the Philippines and New Zealand — will open selective service sectors on a ‘positive list’ basis. The others will open all service sectors unless expressly excluded.

RCEP’s membership has considerable overlap with that of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). The latter addresses indirect barriers such as state-owned enterprises, subsidies, labour rights, environmental protections and climate change.

It also provides stronger intellectual property rights protections than RCEP. This may steer investment to RCEP members who are also part of CPTPP.

RCEP should help drive economic recovery in Southeast Asia in the short term as the region battles through the latest surge of Covid-19.

In the medium term, it should increase trade and investment within the region. Estimates vary widely, but there is agreement that it will be material and in part at the expense of other parts of the world.

This will accelerate the emergence of a China-centric regional economic sphere that has been occurring for some years and is distinct from markets in the West and the supply chains that feed them.

The shift of the world’s centre of economic gravity to the region would be slowed if the United States and the EU were to join one of the two groupings. Prospects for either are dim, with an increased number of bilateral trade agreements more likely, especially with security partners.

In the longer term, as RCEP’s member countries develop, they will have to address the structural, protectionist issues that the agreement has parked to the side. That will bring political tensions.

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China Kicks Out Tattoos

OUR MAN AMONG the muddied oafs sends word that China is banning its footballers from having tattoos, another sign of the expanding imposition of a state-directed morality to crack down on alternative cultures.

Tattoos have gained popularity with footballers and young people worldwide, including in China of late, belying their stigmatised associations with individuals and groups on the margins of society. Older Chinese associate them with the criminal underworld, prisoners, slaves, concubines and ethnic minorities.

They have long met with Party disapproval. Mao outlawed tattoos. Even today, tattoo shops operate in a grey area between legality and illegality. They scarcely seem to fit with Xi Jinping Thought on developing citizens ‘with an all-round moral, intellectual, physical and aesthetic grounding’.

The General Administration of Sport of China (GASC) has now ordered footballers who sport them to remove or cover them up to set a ‘good example for society’.

Players with tattoos will not be selected for China’s national and age-group teams. The GASC directive said that national teams should strengthen athletes’ ‘patriotic education’ to enhance the teams’ ‘mission, responsibility and honour’.

Many Chinese footballers have already taken to wearing long-sleeved shirts to cover their tattoos.

A year ago, a women’s university football match was called off with the organising authorities telling players that any who had tattoos or dyed hair would be banned.

Football follows television’s censure of actors with tattoos since 2018’s crackdown by the media watchdog on what is deemed unhealthy content and immoral culture. That has led to on-screen images of tattooed actors and athletes being blurred. Albania’s Eurovision entry was cut from the Chinese broadcast one year because the singer had extensive tattoos.

As younger Chinese have started to adopt tattoo culture recently, they have shown a preference for Western symbols, another reason for authorities to repress inking in the drive to build a narrative of Chinese exceptionalism around historical Chinese culture. Conversely, Chinese literature, myths and calligraphy often inspire Western body ink.

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