The Disneyfication of Shanghai

Magic Castle at Disneyland ShanghaiTHERE AREN’T MANY places you could convene a crowd of 60,000 in China without police of any stripe in sight. Indeed, there may be only one — the new Disneyland in Shanghai (above).

Such was the appetite for Shanghai to land the theme park that Disney was able to negotiate self-policing rights. Chinese police authority stops at the exit to the new metro station outside the front gate.

Thereafter it is the Disney security staff that you can see anywhere in the world there is a Disneyland. Shanghai’s may turnout to the be world’s most-visited theme park. What does that say about whether American or Chinese culture is the most dominant?

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Fixing China’s Corporate Debt Problem

A SUCCINCT SUMMARY of China’s debt problem is offered by the IMF’s David Lipton. He zeroed in on corporate debt in a speech to the Chinese Economists Society in Shenzhen these few days past:

Overall, total debt is equal to about 225 percent of GDP. Of that, government debt represents about 40 percent of GDP. Meanwhile, households are about 40 percent. Both are not particularly high by international standards. Corporate debt is a different matter: about 145 percent of GDP, which is very high by any measure.

By IMF calculations, state-owned enterprises account for about 55 percent of corporate debt. That is far greater than their 22 percent share of economic output. These corporates are also far less profitable than private enterprises. In a setting of slower economic growth, the combination of declining earnings and rising indebtedness is undermining the ability of companies to pay suppliers or service their debts. Banks are holding more and more nonperforming loans, or NPLs. The past year’s credit boom is just extending the problem. Already many SOEs are essentially on life support.

The Fund’s most recent Global Financial Stability Report estimated that the potential losses for Chinese banks’ corporate loan portfolios could be equal to about 7 percent of GDP. This is a conservative estimate based on certain assumptions about bad-loan recoveries and excluding potential problem exposures in the “shadow banking” sector.

This is potentially a deep fault line running through ‘rebalancing’. Corporate debt problems if left unresolved can quickly become systemic debt problems. Authorities need to move with more despatch than they have done to deal with both zombie companies and the banks carrying their zombie loans — and they can’t deal with one without dealing with the other otherwise they will still be left with insolvent companies or undercapitalised banks.

This will not be easy given the political dimensions involved. The nearest example to draw from might be the experience of South Korea’s chaebol in the aftermath of the 1997-98 Asian financial crisis when those economically dominant and politically well-connected conglomerates had to be restructured. That, though, took both government-supported and court-supervised measures to break the power of the controlling shareholders. China’s legal system might find the latter part a challenge.

Lipton also stresses the importance of reforming the governance inadequacies that created the situation in the first place:

Governance certainly must be based on a robust legal framework: the laws and regulations that establish an effective system of insolvency and enforcement that help create payment discipline. But governance also means regulatory and supervisory policies that promote the proper assessment and pricing of risk at the individual loan level. It means robust accounting, loan classification, loan loss provisioning, and disclosure rules. It means a system that avoids moral hazard.

But there is also a socio-cultural dimension; an acceptance that the transition from a state-directed to a market economy requires the transcension of special interests and connections.

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State-Owned Enterprise Reform Slogs On Slowly

TWO THINGS WILL emerge — eventually — from China’s reform of its state-owned enterprises (SOEs): the elimination of a lot of redundant capacity in heavy industry and some multinationals that are strategically important domestically and formidably competitive internationally.

China has 111 centrally owned SOEs (those under the State-owned Assets Supervision and Administration Commission), down from 196 in 2004. The goal is to more than halve the number to around 50.

The consolidation of heavy industry, which accounts for more than two-thirds of SOEs, will let that target be attacked forcefully. Capacity reduction, particularly in steel and coal, is a policy priority in the near term.

That will drive consolidations. So, too, with inefficient and unprofitable, or zombie, SOEs in all sectors. Making globally competitive SOEs, particularly those that can underpin and benefit from the ‘One Belt, One Road’ initiative, will also be undertaken by horizontal and vertical merger and acquisition.

Similarly, SOEs that operate in sectors identified as strategically important: vehicle making, ‘green’ industries, information technology, biosciences, advanced engineering (from defence to aerospace, robotics and advanced transport), energy (nuclear and renewables) and new materials. AVIC in aerospace and CRRC in high-speed-rail equipment are examples of merging existing SOEs into huge monopolists that can dominate the domestic market and provide a platform for international sales (just, it seems, the same way Western companies are going).

The intention is to reinforce government control over core industries while opening up some parts to private and, particularly in financial services and telecommunications, to foreign investors. The intention of what is delicately called ‘mixed ownership’ is to drive improvements in governance, competitiveness and efficiency. Wholesale privatisation is not on the cards, though some spin-offs, such as Sinopec’s sale of its retail division, are.

A contradiction in all this is that the current five-year plan, to 2020, calls for its ambitious growth target (average annual GDP growth of 6.5% to vault the ‘middle-income trap‘) to be achieved through innovation based on entrepreneurship and advanced technology, not oligopolistic state capitalism.

Yet economic decision making is being centralised as warp and woof of the Party’s reassertion of its political control.

At the same time, SOE reform is proceeding slowly (too slowly for the IMF) in the face of stiff resistance from long-standing interests that feel endangered and the anti-corruption investigations that are being used by President Xi Jinping to break it. The Maoist tradition of regarding SOEs as economic arms of political institutions (and the politicians that control them) has deep roots.

A similarly live memory is of the social unrest that followed Prime Minister Zhu Rongji’s round of SOE reform in the 1990s. Then, tens of millions of workers lost their jobs and the big state-owned banks carrying the SOEs bad loans had to be bailed out.

Even though SOEs have steadily withdrawn from labour-intensive industries over the past two decades and they no longer get favoured policy loans to the extent they once did, the risk of social unrest remains a significant reason that this latest round of SOE reform will proceed slowly.

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Is Hong Kong’s Peak Behind It?

Hong Kong skyline, September 2014

NEXT YEAR SEES  the start of the 20th of the 50 years during which the 1997 handover agreement specified that Hong Kong’s way of life would remain unchanged. But with three decades still to go, ennui has settled over the city.

This disquiet goes beyond the chilling of civil rights by authorities that seem far distant from the mass of the population. It is a more existential concern.

Hong Kongers are not living in a place that, as many had once pragmatically expected, would inevitably become just one more big Chinese city but which the motherland would still want for its vibrancy and as a gateway to a wider world. They are, instead, living in a place that matters less and less to a China that has more and more direct access to the world (and bigger things to worry about than 1,100 square kilometers of rocky land on its southern coast).

Hong Kongers greatest fear has become that they are just being left to atrophy.

The chart below gives a sense of the economic driver behind that. As China’s economy racked up year after year of double-digit growth, it was inevitable that Hong Kong would seem smaller and smaller in comparison. But the diminution still points to a reality. Hong Kong remains a trade and investment bridge between China and the rest of the world, but it is no longer the only or most important one.

Hong Kong's GDP as % of China's, 1960-2014

 

Hong Kong’s entrepot role is longstanding, though where once merchandise trade was at the forefront, today it is capital. The city’s rule of law, functioning markets and financial institutions, and supporting social and business infrastructure made it a regional financial centre that was once essential to China.

But over the years, Shanghai has been growing as a rival. In the latest Global Financial Centres Index, Shanghai moved up five places to 16th while Hong Kong fell one to fourth, trading places with Singapore. In in the fullness of time, Shanghai, which in GDP terms is already about one-third larger than Hong Kong, will eclipse it as China’s financial centre. That will undermine Hong Kong’s utility as a regional financial hub.

The same will likely be true for Hong Kong’s recently adopted role as shopping mall for mainlanders if China is successful in rebalancing its economy over the long term towards domestic consumption.

Hong Kong will by then have had to reinvent itself–and Hong Kongers are nothing if not inventive. However, even though Hong Kongers have developed an identity of their own, independence as a Singapore-like city-state is a non-starter politically, as all but the tiniest slither of the population understands. A Taiwanese-like model of arm’s-length separation despite being joined at the hip is perhaps the best that can be hoped for–and even then the arm’s-length separation will be gone in barely 30 years. Little wonder there is a feeling of listlessness at that prospect.

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IMF Nudges Up China Growth Forecast, Cajoles On Reform

THE INTERNATIONAL MONETARY Fund has nudged up its growth forecasts for China over the next couple of years. The latest update to its World Economic Outlook says the Fund expects growth to be 6.5% this year and 6.2% next, both 0.2 percentage points higher than its January forecast, which in turn had been unchanged from last October’s.

These are both lower growth rates than 2015’s 6.9%, however. The Fund identifies policy stimulus as the reason for its revision, but adds:

A further weakening is expected in the industrial sector, as excess capacity continues to unwind, especially in real estate and related upstream industries, as well as in manufacturing. Services sector growth should be robust as the economy continues to rebalance from investment to consumption. High income growth, a robust labor market, and structural reforms designed to support consumption are assumed to keep the rebalancing process on track over the forecast horizon.

The Fund forecasts inflation to remain low at about 1.8% in 2016, reflecting lower commodity prices, the real appreciation of the renminbi, and somewhat weaker domestic demand.

It also notes the challenges of rebalancing and says with some understatement that the transition “has been bumpy at times”.

Slowing growth has eroded corporate profitability, which in turn, hinders firms’ ability to service their debt obligations, raising banks’ levels of nonperforming loans:

The combination of corporate balance sheet weakness, a high level of nonperforming loans, and inefficiencies in bond and equity markets is posing risks to financial stability, complicating the authorities’ task of achieving a smooth rebalancing of the economy while reducing vulnerabilities from excess leverage.

It also says:

Limited progress on key reforms and increasing risks in the corporate and financial sectors have led to medium- term growth concerns, triggering turbulence in Chinese and global financial markets. Policy actions to dampen market volatility have, at times, been ineffective and poorly communicated.

The risk is that:

A sharper-than-forecast slowdown in China could have strong international spillovers through trade, commodity prices, and confidence, with attendant effects on global financial markets and currency valuations.

That would be felt in both emerging market and advanced economies. On the upside well-managed rebalancing would ultimately lift global growth and reduce tail risks.

The Fund says the international community should therefore support Beijing’s efforts “to transit to a more consumption–and service–oriented growth model while reducing the vulnerabilities from excess leverage bequeathed by the prior investment boom”.

To that end, strengthening the influence of market forces in the Chinese economy, including in the foreign exchange market, is a key objective.  However:

Further structural measures, such as social security reform, will be needed to ensure that consumption increasingly and durably takes up the baton from investment. Any further policy support to secure a gradual growth slowdown should take the form of on-budget fiscal stimulus that supports the rebalancing process. Broader reforms should give market mechanisms a more decisive role in the economy and eliminate distortions, with emphasis on state enterprise reforms, ending implicit guarantees, reforms to strengthen financial regulation and supervision, and increased reliance on interest rates as an instrument of monetary policy.

The Fund notes the progress in financial liberalization and in laying the foundations for stronger local-government finances, but says, again, that the reform for state-owned enterprises needs to be more ambitious, clearly laying out and accelerating a substantially greater role for the private sector and hard budget constraints.

Easier to say than politically to execute. Little progress is being made on dismantling the clientelist structure of state-owned enterprises, as a reading between the lines of what this state media report on the recent meeting of the Leading Group for State-Owned Enterprises Reform doesn’t say highlights.

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A Kenyan One-China Lesson

WORD REACHES US from Nairobi of two curious incidents involving Kenyan authorities deporting groups of Taiwanese to China.

Last Friday, eight Taiwanese were forcibly sent to China in what Taiwan’s foreign ministry called an ‘extrajudicial abduction’. Although the eight had been on trial in Nairobi on fraud charges, they had all been acquitted and told to leave the country under their own steam within 21 days. However, police handed them over to Chinese officials who put them on a flight to Guangzhou.

Today, at least a further 15 and possibly as many as 37 Taiwanese, who appear to have been involved in the fraud case but details are confused, were also forcibly enplaned by police following a scuffle involving tear gas and flown to China. Kenya does not recognize Taiwan diplomatically so can argue that it was deporting Chinese nationals to China.

Beijing has, not surprisingly, praised Nairobi’s adherence to its ‘One China’ policy.

We have no idea of the details of the individual cases, said to involve a telemarketing scam of people in China perpetrated by a ring comprising nationals from both the mainland and Taiwan. (Update: The Ministry of Public Security said in a statement that China had legal rights of jurisdiction over 77 telecom fraud suspects being ‘repatriated’ from Kenya, including 45 Taiwanese.)

This may also be a case of Beijing throwing its weight about less than a month before a new, less-China-friendly government takes office in Taipei. The question is whether this is a warning shot at President Tsai Ing-wen and her pro-Taiwan independence party, or a harbinger of a more lasting chill in cross-strait relations.

Meanwhile, we understand that a further 31 people are awaiting verdicts in connection with the alleged telecoms scam that are not expected to be handed down until June. At least five are Taiwanese and the rest from the mainland.

One report says China has been talking to Kenya since the start of the year about extraditing all the suspects in the case to face charges in China. However, China and Taiwan have an agreement not to extradite each other’s citizens, so there may well be much more to come in this story.

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Two Deals Highlight China’s Push To Make Self-driving Cars

A couple of relatively small recent M&A deals have caught this Bystander’s eye.

Auto parts maker Ningbo Joyson Electronic Corp. said it had signed the deal it announced in February to pay $920 million for Key Safety Systems Holdings, an American firm that makes airbags for cars but, more critically to this deal, is developing collision avoidance technology and other autonomous car-safety systems. Ningbo Joyson’s other deal is a $205 million acquisition of TechniSat Digital, a German maker of sat nav systems.

Where the deals fit into the broader scheme of things is that both sets of technology are needed for the development of self-driving vehicles. China, the world’s largest auto market, does not want to be left behind in what promises to be the next revolutionary development in the car industry and a potentially whole new industry of shared mobility services.

Hitherto, much of the research in this area has been done by the military. The National University of Defence in Bejing is reported to have road tested a prototype driverless car in 2011 and the Military Transportation University in Tianjin to have done so the following year.

Commercializing military technology to help push China’s manufacturers up the value chain appears to have been given the green light, with autonomous vehicles a clear early application. Easing traffic congestion and air pollution and improving road safety are three reasons that the government would put its weight behind the initiative. Beating out the U.S. and Europe in a new, technologically driven market would be another.

State media have reported that the National University of Defence plans to cooperate with FAW Automotive, one of China’s ‘Big Four’ vehicle makers, to develop driverless vehicles.

In an uncanny echo of Google’s venture into autonomous vehicles, the search engine Baidu has teamed up with Germany’s BMW to focus on self-driving buses and jitneys. Its target is to have them operating on the roads by 2019 and in mass production within five years. Yutong, China’s largest bus builder, has already tested a prototype of its own.

Baidu spent $10 million buying Indoor Atlas, a data mapping company, and is developing Baidu Brain, a system to improve image recognition. It road tested a prototype car (a converted Series 3 BMW, not a bus) at the end of last year.

Volvo, which is owned by Zhejiang Geely, also plans to test 100 driverless cars in cities around China, though details are sketchy.

The Boston Consulting Group has forecast that China will be the world’s largest self-driving market by 2035. Ningbo Joyson’s deals suggest it believes that forecast will prove well founded.

Update: Changan, one of China’s ‘Big Four’ automakers, has sent a self-driving sedan on a 2,000 kilometre trip from its research headquarters in Chongqing to Beijing, claiming to be first Chinese automaker to undertake such a lengthy driverless journey.

 

 

 

 

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