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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Myanmar And China Reset Rocky But Key Relationship

 

China's Foreign Minister Wang Yi and Myanmar's Aung San Suu Kyi in Naipyidaw, April 2016LITTLE UNDERLINES CHINA’S importance to Myanmar as much as Myanmar’s de facto leader Aung San Suu Kyi choosing to make a meeting with China’s foreign minister Wang Yi , seen above, her first with a foreign leader since her party historically took office on March 30.

China is Myanmar’s largest trading and investment partner, but the two countries have had a rocky relationship over the past few years. Points of dispute have been the fighting in the northeast of the country between Myanmar’s military and ethnic insurgent groups seeking greater autonomy, including ethnic Chinese Kokang, which periodically spills over into China, and controversial Chinese-backed infrastructure projects, notably the Myitsone dam near the headwaters of the Irrawaddy river and an oil and gas pipeline from Yunnan to the Indian Ocean that would let Chinese energy imports from the Gulf bypass the chokepoint of the Malacca Strait.

When Myanmar was still under military rule, China was able to take advantage of crony deals with Myanmar’s generals and some ethnic elites to exploit the country’s natural wealth; huge volumes of illicit timber and jade as well as drugs flow across the border into China.

Former President Thein Sein sent the relationship into a spin in 201o when he unexpectedly and unilaterally suspended the Myitsone project, which was being built by state-owned China Power Investment Corp. and its sub-contractor SinoHydro.

Wang and Suu Kyi at their meeting this week chose to emphasize resetting the relationship on a more positive footing, not discussing what her spokesman described as ‘controversial’ Chinese projects. Wang subsequently said that China would ‘guide’ Chinese companies operating in Myanmar to ‘respect’ Myanmar’s regulations, society, and environment.

That probably means paying a bit more than lip service to local concerns about environmental protection, land-grabs and lack of compensation for displaced communities, and bringing in Chinese labour to build Chinese-financed projects. A deal is likely to be struck to restart Myitsone in some form, probably addressing some of the social responsibility concerns and earmarking more of the electricity the dam will generate for consumption in Myanmar and less to be transmitted back to China.

Nothing is likely to happen until after the end of the rainy season in October at the earliest. However, Beijing has a diplomatic card it can play to support its infrastructure ambitions — helping to broker peace with some of Myanmar’s ethnic insurgent groups. Suu Kyi’s government will need Chinese cooperation if it is to generate the national peace settlement it has said is a priority.

However, while China will remain a key economic and political neighbour, Suu Kyi will want to be careful to avoid over-reliance on Beijing. She will also court U.S. trade, aid and investment and that from other regional powers, notably Japan and India, both of which have reasons of their own or wanting to counterbalance Beijing’s influence in a critical corridor between East and South Asia.

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China’s Steel: The Big Chill

CHINA’S STEEL INDUSTRY is huge — and its proposed restructuring is a commensurately massive task. The State Council has approved a cut in steel production capacity by 100 million-150 million tonnes over an unspecified time frame, part of a broader plan to reduce industrial capacity as the economy slows its growth rate and rebalances towards consumption-led growth.

In the steel industry’s case, with demand in China shrinking for the first time in a generation in what is a structural not cyclical change, that could cost as many as 400,000 jobs, according to Li Xinchuang, head of the China Metallurgical Industry Planning and Research Institute. To put that in context, the iron and steel sectors employ more than 6 million people, accounting for some 4% of total industrial employment.

However, even production cuts on the scale proposed would be sufficient to remove only one-third to one-half of the estimated overcapacity in the industry. The new five year-plan is said to target a reduction in the industry’s annual production capacity to 700 million tonnes from the current 1.2 million tonnes.

Meanwhile, China’s steelmakers have found themselves in the middle of an unexpected trade spat with the United Kingdom, whose own small steel industry is facing the loss of one of its storied steel plants, Port Talbot, now owned by Tata Steel, with the finger of blame pointed at China for the effect its overproduction has had on depressing world steel prices.

When China started industrializing in 1980, it produced less than 40 million tonnes of steel a year, accounting for 5% of global steel output. Last year, it produced 804 million tonnes, just shy of one-half of world output, according to the World Steel Association’s data.

Crude steel production, China vs rest of world, 1980-2015 '000 tonnes

As the chart above of China’s crude steel production against that of the rest of the world’s shows, China’s steel output took off a decade or so ago. Annual production has now tripled from 2003’s level, peaking at 832 million tonnes in 2014.

However, China cannot consume all the steel it is producing, although it is important to note that it is not self-sufficient in many types of speciality steels in particular, of which it imports 20 million tonnes a year.  Moving into high-end steelmaking is the direction in which the industry will be pushed by policymakers, to meet the increasing needs of the advanced engineering industries such as aerospace that have been designated at China’s industrial future.

However, this year, crude steel output may drop for the second successive year, to 783 million tonnes, on official estimates. The domestic property market, a significant customer, has slumped and infrastructure spending has been reined in. 

China still consumes the equivalent of about 45% of global steel production, so it has increasingly turned to export markets, particularly the U.S and the E.U., to rid itself of its surplus stocks. Chinese steel makers sold more than 100 million tonnes abroad for the first time last year, a 20% increase on 2014’s export volumes which were themselves, double the previous year’s level.

With Russia and Ukraine also turning aggressive exporters, it is not surprising that global steel prices have slumped to their lowest levels in more than a decade, with the depreciating yuan making Chinese steel even cheaper for foreign buyers. A tonne of steel billet sold for more than $500 a tonne at the start of 2012; today it sells for $50 a tonne.

Wherever China’s export prices lie in the inevitable chicken-or-egg argument, the world’s steel industry is in disarray. Angang Steel Co., China’s fourth-largest mill, warned that not just China’s but the global steel industry’s crisis has become so severe that it’s comparable to a new ‘Ice Age’. 

Angang, like China’s other big mills, has just announced an annual loss for last year, in its case of 4.59 billion yuan ($710 million), compared with a profit a year earlier. Overall, the Chinese steel industry recorded estimated losses of $12 billion last year, making it an easy target for those that accuse it of using state subsidies to let it dump steel at below cost on world markets.

The U.S.and the E.U. have initiated anti-dumping investigations against Chinese steel exports, prompting tit-for-tat anti-dumping tariffs including the newly announced ones on the grid-orientated electron steel (GOES), used in power and audio transformers, from the E.U., U.S. and South Korea. Japan, South Korea and India have also initiated anti-dumping complaints against Chinese steelmakers.

The bigger political concern for Beijing is not being caught in a trade skirmish with the UK, whose loss-making steel industry is only one of those within Europe that feels it has been battered by China’s cheap exports, but that it may put the  determination of whether or not China is a ‘market economy’ under World Trade Organisation rules at risk. The E.U. still has to decide its position on the issue, which has broad implications for how China would be treated in anti-dumping disputes.

The even bigger concern for Beijing is the risk of domestic social unrest  sparked by large-scale layoffs not just in the steel industry but across its heavy industry.  The coal, cement, aluminum and glass industries are all facing similar restructuring. As we have noted before industrial unrest is on the rise. In one of the latest incidents, hundreds of steel workers in Tangshan in Hebei province demonstrated in support of their demands for payment of wages after their plant was closed, according to the China Labour Bulletin, a Hong Kong-based labour activist group.

Social unrest, not trade policy, will be Beijing’s priority.

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