Monthly Archives: February 2011

Exports Said Important, Not Dominant Driver of China’s Growth

McKinsey, the management consultancy, is recirculating a recalculation it published last September of the value of China’s exports that strips out the value of imported components and semi-manufactures that get assembled into final export products. It is worth another look at the exercise, which was intended to create a truer picture of the dependency of China on exports for its economic growth and thus take a better measure of the strength of the shift to domestic demand now underway.

Arithmetically, what McKinsey calls domestic value-added exports will have to be a smaller percentage than the standard export numbers show (unless Chinese export manufacturers destroy value), so the interest lies in the scale of the reduction. What the firm found is that domestic value-added exports contributed 19%-33% of total GDP growth from 2002 to 2008, almost half the contribution indicated by the conventional numbers. So exports are an “important” but not “dominant” contributor to growth, McKinsey concludes.

One other inference to be drawn from the calculations is that China’s export manufacturers are moving up the value chain and becoming less pure assemblers, which is in line with the observable evidence. “If your company is a manufacturer in China that is primarily processing intermediate components for reexport…it’s probably time to consider alternative locations for the assembly work,” McKinsey advises.

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Drought Now Reported In Southwest China

Xinhua says that 190,000 people in one county in the Chongqing municipality in southwest China face water shortages because of a lack of rain for four months. Ponds and wells are said to have dried up. Light rain is in the forecast for the area for the next few days but it is unlikely to be sufficient to break the drought.

Unlike the North China Plain where drought is posing a serious threat to China’s grain harvest, the Sichuan basin is more a producer of livestock, milk, poultry, eggs and vegetables. Chongqing municipality and Sichuan, from which it was carved out in 1997, account for 10% of national meat production and 7% of the country’s eggs. If the drought persists, the risk is to the fodder crops for livestock, which could mean more corn having to be bought, putting further pressure on grain prices. If the dry weather is accompanied by above normal temperatures that will put chickens at risk of death from heat exposure.

 

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Protest, Party And Propaganda

Given the authorities’ dousing of any inflammatory news about civil uprisings against long-standing leaders in Tunisia, Egypt and elsewhere in the Middle East, this Bystander is not surprised that the full fire hose of state propaganda and security was directed at the putative protests called in 13 Chinese cities this weekend. They were in any event damp squibs, seemingly occurring only in Beijing, Shanghai and Guangzhou–if gatherings where police and onlookers believing a crowd was gathering because of the presence of a celebrity heavily outnumbers demonstrators can be called a protest. Even the arrests were in single figures.

It is no secret that the Party leadership has long been concerned about threats to its legitimacy to rule coming from the tens of thousands of protests that break out every year across the country. These are born of grievances over a myriad of local complaints about everything from corrupt officialdom to land disputes and environmental degradation. President Hu Jintao’s drive to create a harmonious society and to close the growing wealth gap in the country is an attempt to nip in the bud the potential civil unrest–and political groups–that could grow from all these.

So longstanding has been this concern that Beijing has already put in place the propaganda and security tools to control the information war. Like the telecoms and cable companies in the U.S. it understands that it is the sovereign of the Internet infrastructure that rules the Internet’s content. Within the Great Firewall, Google, Twitter and Facebook can’t help grass roots activists get around official censorship in China in the way they have facilitated in the Middle East with new software services such as Speak To Tweet. The companies aren’t present in China or in Google’s case, are heavily controlled. Local equivalents, particularly the microblog services, have patriotic obligations put upon them. Independent blogs and news sites get closed down in short order. An army of official posters and censors puts up pro-governement posts and takes down any deviating from the Party line. Mainstream media is overwhelming state run and, where not, expected to follow the guidance of Xinhua, especially when it comes to news reporting and commentary. The Politburo has reinforced the rules since Hosni Murbarak was forced to resign as president of Egypt earlier this month, and the Propaganda Department stepped up enforcement, including guidance to tone down reporting of any local incidents of disturbances.

This weekend, President Hu Jintao outlined eight points for strengthening the Party’s management over social order. The reemergence of the term social management indicates some sort of compromise, or stand-off, between the Party’s hardliners and reformers. Among the eight was one calling for tighter management over what is being said over the Internet, though Harmonious Hu also stressed the need to address the underlying problems causing the societal issues:

Further strengthen and improve controls on the information web, raising our level of control over virtual society, and perfecting our mechanisms for the channeling of public opinion online.

The goal is not anything as crude and easily criticized as shutting down the Internet or even to shut down the online conversation, but to cower and control it, with the hard and well practiced power of preemptive rounding up of dissidents providing the steel within the velvet glove.

Gene Sharp, the American nonagenarian academic who wrote the handbook on the non-violent overthrow of dictators, From Dictatorship to Democracy, a pamphlet that has been used by activists from Indonesia to Serbia to oust governments, but which, equally, provides a readymade excuse for any dictator that the U.S. is behind attempts to unseat them, argues that the power of dictatorships comes from the willing obedience of the people they govern, and that regimes don’t fall until the people withhold that consent. The Party understands that and is determined not to let itself get pushed to anywhere near that point.

Beijing has got ahead of this in a way that no authoritarian ruler in the Middle East had even begun to think about until recently. In China, the outbreak of the unrest in the Middle East, and particularly the toppling of leaders in Tunisia and Egypt, has sharpened Beijing’s need to be on top of its game. But it is one that it has been playing for a long time. Sharp’s argument for not taking the violent path to revolution is that that means taking on a regime’s best weapons. In many countries where social media have helped force regime change, the authorities were not just outgunned on the Internet, they didn’t know how to fight there or even that it was a theatre of war. It is far from clear that that is the case with China. We have even heard suggestions that the calls for his weekend’s protests were no more than an elaborate official fire drill.

Authoritarian regimes don’t fall because a few activists have read a pamphlet and put out a few Tweets. Conditions within a society have to be ripe. Uprisings to overthrow the Tsars in Russia failed in 1905-06 but succeeded in 1917; Murbarak was able to put down protests against his regime in 2006 but not this year. In both cases conditions on the ground had changed. We don’t believe conditions are ripe in China at this point to support a popular uprising that could overthrow the Party non-violently. We do believe the seeds for such conditions exist. Whether they flourish of wither is as much in the hands of the Party as it is in those of the people.

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Huawei Performs U-Turn On CFIUS Review

If Huawei Technologies’ decision to contest a U.S. national security review rejecting its acquisition of patents from 3Leaf Systems was perplexing, its U-turn to accept it is a surprise. The company says it has changed its mind because of the controversy around its earlier decision to throw itself on the mercy of an executive ruling by President Barack Obama after the Committee on Foreign Investment in the United State (CFIUS) had recommended the deal be unwound. We had thought that the company might have had some backing from Beijing for its extraordinary initial position, and earlier this week a commerce ministry spokesman called for Washington to make its national-security reviews more transparent. Maybe this was all just testing the waters of Sino-American relations and finding them a bit too choppy.

Update: A bit of backwash from state media, suggesting the U.S. has overreacted in this case.

Further update: Reports from London (here via the FT) say Huawei is offering to give London’s metro system a free mobile wireless system in time for the London Olympic Games in 2012, an ‘Olympic host to Olympic host’ gift that it is estimated would cost the company upwards of $80 million. The inevitable national security concerns about a Chinese company running such a network in London have already been raised, but we do wonder what might be said it they had proposed the gift for the Metro in Washington, D.C. instead.

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Xi Jinping: A Princeling’s Princeling

How is Washington sizing up the man who looks set to be China’s next president, Xi Jinping? Reuters news agency has reviewed a large number of U.S. State Department cables sent to WikiLeaks but unpublished to date. From the snippets of information and analysis in these gained over several years by American diplomats from their sources, Reuters constructs a biography that paints a picture of the 57-year-old Xi as:

…untainted by corruption–he is referred to as ‘Mr Clean’–and disdainful of China’s nouveau riche and consumer culture. He is also depicted as an elitist who believes that the offspring of Maoist revolutionaries [the princelings] are the rightful rulers of China. His father was a major Communist leader who fought alongside Mao Zedong and helped implement Deng Xiaoping’s economic reforms.

Xi emerges as competent, conservative and cautious. Somewhat taciturn, he is a man whose ability to keep his own council and no clear record of imposing his own agenda make him a leader acceptable to the competing factions among the princelings. They see him as one of their own and a safe pair of hands. His smooth ascendancy of the Party ranks suggests no political naivety, however. His wife, Peng Liyuan, is a well known (and wealthy) singer with the People’s Liberation Army, giving him good links to a crucial domestic political constituency often underestimated by outside commentators.

What sort of president will Xi make? Even allowing for the fact China’s president is more a convener of the Politburo rather than a leader in the Western sense, it is impossible to say on the evidence of the cables. If anything the profile raises more questions than it answers. If Xi is a chip off the old block, he will be more a Dengist reformer than a Hu Jintao equalizer. His father, Xi Zhongxun, when Party boss in Guangdong from 1978 to 1980, set up the first special economic zone in Shenzhen, now regarded as ground zero of China’s explosive economic growth of the past three decades. The younger Xi has made his political career in provinces known for economic openness, trade and rapid wealth creation.

Xi senior is also believed to have opposed using troops to clear Tiananmen Square in 1989, prompting some sources to suggest that the younger Xi might have similar liberal leanings. Despite some tinkering with low-level political transparency in Zhejiang and Shanghai, we see little evidence to support that. Rather we see a man who will act pragmatically to secure the long-term interests of his fellow princelings as the guarantors of the Party’s primacy. If so, that will translate into a continuing but slowing pace of reform.

If he is driven by anything, the cables suggest, it is by a sense of a loss of the Party’s traditional moral values of honesty, dignity and self-respect. He is unusual among his Cultural Revolution disrupted generation to have embraced the Party at an early age in preference to hedonism and moneymaking. Some sources suggest Xi is repulsed by China’s corruption and its all-encompassing commercialization. He is said to be dismissive of the ‘shopkeepers’, the nouveau riche elite who cannot trace their wealth or political lineage to revolutionary roots. If Egypt and the rest of the Middle East is any harbinger, he may need to be more worried by the shoppers than the shopkeepers.

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China Again Raises Banks’ Capital Reserve Ratios

China’s anti-inflation ratchet is clicking ever more frequently. The People’s Bank of China is again raising banks’ capital reserve-ratios. An increase of half a percentage point will come into effect on February 24th, taking the ratio to 19.5% for most large banks, and 20% for some.

It is the second time this year that the reserve ratio has been raised and eighth time over the past two years. It follows an increase in benchmark interest rates earlier this month (the third since the central bank started raising rates last October) and a January consumer price inflation number, 4.9%, which dashed any lingering hopes that inflation had peaked last November.

The central bank has been struggling to drain off the excess liquidity in the system. New bank lending in January was 1.04 billion yuan ($158 billion). The early months of the year tend to see a surge in new lending as banks clear their backlog of applications held from the previous month so they could stay in touch with their annual lending quota. But on top of the growing trade surplus swelling China’s foreign-exchange reserves and the yuan not appreciating that quickly to compensate, this means the central bank is facing an uphill battle to sterilize all those funds. We expect the click-click of the ratchet to continue.

 

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G-20 Finance Ministers To Stumble, Squabble Through Paris Meeting

The G-20, whose finance ministers and central bankers meet in Paris this weekend, no longer looks as unified, and thus as relevant, as it did in the heat of the global financial crisis. Its summit meeting in Seoul last November left a lot of unfinished business on the table — global imbalances, capital flows, America’s monetary policy and China’s exchange rate. This weekend’s ministerial meeting has to pick these up again if there is to be any hope that they can be cleared off the table when their bosses convene for their heads of state and government summit in Cannes in November.

Since Seoul, there has been some progress on the issue of the yuan’s revaluation and China’s rebalancing by shifting from export-led to domestic-demand-led growth, though neither far nor swiftly enough to satisfy Beijing’s critics on either score. China, like most of the advanced G20 members with the notable exceptions of the U.S. and Japan, has also made a start on draining off some of the liquidity pumped in by stimulus programs. Beijing has also made more moves to make the yuan a more international currency though it is not yet sufficiently convertible for inclusion in the currency mix behind the IMF’s Special Drawing Rights. However, reform of the international monetary system and global governance are pet projects of this year’s G-20 president, France’s President Nicolas Sarkozy. Those could put some wind behind China’s sails in Paris, but it will be mostly rhetorical wind we suspect. A fully internationalized yuan remains a distant prospect.

The most that is likely to be achieved in Paris is some sort of agreement over which national economic indicators should be used to analyze global imbalances. Even these will be no more than broad-brush current-account measures. Numerical targets to set against those indicators aren’t in even the wildest imaginations. China, along with Germany, the world’s two biggest exporters, have made clear that they have set their faces against any target for current-account imbalances expressed as a percentage of GDP.

Commodity prices, and particularly the high prices of agricultural commodities, are most likely to hijack the agenda. This is an issue of acute interest to Beijing, where drought and inflation remain stubbornly persistent and thus politically threatening. The French have been pushing the idea of G-20 price controls, though it is far from clear how those would work in practice even if they could be agreed on, which is doubtful given the disparate commodities interests of the G-20 members. Sarkozy has called a first ever meeting of G-20 agriculture ministers in May, but it is whether finance ministers decide to doing anything about commodity derivatives that will matter more. We suspect we shall see nothing more biting than a study.

 

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China Puts A Number On Hot-Money Inflows, And It’s Small

China’s policymakers have long pointed an accusatory finger at the impact of hot-money inflows on inflation and asset bubbles. To what extent that is true has been difficult to assess. Quantifying such speculative investment inflows is tricky. In essence, analysts look for foreign-exchange reserves not explained by traditional transactions such as trade and foreign direct investment.

The State Administration of Foreign Exchange (SAFE) has taken a stab. The numbers it comes up with are $75.5 billion for 2010, and, after netting out cross-border yuan settlement, $35.5 billion, which is equivalent to 7.6% of the year’s total increase in foreign-exchange reserves. By way of comparison, SAFE reckons, total hot-money inflows in 2009 were $29.1 billion and averaged $25 billion a year over the previous decade, accounting for the equivalent of 9% of annual foreign-exchange reserve increases on average. (The is no netting out number as cross-border yuan settlement is recent.)

The numbers suggest that hot-money inflows account for a relatively small part of capital inflows, and are but a spec compared to the size of the economy as a whole. They took a large leap last year and any extra irritant to inflation is unwelcome to policymakers struggling to drain the excess liquidity from the economy in a controlled and orderly way. They also suggest that China is having increasing difficulty in maintaining effective foreign-exchange controls.

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China’s High-Speed Rail Corruption Investigation Reportedly Broadens

The Economic Observer adds a second corruption inquiry that is possibly tied to under-investigation Railways Minister, Liu Zhijun. This involves Luo Jinbao, former chairman of China Railway Container Transport Corp., which is a subsidiary of the Ministry of Railways, and also of Shanghai-listed China Railway Tielong Container Logistics Co., from which he stepped down as chairman in October last year after only six months in the job and without explanation. The latter is the first publicly listed company to be connected to the investigations.

The publication says it was this case, on which it reported briefly in January, that first cracked open the possibility of high-level corruption around the development of the country’s high-speed rail network. It also adds that it was through Luo that Ding Shumiao, whose business dealings are also under investigation as we noted earlier, first met then Deputy Railways Minister Liu in 2000.

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Huawei Technologies: Beijing Gets Its Reciprocity In First?

We have been wondering what to say about Huawei Technologies’ decision not to follow last week’s recommendation by the U.S. Committee on Foreign Investment (CFIUS) that it sell patents acquired as part of last year’s acquisition of 3Leaf Systems, a U.S. software company that lets many computers combine as more than the sum of their parts. But now we have a conspiracy theory.

Huawei has instead chosen to throw itself on the mercy of an executive decision by the U.S. president, Barack Obama. This struck us as a hiding to nothing. It is highly unusual for a U.S. president to overrule any CFIUS recommendation. In this particular case, where domestic political pressure brought about a retrospective CFIUS national security review of the deal and there is no apparent argument to be made that the committee made a glaring error, the political cost would be so great that it is hard to imagine any quid pro quo that would make Obama willing to devote even a scintilla of his political capital to pay it, even if that quid pro quo came from Beijing.

By taking the decision it has, Huawei keeps clean its argument that it is a civilian telecoms company and not a front for China’s military, the accusation made against in the U.S. and which it denies. Yet by not doing the expected thing — quietly walking away form the deal in the face of an adverse CFIUS finding –  it is setting itself up for a public rebuff from Obama, assuming that he rules as we believe he will. To paraphrase  Oscar Wilde’s Lady Bracknell, to lose one U.S. deal on national security grounds, as Huawei has already done in 2008, may be regarded as a misfortune. To lose both looks like carelessness.

Yet it is equally difficult to believe that Huawei would put itself through all that without at least the tacit support of Beijing — which will have to do a bit of diplomatic huffing and puffing in the event of the deal being unwound. Obama has only 15 days to decide so the decision is likely briefly to unsettle Sino-American relations so soon after President Hu Jintao’s state visit to Washington last month sought to smooth them. But equally, Beijing, ever one for reciprocity, may be quite happy to have a rejected Chinese takeover deal for an American company in its back pocket along with some ruffled national amour-propre now that it is setting up a committee of its own to review foreign acquisitions on national security grounds.

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