Monthly Archives: July 2011

China’s Financial Reform On Hold

The report on China’s economy prepared by the IMF as part of its annual bilateral discussions with Beijing highlights the importance of advancing financial reform in the cause of rebalancing the economy.

Financial reform holds significant promise in contributing to the needed transformation of the Chinese economy. Over the horizon of the 12th Five-Year Plan, reforms should seek to secure a more modern framework for monetary management, improve supervision and regulation, deepen the channels for financial intermediation, transition to market-determined deposit and loan rates, and open the capital account. In all of this, a stronger renminbi will be an important complement.

Financial reform alone isn’t sufficient for rebalancing the economy in the IMF’s view. There will also need to be a stronger social safety net, higher household incomes and increases in the costs of various factors of production–i.e. an unwinding of price-distorting subsidies to things like energy. But the need for financial liberalization is pressing.

[The] potential combination—of rising inflationary pressures, already-high prices in the property market, and a weakening of direct monetary control—poses significant risks to financial and macroeconomic stability. In addition, the current system for financial intermediation continues to hold back rebalancing and the development of the service sector, generating industrial overcapacity that could present negative implications for long-run growth prospects.

China’s economy has become complex. Further financial liberalization will have to advance on a wide front: appreciating the currency, absorbing liquidity and strengthening monetary management, improving regulation and supervision, developing financial markets and products, particularly in fixed-income to help develop institutional investors, liberalizing interest rates and, once more market-based macroeconomic policymaking is in place, easing controls on capital flows.

The new five-year plan is broadly aligned with these needs. The question will be how far and how fast the reformers can push. Policymaking on this, and most other fronts, is now in stasis because of the leadership transition. There will always be economically delicate and politically difficult trade-offs between growth, inflation, financial stability and structural liberalization of the economy. Tackling inflation is the short-term political priority for economic policymakers, and absent a property or bank-credit crisis, there won’t be much political appetite for tackling financial reform until the factional jockeying for position within the Party’s new leadership calms down. That won’t happen for at least a couple of years, by which time the five-year plan will be deep into its second half, and the financial sector, we suspect, not look a lot different from what it is today.

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An Indian Lesson For China’s High-Speed Railways

An interesting tidbit from our man in Delhi who says that the 7/23 Wenzhou train crash has struck a particular note there as India evaluates where to build its first high-speed passenger rail line.

For all its extensive rail system and extensive railway exports to elsewhere in Asia and Africa, India has been cautious about committing the considerable financial resources that are needed for such projects. But what caught our ear was our man’s description of how public the debate has been in India over high-speed rail and how independent the assessments of the feasibility of the competing projects have been.

That stands in marked contrast to the experience in China. We read daily of how former railways minister, Liu Zhijun, now removed from office and under investigation for corruption, forced through his plans to build out rapidly China’s high-speed rail network, regardless of expense, brooking no opposition and freezing out critics who said he was sacrificing safety for speed.

In the mid-2000s, our man tells us, when India’s railway ministry proposed a high-speed passenger line from Mumbai to Ahmedabad, the government had it reviewed independently by a state-owned transport consultancy, which decided the project was not economically viable as a passenger line, given India’s state of development, but could be beneficial to the country as a freight line, so the passenger plan was scrapped. No cosy arrangements there.

India’s latest effort in this area was announced last year by then railways minister, Mamata Banerjee, now chief minister of West Bengal, who proposed six possible lines. These the government has had studied over the past year by international consultants, with a choice expected shortly of which will be first to be built. The cabinet is also proposing to set up an independent agency that will monitor the implementation of whichever line is chosen.

How fast the trains will run has also been a matter of debate. Many in the railways ministry wanted to start slow, 200 km/h-250 km/h, though there has been some political pressure to go faster, 350 km/h, to show that India can bridge the technology gap as Japan has done and China had appeared to have before the Wenzhou crash confirmed the worse fears of critics.

Now, India has no high-speed passenger rail lines and China has the world’s largest network at approaching 10,000 kms. But, had China’s high-speed plans had the transparency, scrutiny and accountability that occurred in India, not only might the railways ministry not have debt of 1.25 trillion yuan ($194 billion) but the Wenzhou tragedy may never have occurred.

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Official Pictures Of China’s First Aircraft Carrier

The first official pictures released by China's defense ministry of the refitted Soviet-era carrier bought from the Ukraine.

China’s defense ministry has posted to its website for the first time pictures of its worst-kept military secret, the country’s first aircraft carrier (above), a refitted 1980s-era former Soviet carrier, the 58,500-ton Varyag, that China bought in 1998. The ministry has also talked about the vessel in public for the first time, though its spokesman didn’t add anything to what was already known. The vessel remains unrenamed and no date was given for the start of full sea trials. These, though, are expected to start imminently as the carrier is due to be brought into service next year, the year that China’s first batch of naval carrier pilots will graduate from the PLA’s Dalian Naval Academy. Online video of the carrier sailing under its own power in waters off Dalian, where the fitting out is being done, was posted back in January.

The spokesman also confirmed that the carrier was to be used for research and training, as has always been taken to be the case. As we noted last year, coming along behind are two 50,000-60,000-ton conventionally powered indigenous carriers being built in Shanghai with the first planned for launch in 2014. A nuclear powered carrier is scheduled to be launched by 2020. They will be warships of the line.

The pictures the ministry has posted are undated. There are four more here. The Google map below, also undated beyond this year, shows the vessel in the water in Dalian.

China's first aircraft carrier being fitted out at a shipyard in Dalian

Footnote: The Varyag is not the first ex-Soviet aircraft carrier that China has purchased. It bought two others, in 1998 and 2000, that went into theme parks in Shenzhen and Tianjin respectively. It also bought an old World War II-era British carrier that London had sold on to Australia and which Beijing bought for scrap. (H/t to Caixin.)

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The Political Damage Of The Wenzhou Train Crash

Beijing’s top-level ordering of an investigation into the weekend’s fatal high-speed train crash at Wenzhou hard on the heels of a railways ministry decision to implement a two-month safety review of the whole troubled system reeks of crisis management badly handled by a government on the back foot. The leadership has not faced such public criticism for its handling of a disaster since the 2008 Sichuan earthquake.

Questions are being raised about Beijing’s competence to look after its people, which hits directly at the basis of the legitimacy of its monopoly rule. That is more serious for the Party than the shredding of national pride in the rapid development of a high-speed rail network, already tattered over recent months by the corruption and safety scandals surrounding it, or what looks like an immediate coverup by railway ministry officials by burying the evidence, pretty much to be expected.

The initial reaction of paying off the families of the victims in short order at 500,000 yuan ($77,600) and the sacking of three rail officials, even before rescue operations were complete, reflects an old-school attitude that government is about administration, silencing and punishment that is increasingly out of touch with the expectations of Chinese. So is the instruction to state media to focus on positive stories while the official investigation is carried out. Online discussion, by contrast, has been angry, and about transparency, the quality of economic growth and the value of prestige projects.

Adulterated food, melamine-tainted infant formula, chemical spills in rivers, the most dangerous coal mines in the world: the list of where China falls short in safety seems to grow daily, and the victims are its own. History shows that every industrializing society tends to have one disaster that triggers change in official attitudes to safety. The Wenzhou crash may or may not turn out to be that symbolic moment. But it is significant. High-speed trains are not mass transportation. They are used by the prosperous, urban, middle-class. Criticism by an educated, well-connected section of the population is of particular concern to the Party, as it is from there that any long-term challenge to its monopoly rule is likely to come. That is why the leadership is now scrambling to regain control.

Footnote:  The crash has also inflicted a body blow to China’s hopes to export its high-speed trains and the rails on which to run them. It confirms its critics worse fears of inferior equipment and shoddy construction that no amount of low cost can offset. Japan and South Korea are the likely beneficiaries, a further prick to national pride.

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More Senior Corrupt Officials Fleeing China

As the drive against corruption continues–a former senior Inner Mongolia official whose expulsion from the Party was announced on Sunday is the latest example–comes a reminder that it was always thus. More than 4,000 corrupt officials have fled China in the past 30 years, each carrying off an average of 100 million yuan ($15 million) with them. That adds up to 400 billion yuan in all. The numbers are attributed to the Chinese Academy of Social Sciences (via Caijing), and we suspect, if anything, undercount the totals. Approaching three out of four absconders are officials working in the financial system and government-run companies, the Academy says. The U.S., Australia and Canada are the favoured bolt holes.

The Academy also notes that while most of those skedaddling are middle ranking officials more and more high-ranking ones have been leaving with ill-gotten gains in recent years.  Earlier this month, two former vice mayors of Hangzhou and Suzhou, Xu Maiyong and Jiang Renjie respectively, were executed for bribery. Both took kickbacks from property development projects.

Meanwhile, Zhang Chunjiang, former deputy chairman of state-owned China Mobile has been given a suspended death sentence following his conviction on charges of taking 7.5 million yuan in bribes between 1994 and 2009 when he was deputy director of the Liaoning Provincial Postal Administration and general manager of China Netcom before becoming deputy chairman of China Mobile.

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New Rules For M&A In China, The Podcast

A quick update to a post from May about a paper from PricewaterhouseCoopers, the business advisory services firm, on the changing trends in M&A in China. We have now somewhat belatedly come across a 12-minute podcast version.

Three members of the firm, Alan Chu, China Business Services Leader in the U.S., Curt Moldenhauer, Transaction Services partner in Shanghai and Malcolm MacDonald, Transaction Services partner in Beijing, discuss the impact of the new five-year plan on M&A and the prospects for domestic, inbound and outbound deals as a result of Chinese firms having a combination of access to a fast growing domestic market and cheap capital. No great surprises, to our minds, but the trio rounds up the trends and issues into a coherent overview.

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A More Influential Chinese Voice At The IMF

This Bystander has been tardy in recognizing the elevation of Zhu Min from special adviser to the managing director of the International Monetary Fund to deputy director, and belatedly does so now. It is the first time a Chinese official–Zhu is a former deputy governor of the People’s Bank of China–has held such a high post at the Fund. It is also one of the first appointments of the new managing director, Christine Lagarde, along with that of David Lipton to replace his retiring fellow American John Lipsky as first deputy managing director.

We are, though, not surprised by Zhu’s promotion. To what extent it is a quid pro quo for Beijing going along with Lagarde’s own appointment, we can only speculate, and Zhu certainly is worthy of the job on his own (considerable) merits. But, equally, it certainly reflects a further increase in China’s growing influence on the governance of the global financial system via the IMF.

Zhu has been a staunch defender of Beijing’s foreign-exchange policy in the face of U.S. pressure to revalue the yuan against the dollar. While that is a position he espoused as special assistant, it will be interesting to see how he and the Fund square that circle as deputy managing director. His promotion may also prompt the IMF to start asking some harder–and necessary–questions about the U.S.’s fiscal and monetary policies, questions the Fund has in the past tended to fight shy of in all its talk of redressing global imbalances. For an institution traditionally headed by a European, it has long been under Washington’s sway.

Such discomforting questions would have been good to have had raised before the 2008 global financial crisis. As it happens, Zhu warned in January 2007 at the World Economic Forum in Davos that loose monetary policy in Washington was providing ample easy credit that was prompting risk-careless investment on Wall Street. That was the same Davos meeting at which Robert Kimmitt, deputy secretary at the U.S. Treasury, reflecting the consensus view of western economic policymakers, opened his remarks at a panel on the global economic outlook with “the economic outlook in the United States is positive”. With America again playing domestic politics with the global economy, another dose of realism from the outside wouldn’t go amiss.

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A McKinsey Take On The Implications of China’s New Five-Year Plan

McKinsey, the international management consultancy, has taken a detailed look at the impact of the new five-year plan on 33 industries, in particular its likely effect on the competition and profitability prospects. There is nothing to sum up overall as its value lies in the industry specificity, which is niftily displayed in an interactive chart. Well worth a look.

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China’s Economy Slows Nicely; Too Nicely To Be True?

China’s latest quarterly growth figures show the economy’s growth is slowing at a measured pace, which should reassure investors worried about the possibility of a bumpier deceleration. Year-on-year growth for the second quarter was 9.5%, down from 9.7% in the first quarter and generally beating analysts expectations. There is always a slightly malleable soft focus to China’s published GDP numbers. While  the latest set will certainly reflect the trend of a slowing economy seen in a range of other monthly indicators, they may well be erring on the side of the comforting in doing so. For Beijing’s policymakers, investor expectations are just another component of managing a soft landing for the economy as a whole.

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The Cold War’s Role In Triggering China’s Economic Reforms

Deng Xiaoping took smart advantage of the Cold War between the U.S. and the Soviet Union encouraging the normalization of Beijing’s relations with Washington to open up U.S. technologies and trade to China’s emerging manufacturers. With America acting as handmaiden to China’s integration into the world economy and China having cheap labour, sitting at a crossroads of global trade, adapting the best of foreign development models to its own circumstances and maintaining a solid political commitment to economic reform, a unique combination of political and economic events converged that allowed China to develop as it has done over the past 30 years.

That, in summary, is the view of Andrey Denisov, Russia’s first deputy foreign affairs minster and the China hand among his country’s senior diplomats, given in an interview to Vestnik McKinsey, a Russian-language publication of the international management consultancy. (A shortened English version has been published in the McKinsey Quarterly.)

It is a conventional analysis with the exception of the Cold War point that Denisov says tends to be “overlooked” but for which he makes a compelling case that it was a critical catalyst. Denisov also provides the American or European reader with a necessarily different perspective on China’s development, and there are some telling if unstated comparisons with Russia’s own economic reforms after the collapse of the Soviet Union. (The Russian version is titled, The Chinese Path: Lessons for Russia.)

Denisov is similarly succinct about the challenges China faces in replacing imitation with innovation and in dealing with the environmental, farming, water and corruption problems that economic reform has brought. He also talks about Russia’s development of its own Far East and its future relations with Asia. Well worth the read.

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