Monthly Archives: May 2012

Yuan-Yen Direct

Direct trading between the Chinese and Japanese currencies starts Friday, cutting out the dollar as an intermediary. Rates will be posted in Tokyo and Shanghai, with China’s monetary authorities allowing a 3% daily trading band for the yuan against the yen (the dollar gets a mere 1% band).

And so Beijing takes yet another step along the long road to the internationalization of the yuan. How long before the won joins in, a likely next step given the plans for a free trade agreement between China, Japan and South Korea?

There is no particular reason for trade not involving the U.S. to be exposed to the potential volatility of the dollar. Direct currency settlement should increase yuan settlement of China’s imports and exports, as it lessens the currency risk for Japanese and South Korean buyers of goods denominated in yuan. The same idea is behind plans for an agreement between China and its fellow Brics, Brazil, Russia, India and South Africa, to make loans in their own currencies to facilitate trade. The five Brics plus Japan and South Korea account for about 30% of world GDP, compared to 45% for the U.S., the U.K. and the Eurozone.

Greater use of the yuan in trade could eventually grow into full convertibility of the currency. Before then, though, there will need to be a loosening of China’s capital controls and more opening of China’s capital markets. Both represent a greater political challenge than expanding trade finance. Opponents of reform have been able to argue that China’s national interest has been well served by cross-border capital controls and the ring-fencing of the country’s financial system. Only beyond that still distant horizon lies reserve currency status.


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A Stimulus By Any Other Name

When is stimulus spending not a stimulus package? When it is previously planned projects just being brought forward, apparently. State media are reporting that Beijing is saying that it is not going to stimulate the economy in the way it did after the 2008 financial crisis (via Bloomberg). That pumped 4 trillion yuan ($600 billion) in to China’s economy, an steroid-like injection of credit whose side-effects are still being felt in persistent inflation, ailing bank debt and excess industrial capacity.

With the economy again slowing, the temptation is to fall back on tried and trusted methods of state capitalism, and the devil, again, take the consequences. Up to point. Latter this year a new generation of leaders will be ushered in who will have to establish their political legitimacy and sustain the Party’s legitimacy through making all Chinese better off. A delicate balance between a quick fix and sustainable growth will have to be found that still promotes the long-term rebalancing of the economy.

So all praise to five-year plans. The National Development and Reform Commission, the agency that oversees national planning and green-lights individual projects lower down the development food chain, has the capacity to advance 1 trillion-2 trillion yuan-worth of infrastructure projects. It has already approved nearly 900 projects in the first four months of this year, twice the number in the corresponding period of last year. If anything, the pace of new approvals is gathering.

The constraint on policymakers is anunwillingness to repeat 2008s reliance on bank lending to local authorities to finance the stimulus, and a reluctance of the big-state owned banks to make their balance sheets creak any more under a further burden of new loans. Hence the talk on more private-sector financing of the proposed infrastructure investment in railways, energy, green technology, telecoms, healthcare and education.

This month, Beijing has announced a series of measures to give more scope to private capital and to expand domestic demand by subsidizing sales of consumer goods (as it did after 2008). Whether China’s private lenders will provide better judges of risk than their state-owned counterparts is yet to be seen, especially when there are national development goals breathing down their necks. Yet there is also no getting away from the fact that lending outside the state-owned banking sector is rudimentary or informal. The big state owned banks will still have to do most of the heavy lifting of a new stimulus, however it is labeled. Everyone will want to keep their load as light as possible.

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Party Expels Former Railways Minister Liu Zhijun

Disgraced former Railways minister Liu Zhijun has been expelled from the Party for corruption. He is also taking the fall for the extensive corruption and mismanagement throughout China’s sprawling railway system.

Xinhua reports:

Investigators found Liu used his position to seek huge illegal interests for Ding Yuxin, chairman of Beijing Boyou Investment Management Corporation, maneuvering which caused great economic losses and negative social influence, according to a statement issued by the CPC’s Central Commission for Discipline Inspection (CCDI).

The CCDI also discovered Liu, who the statement labeled “morally corrupted,” had taken a huge amount of bribes and bore the major responsibility for severe corruption in the railways system.

Liu was removed from office in February last year. He will now face criminal charges which carry a lengthy jail term and possibly a death sentence.

The rapid expansion of China’s high-speed rail network has had the bloom taken off it by massive fraud, waste and mismanagement. The Railways Ministry’s all-encompassing control of the system–alone among the world’s largest railways, it makes policy, builds and owns the infrastructure, operates the services and regulates the system, which stands alone from all other forms of transport–is starting to be undone. Last month, plans to allow more private investment into the system were announced, a first step to breaking up the ministry. This would separate the infrastructure from operations, but not go as far as a World Bank proposal to put railways under a new transport ministry.


Filed under Politics & Society, Transport

China’s Growing Impatience With North Korea

The script was meant to go like this: Beijing would back dynastic succession in Pyongyang in return for North Korea under Kim Jong Il’s son, Kim Jong Un, adopting gradual economic reforms along the Chinese model. That way, China’s erratic and impoverished neighbor would become a more stable political and economic ally, and the threat of millions of starving North Korean refugees flooding across the border into northeast China in the event of the collapse of the Pyongyang regime would be alleviated.

Unfortunately for Beijing, Kim Jong Un has lost the plot.

Relations between North Korea and its only friend in the world have hit rock bottom. Beijing is furious. Chinese state media have given unusual prominence to the Chinese fishermen who were seized in North Korea earlier this month and returned with tales of beatings and starvation at the hands of their captors. That was a rare public embarrassment of Pyongyang by Beijing, which for years has defied world opinion in repatriating North Korean refugees caught in China knowing that they and their families will receive similar harsh treatment once returned.

Beijing has other reasons for its displeasure. North Korea is not only not keeping it side of a bargain but it is also not showing the respect China believes it deserves for being its long-suffering political and economic lifeline. Pyongyang didn’t give Beijing advance warning about the deal it struck with Washington in February for American food aid in return for apparent concessions on missile and nuclear programs. It then brushed aside China’s objections to conducting a rocket test, objections made unusually publicly. Beijing even backed a resolution condemning the test in the UN security council, a forum in which it previously backed all sorts of North Korean nonsense. That the test failed so spectacularly–and stood in such sharp contrast to the success of China’s space program–was a cause of a great deal of quiet satisfaction in Beijing.

China has been getting increasingly irritated by its old ally for some time. Bilateral relations are, unusually with China’s foreign policy, handled on a party-to-party rather than a government-to-government basis. While there is historical logic to the practice, it is becoming increasingly anachronistic. China’s incoming generation of leaders were no more than babes in arms, if that, at the time of the Korean War. The Pyongyang regime, where second generation leadership prevails, aren’t comrades in arms. They are a deadweight dragging on China’s increasing global role and an erratic threat to regional security that complicates relations with the U.S., Japan and South Korea for no very great advantage.

Inexplicable and unpredictable provocation was Kim Jong Il’s way. Kim Jong Un may be trying to show himself to be his father’s son. He is likely egged on by generals who threatened by economic reform. Like all North Korea’s political elite, they have vested interests in the military-industrial complex. This includes the country’s international arms trading business and the companies to which North Korea’s 10-year economic development plan has been assigned for implementation. The military-industrial complex is pretty much the North Korean economy.

The poverty of the rest of the country concerns Beijing even more. Millions of starving North Koreans fleeing a failed state into northeast China constitutes the worst-case scenario. The current crackdown on illegal North Koreans in China and on the organizations who help them should be seen in this light.

Beijing’s long-term strategy is to draw North Korea into its economic orbit, with an assumption that a some point foreign policy will follow as the economics start to make cooperation rather than provocation North Korea’s underlying interest in dealing with its neighbors. They have evolved in the more than a half century since the Korean war in a way North Korea has not. China now sees South Korea and Japan as frenemies, potential free-trade partners as well as allies of the U.S. to be contained. Kim Jong Un, however, is still gambling that he can rely on China’s continuing support for as long as stability on the Korean peninsula is more important to Beijing than the collapse of his regime.

If he is testing the limits of Beijing’s support–as good a guess as any given how little is known about what actually goes on in the highest echelons of the Pyongyang regime–he is playing a dangerous game, albeit one learned from his father. Kim Jong Il, however, was adept at calibrating the risks. Kim Jong Un may be too inexperienced to do so.  He may particularly be miscalculating China’s opportunity cost from being seen to be beholden to Pyongyang: a diminution of its credibility as a regional or world power. Beijing still looks after its old friends, but not unconditionally. Beijing may have changed more than Kim Jong Il and the rest of the power elite in the Hermit Kingdom realize.

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The Dalai Lama Calculation

All Western leaders have to make a political calculation over the Dalai Lama: what is the value of showing support for human rights by meeting the exiled Tibetan spiritual leader minus infuriating China?

U.K. prime minister David Cameron seems to have got his reckoning wrong. Beijing cancelled a visit to Britain by Wu Bangguo, chairman of the National People’s Congress standing committee, after Cameron and Nick Clegg, deputy prime minister and leader of Cameron’s party’s coalition partner, met the Dalai Lama earlier this month when he was in London to receive the Templeton prize. The meeting was billed as private and held not on government premises but at St. Paul’s Cathedral during the award ceremony. Beijing still regarded this as an “affront to the Chinese people”, and launched “solemn representations” with London.

The symbolism of canceling a visit by Wu, who is second in the Politburo hierarchy, may be lost on many Britons outside diplomatic and Sino-centric circles, who likely won’t have heard of him and would be surprised to learn Wu outranks the prime minister they may have heard of, Wen Jiabao. Those in diplomatic and Sino-centric circles will be decoding where the cancellation ranks among rebukes. Wu is not only senior but also the most senior Chinese to travel to the UK in recent years, but his visit was going to be no more than a stopover en route to Europe. Nor was the cancellation officially announced. It only emerged after Wu’s trip had started.

France was given the cold shoulder after its then president, Nicolas Sarkozy, announced plans to meet the Dalai Lama in 2008. A China-EU summit he would have chaired was scuppered and new big-ticket commercial deals with France stopped for a couple of years, but then resumed. Smaller countries get harsher treatment. Norway, where the 2010 Nobel peace prize was presented to Liu Xiaobo, a Chinese dissident currently imprisoned for subversion, has yet to return to Beijing’s good books.

The U.K. may be commercially too important to China to be left standing in the corner for too long. London is making a great play to be the non-Asian trading hub for the yuan as Beijing pushes it towards a greater role in the international financial system. The only viable alternative to be London would be New York, a switch that would have officials in Beijing making a separate set of calculations of their own.

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China’s Big Banks’ Wealth Management Products Raise Concerns

An often overlooked red flag about the creditworthiness of China’s big state-owned banks was raised by Fitch Ratings on Monday. In a report reaffirming the ratings of the Industrial & Commercial Bank of China, China Construction Bank, Bank of China, Agricultural Bank of China and Bank of Communications, the U.S. credit rating agency noted:

One key risk over the short-term is Chinese banks’ rapidly growing wealth management offerings, of which state banks are the leading issuers. At end-Q1 12, Fitch estimates that the amount of outstanding wealth management products in the banking system reached 10.4 trillion yuan ($1.6 trillion). While this represents a relatively low 12% of total deposits, an estimated half of all new deposits are raised through these products. Poor matching of the maturities of the liabilities with the assets underlying the products means banks often do not have money coming in on the products to repay investors upon maturity. Instead, banks often rely on new issuance or product rollovers to repay investors.

This is a different concern to the more common one about the quality of the banks’ loan books in the wake of the credit-fueled stimulus splurge that followed the 2008 global financial crisis which saw the banks’s credit exposure growing twice as fast as nominal GDP in the three years to the end of last year. That widening gap raises questions about borrowers’ ability to repay as these loans fall due this year and next, especially as the economy slows. We are already seeing the big banks showing great forbearance, especially to local government borrowers, and dutifully finding ways to keep those pressures on asset quality from showing up in higher non-performing loans numbers.

The expansion of wealth management products threatens the big banks less with solvency issues and more with funding and liquidity ones, given how important this activity has become to deposit growth. True, as Fitch acknowledges, the banks’ state backing, strong deposit networks and 19% capital reserve ratios provide “substantial resources” to absorb increasing funding or liquidity strains were there to be a disruption to the wealth management business. And if the worst came to pass, Beijing would likely shore up the balance sheets of  failing institutions, as it has shown itself willing to do in the past. But it could be bumpy. What happened in the informal banking sector in Wenzhou provides a microcosmic reminder of what can go wrong when a slowing economy can’t keep up with the race for yield.

It is worth remembering that four China’s five biggest state-owned banks rank among the six largest banks in the world. Just as their sheer size means credit losses could be significant, so the volume of the wealth management business means a disruption of it could put pressure on China’s sovereign credit rating should Beijing have to provide material support.

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Scarborough Shoal Dispute Flares Up Again

Landsat 7 image of Scarborough Shoal in South China Sea dated 23 February 2000The Philippines says that two of China’s most advanced fisheries protection vessels have been deployed in disputed waters of the South China Sea off the Scarborough Shoal, known as Huangyan Island to China (shown right). They are among five Chinese government ships–three from Fisheries Enforcement and two Coast Guard–16 fishing boats and 56 utility boats Manila says are plying waters that saw a stand-off between the two countries’ coast guard vessels last month and sparked a continuing diplomatic row. Beijing says that only 20 fishing boats are in the area, a typical number for this time of year.

The two countries had announced separate seasonal fishing bans in an effort to diffuse the dispute. Beijing says the Chinese vessels are observing its. Manila says they are harvesting clams and coral, in contravention of its ban, and has demanded they withdraw. The satellite image above shows the entrance to the lagoon bottom right; the outline is marked by the coral reef. On Tuesday, the foreign ministry said that what it called the Philippines’ provocations had necessitated “China to adopt corresponding measures to strengthen management and control.” It also took a dig, if not in name, at the U.S. for selling the Philippines a Hamilton class naval cutter. None of this sounds like an easing of tensions.


Filed under China-Southeast Asia