Category Archives: Banking

China Props Up Housing To Reinforce The Economy

FRIDAY’S CUT IN mortgage rates, the second this year, had been signalled, but its size was a surprise.

The People’s Bank of China lowered the five-year loan prime rate by 15 basis points to 4.45%, the deepest cut since the 2019 revision of its interest rate mechanism, and at least half as much again as private economists expected.

However, the central bank left its one-year reference rate unchanged at 3.70%. This hints that caution over policy easing persists even as authorities seek to boost the beleaguered housing sector to prop up an economy sagging under the weight of the zero-Covid strategy to contain outbreaks of infection.

Housing starts, sales and prices all fell in April. Construction activity fell by 44% year-on-year, following a 20% year-on-year drop in January-March. For the first four months of the year, residential property sales were down by 32.2% year-on-year and commercial property sales by 29.5%.

More than 100 cities have introduced measures in recent months to support first-time buyers while keeping speculative investors at bay. In the short term, the latter group’s return would most rapidly ginger up housing market activity, even if the long-term costs are undesirable.

For now, authorities can hope to do little more than stabilise the property downturn, especially while cities remain in lockdown. Reinflating prices would require broader stimulative measures, undoing several years of stop-go deleveraging of the debt risks in the economy.

Meanwhile, the scope for broader interest cuts is also limited by fears of accelerating the pace of capital outflows as the US Federal Reserve raises its rates.

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Soft GDP Number Will Pressage More China Stimulus

THE PEOPLE’S BANK OF CHINA (PBOC)’s announcement that it was cutting banks’ reserve requirement ratio by a quarter of a percentage point from April 25 was well signalled.

It is likely the first in a series of small stimulus measures as authorities seek to counter the slowing of the economy in the face of the country’s worst wave of Covid outbreaks and soaring food, energy and metals commodity prices due to the war in Ukraine.

Premier Li Keqiang has stressed the need to ensure that economic growth picks up in the second quarter. Economic stability is the new watchword.

Monday’s first-quarter preliminary GDP figures are unlikely to make pretty reading. Year on year growth is expected to slow from 4.0% to around 3.5%, and quarter-on-quarter growth from 1.6% to barely 1.0%. The accompanying industrial production and retail sales numbers will also likely be soft.

Beijing will find it difficult to reach its 5.5% growth target this year, but there is no sign yet that it will be jettisoned.

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CIPS Replacement Of SWIFT Will Not Be Swift

Screenshot of page from SWIFT website captured February 27, 2022

THE DECISION BY Western nations to sanction some Russian banks by excluding them from the SWIFT messaging system that underpins international bank payments will spur Beijing to accelerate the adoption of its alternative.

At its core, SWIFT is a secure messaging system, as its full name — Society for Worldwide Interbank Financial Telecommunication — implies. Thus there is no reason that its functionality cannot be replicated.

China and Russia have had rivals since 2015, the Cross-Border International Payments System (CIPS) and the System for Transfer of Financial Messages (SPFS), respectively.

However, SWIFT’s power comes from its near-universal usage by more than 11,000 financial institutions across 212 countries, conducting 42 million transactions a day on average worth some $5 trillion.

By comparison, CIPS is in its infancy. It embraces only 80 foreign banks, including some Russian ones, but most of its 1,200 participant banks are Chinese or their overseas subsidiaries.

CIPS is mainly used domestically and for transactions between Hong Kong and the mainland. There is some regional use (8% of total CIPS transactions in 2020), but take-up is marginal in Africa, Latin America, and Europe.

In 2020, CIPS handled 2.2 million payment transactions across the year, with a total value of $7 trillion. However, that represented an increase over the previous year of about one-fifth for transaction volumes and approaching one-third for values.

CIPS has been getting more policy attention since the introduction of Hong Kong’s National Security law, which heightened concern over financial sanctions from the West. This has slightly shifted the focus from CIPS’s original goal of supporting yuan internationalisation to creating a SWIFT alternative should one become necessary.

SPFS, too, is used mainly domestically, accounting for around one-fifth of domestic financial payments. However, only a handful of international banks have signed up.

Neither system is anywhere near challenging SWIFT, even though Iran, which was kicked off SWIFT, in 2019, has declared it may soon be able to circumvent Western sanctions by using a combination of the Chinese and Russian alternatives to get around its own sanctions problems.

Its optimism is based on talks between Presidents Xi Jinping and Vladimir Putin in December. According to the Russian side, the two leaders agreed to develop a joint financial messaging and clearing system that would recruit numerous international banks. That will not happen overnight.

It is not a question of building out the systems. It is getting financial institutions to use them. SWIFT has more bells and whistles than CIPS and SPFS and can be used for capital transactions. Yet they are both still clearing and settlement systems, not rocket science. They just have to be reliable, efficient and cheap.

Usage has an element of chicken and egg. As long as so few global transactions are conducted in yuan, a Chinese clearing system will not attract many foreign adopters. Yet, if the system is little used, there is scant incentive for trade to be denominated in yuan.

Further, the strong network effects SWIFT enjoys also mean high user stickiness and substantial switching costs. This Bystander has read estimates that of the banks on CIPS and SPFS, only 10% of their transactions go through one or other of the services.

SWIFT is not a dollar-based system per se or even a US entity. It can clear in 26 currencies, operates from Belgium under Belgian law, and is overseen by Belgium’s central bank.

Yet SWIFT’s geopolitical power accrues to the United States as it is one of the critical props of the dollar’s centrality as a global currency. The dollar and euro have swapped primacy back and forth as the most used currency for international payments.

Yet, at around 40% each, both overshadow the yuan’s share of barely 3%, making it difficult for China to circumnavigate the Western financial system. The dollar’s use is the root of its global influence.

China would like the yuan to break the dollar’s hegemony over international trade. It has been actively pursuing bilateral currency swaps, such as its rolling three-year arrangement with Russia so that more trade can be settled in yuan. However, even its Belt and Road contracts tend to be dollar-denominated, and the bulk of China’s international trade is conducted in currencies other than the yuan.

Once that changes, which will likely require more relaxation of capital controls, CIPS is in place to facilitate that trade. But the cart can’t pull the horse.

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China’s New Tech Order

AFTER NEARLY TWO years of crackdowns on various tech industry sectors, a series of policy plans have emerged that collectively outline a path of re-organisation and gradual but not disruptive development into the middle of this decade.

They bring some cohesion to the loosely connected regulatory measures taken since late 2020. The steady implementation of a clear regulatory and policy framework will replace what has looked like abrupt and random regulatory interventions.

This will be a cornerstone of the recently issued five-year plans for national informatisation and the digital economy,

China’s goal is to streamline private tech businesses from fintech firms to app platforms and enmesh them with state-owned enterprises and investment vehicles to ensure greater policy control. There is a particular focus on data and aligning the tech sector with the ‘common prosperity’ and ‘dual circulation’ development agendas.

It will be a balancing act. Beijing needs to avoid squashing innovation as it pushes to develop an indigenous tech sector that can improve economic self-reliance and be internationally competitive.

Policymakers want to use digital technologies to enhance service capacity and quality across the economy and serve underserved populations, for example, by expanding social services to rural consumers or extending credit to small and medium-sized enterprises. Yet, they also want to ensure state control of the data generated by private businesses and that those businesses do not use oligopolistic power to exploit the troves of data they collect from consumers and citizens.

The plans align with the intent to redress ‘the disorderly expansion of capital’. As with the admonition to the real estate industry that housing is for living in, not speculation, the tech sector is being schooled that it has to fulfil the needs of the real economy.

In particular, that means contributing to national innovation to help transform legacy industries in manufacturing and agriculture and playing a more significant role in generating access to and delivery of government and public services.

That message is being strongly sent to fintech firms, in particular. The idea is that fintech should be incorporated into the existing banking system, not disrupt it.

Financial instability remains a worry. Authorities are increasingly concerned that fintech products for consumers risk adding a layer of unsustainable household debt on top of existing corporate debt. Concerns about threats to the financial system were one of the reasons that authorities banned cryptocurrencies last year.

For tech companies as a whole, Beijing is making it clear that it rejects the digital economy model of large, winner-takes-all platforms as seen in the West and embraces new business models that enmesh state and private actors.

The era of unregulated growth is over. Tech firms will now be expected, for which read required, to contribute to the Party’s other policy objectives — tackling financial risk, supporting social objectives and development goals, improving market regulation and data security — and their shareholders, patriotically, to bear the costs.

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Rate Cuts Highlight Tricky Growth Balance China Has To Strike

Chart showing China's quarterly GDP growth year-on-year from Q1 2019 to Q4 2021

CHINA HAS CUT interest rates for the first time in two years as the property sector debt crisis and a resurgence of Covid-19 weigh on the economy.

Fourth-quarter GDP growth came in at 4.0% year-on-year, its slowest pace of growth in 18 months. Quarter-on-quarter growth was 1.6%, up from the third quarter’s 0.7% but still far from robust.

While both the y-o-y and q-o-q numbers slightly exceeded consensus expectations, they confirm the return to the trend slowdown in growth seen before the distortions of the pandemic.

Year-on-year growth slowed in each quarter last year, although the economy expanded by 8.1% for the full year as it bounced back from 2020’s initial outbreak of Covid-19. The official target for 2021 was ‘over 6%’.

Retail sales rose by only 1.7% in December, much less than forecast, as new Covid-19 outbreaks forced new lockdowns in several cities. Investment also slowed, although industrial output rose.

The interest rate cuts by the People’s Bank of China signals a more assertive monetary approach than the easing already seen in the third quarter with the lowering of banks’ reserve requirement ratios.

Today’s cut in the benchmark one-year loan prime rate by ten basis points to 2.85% and the rate on seven-day reverse repurchase agreements to 2.1% follows December’s five-basis-points cut in the one-year policy loans rate. The five-year loan prime rate, the benchmark rate for mortgages, was left unchanged, but a reduction in that sooner rather than later would not be a surprise.

The reverse repo rate cut is the more unexpected of the latest cuts. It reflects authorities intention to stabilise the economy well ahead of the Party congress later this year when President Xi Jinping will likely be anointed to a third term.

A managed slowing of growth to rebalance the economy is politically tolerable, providing it comes with no social disruption. However, a property sector collapse with widespread developer defaults and the financial and social risk that would bring would not be.

The debt overhang remains serious. Corporate debt was still 156.8% of GDP in the second quarter of 2021. That is down from 163.4% a year earlier but still high enough to complicate the way forward for policymakers aiming to stimulate growth while reducing the economy’s reliance on debt-fuelled infrastructure investment and export-oriented manufacturing.

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PBoC Indicates Careful and Selective Easing in 2022

Headquarters of the People's Bank of China, Beijing 2015. Photo Credit: bfishadow. Licenced under Creative Commons.

THE PEOPLE’S BANK OF CHINA (PBoC) on December 24 provided support for those who think that the central bank’s monetary policy will be more expansive early next year so that the slowing economy does not get ahead of its intended orderly decline.

The statement issued after its quarterly monetary policy committee meeting echoed the view of the Central Economic Work Conference earlier this month that:

The external environment is becoming more complex and severe and uncertain, and the domestic economic development is facing the triple pressure of demand contraction, supply shock and weak expectations.

In response, the PBoC foreshadowed its greater and pro-active support for the real economy through a more forward-looking and targeted monetary policy.

Small and micro businesses are one set highlighted for support. However, this came with the rider that the central bank will ‘strive to ensure that financial support for private enterprises is compatible with the contribution of private enterprises to economic and social development’ — a reminder that private enterprises must remember they are expected to contribute to common prosperity.

Two other stated objectives are to use monetary policy to realise the national goals of carbon peaking and carbon neutrality through developing green finance and safeguarding what the PBoC describes as ‘the legitimate rights and interests of housing consumers’. For those who track such things, the phrase ‘healthy development’ of the real-estate market preceded ‘virtuous circle’ in the statement.

GDP growth is likely to have slowed to 4-5% in the fourth quarter, although it will still come in above the 6% target for the entire year. Sub-6% growth is likely planned for in 2022, even if monetary (and fiscal) policy is carefully and selectively loosened, as the central bank indicates. Economic stability is the watchword for the coming year.

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Beijing Remains Cautious Over Debt Relief For Africa

Screenshot of Forum on China and Africa Cooperation (FOCAC) web site, accessed November 30, 2021

THE EIGHTH TRIENNIAL Forum on China and Africa Cooperation (FOCAC) was held today and yesterday in Dakar, Senegal.

President Xi Jinping kicked it off on Monday via video backing up the obligatory mention of a ‘shared future in the new era’ by announcing a donation of 600 million vaccine doses to the continent and promised to make 400 million more available for purchase. 

The less-feel-good items on the agenda include better balancing the continent’s trade with its largest trade partner by increasing the share of African manufactured goods bought by China. 

African manufacturing capacity is a significant constraint. Although Africa accounts for only 4% of China’s imports of manufactures, that is 70% of African manufactured products (2019 data). 

Thus, Beijing promises to increase its investment, particularly in manufacturing, to facilitate the continent’s industrialisation. It also will increase tariff exemptions for some $300 million worth of imported African goods, extend $10 billion in credit facilities to African financial institutions, and promote RMB-denominated trade. 

Yet that is all small beer by the scale of these things, as is Xi’s offer on debt. He did not offer debt forgiveness, only to write off the interest due on some of the loans to Africa’s poorest countries which fall due at the end of this year. It was not clear if that was the African part of the $1.9 billion in payments due this year to China that it has agreed to suspend under the G20’s debt service suspension initiative for loans to the world’s 73 poorest countries, or the $11.5 billion due this year not covered by the G20 programme, of which Angola, Kenya and Ghana own almost half.

Africa is already heavily indebted to Chinese lenders due to Beijing’s drive to secure commodities, farmland and infrastructure construction contracts. China has become the largest bilateral lender to the continent over the past two decades, racking up a tab of some $150 billion to governments and state-owned companies. 

One of every five dollars borrowed by African governments is owed to a Chinese lender. The Covid-19 pandemic is raising questions in Beijing about Africa’s capacity to repay, and even stay current on the interest payments on that debt.

This debt dilemma is the flip side of the commercial diplomacy that has advanced China’s national interests in Africa. Beijing’s past willingness to lend without conditionality and stay out of domestic politics has let it charge high interest rates with low transparency. 

Getting its money back and the damaging reputational risks of high debt and incomplete infrastructure projects may lead Beijing to offer less onerous terms for its latest aid and investment. 

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Evergrande Worries The US Fed After All

THE US FEDERAL RESERVE’S latest semi-annual financial stability report comes with an uncommon warning about China’s financial stresses, not the sort of thing it typically comments on.

Its concern is that the stresses in China’s real estate sector could strain the Chinese financial system, with possible spillovers to the United States:

In China, business and local government debt remain large; the financial sector’s leverage is high, especially at small and medium-sized banks; and real estate valuations are stretched. In this environment, the ongoing regulatory focus on leveraged institutions has the potential to stress some highly indebted corporations, especially in the real estate sector, as exemplified by the recent concerns around China Evergrande Group. Stresses could, in turn, propagate to the Chinese financial system through spillovers to financial firms, a sudden correction of real estate prices, or a reduction in investor risk appetite. Given the size of China’s economy and financial system as well as its extensive trade linkages with the rest of the world, financial stresses in China could strain global financial markets through a deterioration of risk sentiment, pose risks to global economic growth, and affect the United States.

Was it just two months ago that Fed Chair Jerome Powell said that the risks from Evergrande’s troubles seemed very particular to China?

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A Trail Of Hidden Debt Along The Belt And Road

A REPORT ON Belt and Road Initiative (BRI) funding crosses our desk. It comes from AidData, a development aid research centre at the US university William and Mary, which has compiled a database of China’s international development finance covering 13,427 projects approved between 2000 and 2017 worth $843 billion across 165 countries, of which some 140 have signed onto the BRI.

Among its findings are that China has used debt rather than aid to establish a dominant position as a provider of international development finance, and the political sway that comes with it. That is less of an eye-opener than the estimates that the loans extended to recipient countries — primarily low- and middle-income nations — are far more extensive than generally realised, to the tune of $385 billion of ‘hidden debt’.

The reason for this hidden debt — hidden in the sense that it is not captured by institutional debt monitoring mechanisms such as the World Bank’s Debtor Reporting System (DRS) — is that Beijing’s loans are increasingly going to state-owned companies, banks or other entities that benefit from implicit or explicit, host government guarantees. 

Thus the debt does not show up in counts of sovereign debt, yet the liabilities for the recipient governments do not magically disappear.

The true magnitude of the debt is one concern. By AidData’s estimates, 42 low and middle-income countries now owe China the equivalent of more than 10% of their GDP.

Factoring in their hidden debt could cause reassessments of credit ratings, potentially raising borrowing costs.

A third concern is that hidden dent complicates debt management. Recipient governments may not have a good handle on their debt service requirements. That may complicate making the interest payments and debt restructuring where necessary.

Five key points emerge from the report:

  • the sheer growth of China’s overseas development finance since 2000, outspending traditional Western and multilateral providers by 2-to-1 or more (an average of $85 billion a year for China against the United States’ $37 billion, for example), and doing so with semi-concessional and non-concessional debt rather than aid;
  • a transition from direct sovereign lending pre-BRI to lending to state-owned companies, state-owned banks, special purpose vehicles, joint ventures, and private sector institutions, which, as already noted, keeps the loans off the balance sheets of the governments in the recipient countries but still provide explicit or implicit host government guarantees;
  • the increasingly central role of China’s state-owned commercial banks — including Bank of China, the Industrial and Commercial Bank of China, and China Construction Bank — have played in the transition, including organising lending syndicates and other co-financing arrangements that make it possible to undertake BRI mega-infrastructure projects (financed with loans worth $500 million or more);
  • the growing use of collateralisation to offset increasing credit risk, allowing Beijing to pursue a high-risk, high-reward credit allocation strategy to secure energy and natural resources, with the loans secured against future export receipts, or, for infrastructure loans, physical assets; and 
  • masking from international institutional monitoring, eg, the DRS, the extent of Chinese debt burdens on some recipient countries, estimated to be underreported by an average equivalent to 5.8% of their GDP, which is complicating international debt restructuring talks, which have become as much competitive as collaborative between China and Western donors and creditors of late as Chinese state-owned policy banks can restructure loans on their own terms outside the well-established forums of sovereign debt renegotiations.  

Nor do China’s loans come cheap. The average interest rate is 4.2%, with a repayment period of less than ten years, AidData says. By comparison, a lender like Germany, France or Japan would typically charge 1.1% with a repayment period of 28 years.

A further intriguing point to emerge is that more than a third of BRI infrastructure projects have encountered significant implementation problems—corruption scandals, labour violations, environmental hazards, public protests and the like. In contrast, non-BRI infrastructure projects are less troubled, as are BRI projects undertaken by the host country rather than China. That fits with widespread anecdotal evidence of local resentment when China ships in everything from raw materials to labour.

Whether such concerns amount to a tipping point in a BRI backlash is moot, and may provide only a slither of an opening for the two new Western counters to the BRI, the United States’ Build Back Better World Initiative and the EU’s Global Gateway Initiative.

China may well now have a sufficiently firm foothold in development finance that it will not be dislodged by rival and not necessarily wanted offers of sustainable and transparent financing and good governance. A tweak to Beijing’s messaging,already being rehearsed — no vanity projects and cleaner and greener projects — may suffice.

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Evergrande, Still Breathing Hard, Resumes Construction

BELEAGUERED PROPERTY DEVELOPER Evergrande dodged its October 23 debt default deadline, making an $83.5 million payment to its international bondholders due on September 23, just before the 30-day grace period expired.

That was the first of five coupon payments it has missed on their due dates, totalling a combined $275 million.

It is unclear where Evergrande got the $83.5 million from, but it has bought another week of breathing room, although the company will still be breathing hard under the weight of its more than $300 billion in liabilities.

One place the funds for the coupon payment did not come from was the hoped-for sale of control of its core property business, Evergrande Property Services. Talks to sell a 51% stake of Evergrande Property Services to Hong Kong-listed Chinese property developer Hopson Development fell through.

Trading of shares in Evergrande Property Services resumed on Thursday on the Hong Kong stock exchange, having been suspended since October 4 pending a possible general offer for its shares. Evergrande said the day before that there had been no material progress in asset sales. The last significant disposal was a 20% stake in Shengjing Bank to an agency of Shenyang city’s government.

However, the company has restarted work on up to 10 projects in six cities, including Shenzhen. On August 31, it had acknowledged that delays in paying suppliers and contractors had forced the suspension of some projects. However, its statement on Sunday on WeChat announcing the resumptions did not disclose on how many of its 1,300 developments across China it had halted work.

Last week, People’s Bank of China Deputy Governor Pan Gongsheng reiterated that the risks from Evergrande are controllable, property sector financing is returning to normal, and that the bank will protect households and suppliers.

Not many investors in financial markets share the central bank’s sanguinity. First, there is the ever-present risk of default. Each grace period is starting to feel like a round of Squid Game for Evergrande.

Second, the speed and depth of the slowdown of China’s property market that the crisis has triggered are raising concerns about the extent to which they will weigh on GDP and whether authorities can balance reducing the cost of living by making housing more affordable with managing decelerating growth.

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