THE ANTI-CORRUPTION INVESTIGATION of Fan Yifei, one of the six deputy governors of the People’s Bank of China, may suggest that all does not bode well for the central bank as Xi Jinping starts his second decade of leadership.
Xi has been investigating more than two dozen financial regulators, state banks, insurers and investment funds since last year to assert Party authority over a financial sector that Xi far from trusts. Fan is the most senior of several financial officials detained over the past year.
Fan spent most of his career as a banker with the Construction Bank of China, so there may be skeletons not as deeply buried in his cupboard as he may have thought. Over-closeness of party cadre to private sector business is now deeply out of favour.
Yet there a clues that there may be policy motivations behind his investigation. Earlier this year, the Central Commission for Discipline Inspection, the country’s top graft-buster, criticised the central bank for failing to meet Party objectives.
The central bank’s top leadership has been a stronghold of economic reformers and advocates of internationalisation of the Chinese financial system, a policy direction for which Xi has little instinctive enthusiasm.
The PBOC’s internationally respected governor, Yi Gang, and its party secretary, Guo Shuqing, were removed from the Party’s central committee during the 20th Party Congress last month. That is seen as a prelude to them leaving their positions early next year when senior government jobs get reallocated.
Their replacements are likely to be men who will ensure that the central bank — and the financial sector it regulates — fall into line with Party goals, just as the technology sector has been ‘rectified‘. This Bystander expects to be hearing more about financial inclusion for common prosperity.
Fan’s case is the more interesting because he was the vice-governor responsible for payments and financial technology, which involved overseeing the development of the central banks’ digital currency, the e-CNY or digital yuan. It is an area in which the PBOC has built a substantial lead over other central banks. Fan’s last public appearance, in September, was to announce a further expansion of its trial.
ONE-HALF OF CHINA’S nearly $150 billion of loans to Sub-Saharan African countries since 2000 are hidden, according to a recently published AidData working paper written by Kathleen Brown of Leiden University.
Africa is heavily indebted to China. One of every five dollars borrowed by African governments is owed to a Chinese lender. Hidden debt potentially puts the region more in hock — and thus obligated to Beijing — than realised, as well as posing a threat to global financial stability.
The AidData research lab at William and Mary university in the United States maintains a comprehensive database on China’s global financing activity through government institutions and state-owned entities.
Middle- and low-income economies are notorious for keeping debt off the books and out of sight so that international lenders do not penalise them for being over-indebted or breaking loan conditionalities. Mozambique, for example, concealed $2.2 billion in private bank loans to avoid hitting its internal public debt limits, although it is the World Bank’s debt-to-GDP thresholds that are most relevant.
Beijing is far from forthcoming about the credit it extends internationally. It considers external finance information state secrets and does not report its credit activity to the World Bank’s Debtor Reporting System (DRS), which acts as the global clearing house for such information.
Thus, recipient governments can hide their Chinese borrowings from international view by simply omitting them from their reporting to the DRS. Brown concludes that while some of this is accidental, most is intentional.
She suggests that publically undisclosed Chinese lending in Sub-Saharan Africa is intended to enable recipient governments to keep up payments on foreign debt, continue to buy Chinese imports and keep any threat of a balance of payments crisis at bay.
A separate report in the Financial Times, which reports similar undeclared lending to Asian and Latin American countries, suggests the hidden loans are also intended to prevent defaults on other Chinese Belt and Road infrastructure lending. (This Bystander has previously noted AidData’s analysis of Beijing’s BRI lending.)
China has had plenty of scope to extend its sway in Africa through hidden lending. So far this century, every country on the continent has experienced IMF and World Bank debt stability programs limiting external borrowing and sovereign debt levels.
Brown finds that governments hide an additional 2 percentage points of their Chinese loans as external debt to GDP moves 3.25 percentage points closer to Word Bank thresholds. The exception is when a country is under an IMF programme. Governments then hide less debt because they are more likely to be caught out by the Fund’s rigorous auditing of national accounts.
One implication is that Beijing’s loan recipients see China as a means to keep the IMF at arm’s length. However, that does nothing to reduce a country’s debt-crisis risk. Sri Lanka offers an extreme example of the consequences of the political and economic meltdown that a debt crisis can unleash.
For China, supplying unreported credit provides a way to undermine the influence and reach of the IMF and World Bank as Beijing develops an alternative international financial architecture. Other research has shown that it is common for Chinese lenders to put ‘no reporting’ clauses into loan agreements with middle- and low-income countries,
That the Global South is an active manager of international credit markets by strategically hiding its debt from international financial institutions suggests Beijing is achieving some modest success in that goal.
However, increased exposure to countries borrowing too far beyond their capacity to repay is the price that Chinese financial institutions and state-owned entities are paying. Given the headwinds buffeting the Chinese economy, that looks like an unsustainably high price, as Beijing is starting to acknowledge.
THE 10 BASIS points cut by the People’s Bank of China to its one-year lending rate for the first time since January to 2.75% was unexpected.
It was a direct response to July’s economic data showing the economy slowing further.
Retail sales growth in July slowed to 2.7% year-on-year, down from 3.1% in June. Industrial output growth was little changed from June at 3.9% year-on-year. Fixed asset investment growth, at 5.7% year-on-year in January-July, was nearly half the pace of last year, and private sector investment grew by just 2.7% year-on-year in the same seven-month period.
The downturn in the beleaguered housing market is accelerating. Property investment fell by 12.3% year-on-year in July, the fastest pace this year. New home sales fell by 28.3% year-on-year.
Most concerning for the leadership is that, while urban unemployment overall was steady in July at 5.4%, unemployment among 16-24-year-olds set another monthly record at 19.9%.
The early indications from August are that the economy is not turning round. If anything, the downside risks are growing with the latest lockdowns to control new Covid-19 outbreaks and weaker export prospects as global markets slow.
Further monetary and fiscal stimulus to rev up domestic demand, including state money to revive property development projects, are likely as today’s cut in rates is too modest to have more than a marginal impact.
REPORTS THAT THE leading companies in the $3 trillion trust industry are being audited suggest a coming crackdown on a critical part of China’s financial sector: a hybrid of commercial and investment banking, private equity and wealth management.
Bloomberg reports that for the past month, the National Audit Office has been going over the books of at least 20 trust firms, including the top five.
The concern is the risks the sector poses to financial stability. No other set of financial firms invests in such a broad class of assets, from property to stocks, bonds and commodities. They are also a key intermediary in China’s shadow banking system, a conduit for deposits into risky investments via products often designed to dodge capital or investment regulations.
Auditors appear to be focusing on trust firms’ loans to property developers, suggesting renewed concern on the part of authorities that the problems of the beleaguered property sector could spill over into the broader financial system.
So far this year, trust firms defaulted on $8.6 billion of investment products linked to property developers, according to industry data tracker Use Trust — the knock-on effect of developer defaults and frozen construction across the country.
Trust firms, including Minmetals Trust and Zhongrong Trust, have bought stakes in at least ten troubled real estate projects this year, betting that unfinished homes will eventually yield cash to pay off some of the $230 billion in property-backed funds they have sold to investors.
It is unclear how long the audit inspections will last, whether more firms will be reviewed, or what regulatory actions will follow.
Improving trust firms’ transparency and risk management seems the very minimum to expect. However, that in itself will be insufficient without other changes. Municipal finance needs reforming so that local authorities are not so dependent on land deals to raise revenue and mainstream financial institutions need to offer new retail savings and investment products that can be an alternative to those provided by the shadow banking system.
As Beijing has shown with its rectification of the platform tech companies, it is willing to bear the costs of disrupting even a large domestic industry once it believes that the cost of not doing will be even higher.
THIS BYSTANDER BELIEVES that there is more to be discovered about the banking scandal in Henan that led to violent clashes between depositors and police on Sunday and now to financial regulators ordering the banks involved to start releasing funds to their depositors.
Earlier this month, hundreds of depositors in four rural banks in Henan had the health codes on their smartphone apps used to enforce Covid-19 quarantines suddenly turn red, despite testing negative for Covid-19. Five local officials were subsequently disciplined for a brazen effort to stop the disgruntled depositors from travelling to the provincial capital Zhengzhou to petition authorities for redress.
The scandal had come to light in mid-April after the four rural banks and another in neighbouring Anhui suspended their online banking services and froze an estimated 400,000 customers out of their accounts containing tens of billions of yuan. The purported reason was for the banks to conduct a systems upgrade, one that seemingly never ended.
Depositors at Yuzhou Xinminsheng Village Bank, Shangcai Huimin County Bank, Zhecheng Huanghuai Community Bank and New Oriental Country Bank of Kaifeng in Henan province and Guzhen Xinhuaihe Village Bank in the neighbouring Anhui province were affected.
In May, banking regulators launched an investigation into Henan Xincaifu Group Investment Holding, a private investment firm with stakes in the rural banks involved. By then, (peaceful) protests demanding the accounts be unfrozen had started to be held outside Zhengzhou offices of the China Banking and Insurance Regulatory Commission (CBIRC).
At the start of this week, police arrested what were described as members of a ‘criminal group’ said to be involved in taking over the rural banks and making illegal transfers through fictitious loans. Authorities say they are looking for a man identified as Lu Yi, accused of being the mastermind who controls Henan Xincaifu.
Bank deposits of up to 500,000 yuan ($73,500) per depositor per bank are covered by deposit guarantees, although there is some ambiguity over which rural bank accounts are protected. Nonetheless, the CBIRC says that bank customers with up to deposits of 50,0000 will be repaid from July 15.
It is not yet clear what will happen to deposits of more than 50,000 yuan, although the CBIRC has said it will not reimburse accounts with a whiff of suspicion about them.
This has the look of a central government bailout, perhaps buy-off would be more accurate. It is difficult to escape the thought that, however described, the action was prompted by fears of bank runs on other small lenders and the threat to social stability they would pose.
China has some 4,000 rural banks, many of which have one foot in the murky world of shadow banking and whose ownership structures allow shareholders to gain significant control without regulatory approval and put themselves in a position to syphon off cash through loans.
Bank regulators have been tightening up on rural banks for more than a year. The Henan banks scandal will likely lead to a further turning of the supervisory screw.
In the Henan banks case, one question is whether local officials or regulators were turning blind eyes to whatever was going on, and whether they were benefiting from it.
With central government putting a premium on economic and social stability, this could easily become an exemplary case to demonstrate how local officials are now expected to have ditched the old ways. Protestors’ banners accusing the provincial authorities of corruption that appeared last weekend will be disconcerting to Beijing.
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.
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.
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.
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.
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.
China Bystander 