Category Archives: Economy

China Cracks Down On Cryptocurrencies

THE DEFAULT POSITION of Chinese authorities is that if it exists, it should be regulated. Cryptocurrencies are a prime example.

BTTChina (BTTC), one of the three leading bitcoin exchanges in China and, by extension, one of the largest in the world, says it is to cease trading on September 30 because of regulatory pressure being brought to bear on it. Earlier this week, the National Internet Finance Association, a self-regulatory industry body that the People’s Bank of China set up in 2015-16, warned that there was no legal basis for exchanges trading cryptocurrencies like bitcoin and litecoin and that they were a source of speculative risk for investors and also a conduit for illegal activities such as drug trafficking and money laundering.

Shanghai-based BTTC has read the writing on the wall for domestic cryptocurrency exchanges. So have investors; bitcoin fell by 20% against the US dollar in the latter half of the week.

Word in the industry is that an outright ban on most or all activity one bitcoin exchanges will be instituted shortly. Huobi and OKcoin are the other two leading bitcoin exchanges in China. Both are reported to have received administrative guidance to shut by the end of the month, though both have said they have received no official instruction to do so. (Update: Huobi and Okcoin  have reportedly been given a month’s extension as they have not been heavily involved in ICOs; but authorities expect them to cease trading by October 30.)

If instituted a ban would follow the proscription of initial coin offerings (ICOs), an unregulated means of raising funds increasingly favoured by high-tech startups. These raised 2.6 billion yuan ($398 million) in China in the first six months of 2017 across 65 offerings, which accounted for 20% of the global total. China is the first country to ban ICOs.

A working party of the central government’s office overseeing internet financial risk has been underway for several months, but Chinese regulators are not alone in their concerns about bitcoin exchanges. Their counterparts in Hong Kong, Singapore, the United States and the United Kingdom have expressed similar misgivings in recent months.

The changing mood in China has had a chilling effect on bitcoin. The cryptocurrency reached an all-time high of $5,013 on September 1 but fell below $3,000 this week on the latest reports of the authorities’ crackdown.

The internet financial risk working group says that whereas China accounted for 90% of bitcoin trading volumes two years ago, its share of the now $100-billion-a-year market has fallen to 30%. Trading volumes in Japan and South Korea have been on the rise.

An outright ban on trading in China would hit bitcoin, though not as hard as it would have in the recent past. Bitcoin is still the dominant cryptocurrency though its market share of total transactions is being eroded as Chinese have become less enamoured with it.

However, the setback might equally provide time for the development of an indigenous cryptocurrency. At the same time the central bank is cracking down on the bitcoin exchanges, it is encouraging research into the blockchain technology that underpins virtual currencies.

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VAT And China’s Other Taxing Problems

CHINA STARTED TO replace its Business Tax with a value-added tax (VAT) in 2012 when a pilot scheme was launched in Shanghai. VAT has since been steadily expanded, both geographically and sectorally.

Earlier this month, following an executive meeting of the State Council, chaired by Prime Minister Li Keqiang, plans were announced for streamlining the administration of VAT and acknowledging that it has become a universal national tax.

The service sector first saw the tax in May last year when it was applied to property, financial and consumer services sectors. At the same time, VAT was extended fully nationwide.

Authorities say that between then and June, the switch to VAT has saved businesses 85 billion yuan ($12.8 billion) in taxes, providing an important boost to the ‘rebalancing’ of the economy towards consumption. Total tax savings since the pilot scheme started is put at 1.6 trillion yuan.

In July, the four VAT brackets (17%, 13%, 11% and 6%) were reduced to three with the elimination of the 13% bracket. Agricultural products, tap water, publications and several other ‘13%’ goods were moved down to the 11% bracket, though that still leaves more VAT tiers than the international average.

The new plans foresee digitization of the tax system, simplifying procedures for tax filing and switching from physical to electronic versions of the invoices-cum-receipts (fapiao) that serve as legal proof of purchase for goods and services. Fapiao are a key component of enforced compliance with China’s tax law as they compel companies to pay tax in advance on future sales.

The VAT fapiao is also used for tax deduction purposes within VAT, so digitising the whole process should streamline the accounting.

The tax is still referred to as “the VAT reform pilot program” though that status as a pilot looks like ending de jure as well as de facto; the State Council executive meeting also indicated that more detailed national VAT legislation would be forthcoming.

There is more work to be done on standardising it as a national tax. There are still inconsistencies between sectors in the rates applied to the same goods and services. Also, some tax payers are not able to make full VAT deductions. A further issue to address is compliance costs for taxpayers with multiple business locations.

One major issue that a national VAT does not address is how the tax take is shared at the provincial level. (Germany and Japan, for example, use allocation rules based on population and aggregate consumption, respectively.)

However, China has a bigger problem of fiscal redistribution to tackle. The country has the largest share of local government spending in the world, largely because public services and the social safety net (health, education, welfare, etc.) are centrally mandated but delivered and paid for at the local level. Many federal countries decentralise their social insurance system, but China is a rarity in having both its public pension system and unemployment insurance managed at the local level.

Yet, since the fiscal reforms of 1994, provinces and municipalities have negligible revenue raising powers of their own. Further, although 60% of taxes are collected by local government, those taxes are handed over to central government with some to be returned via revenue-sharing and other transfer schemes through rules that are still not completely transparent.

Transfers from the central government were supposed fully to finance local-government deficits since provinces and municipalities were barred from issuing debt.  In practice, however, local governments were given increasingly large unfunded mandates. Because of the prohibition on issuing debt, they resorted to selling land and using off-budget special-purpose vehicles to borrow and spend on infrastructure, starting the infamous local-government debt bomb ticking.

Local governments debt had reached the equivalent of around 40% of GDP by 2015.

A fiscal reform plan was announced in 2016 to address the misalignment, but it will take a comprehensive imposition of taxes such a market-value-based property tax, local surcharges to personal income tax and maybe even an additional provincial-level VAT — though that is difficult technically to administer; few if any countries have pulled it off.

It will also mean converting the pilot scheme for issuing and trading municipal debt started in 2014 when back door borrowing through special-purpose vehicles was banned, into a national muni-bond market. That, in turn, will require broader financial-system reforms.

Those are proceeding at a cautious, measured pace. Short-term stability and state-centric control is the current leadership’s instinctive approach. That may change after the forthcoming Party congress, but, more likely, it will not. In that context, streamlining VAT to puts greater taxation capacity in Beijing’s hands makes political as well as economic sense.

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China’s ‘Achilles’ Heel’ Of Debt

THE IMF’S LATEST Article 4 consultations report on China’s economy retraces some well-trodden ground. While edging up its projections for China’s growth projections, the Fund again underlines the growing risk from debt in the medium term.

Arguably this is the greatest macroeconomic risk that China faces and which the Fund says needs to be addressed now if sustainable growth is to be sustained. It summarises that risk in a supplementary note to the main report thus:

International experience would suggest that China’s credit growth is on a dangerous trajectory with increasing risks of disruptive adjustment and/or a marked growth slowdown.

Managing the debt issue is inseparable from rebalancing the economy, away from infrastructure investment and export-led growth to domestic consumption.

Progress in rebalancing, the Fund acknowledges, is being made, particularly in reducing industrial overcapacity. Borrowing by local governments is being made more transparent, and regulators have started to address financial sector risks.

The Fund, though, calls, as it has repeatedly done in the past, for the pace of reforms to accelerate, taking advantage of the relatively robust growth the economy is now enjoying.

Its check list of five action points will be familiar:

  • boost consumption by increasing social spending by the government and making the tax system more progressive;
  • increase the role of market forces by reducing implicit subsidies to state owned enterprises and opening up more to the private and foreign sectors;
  • deleverage the private sector by continuing the recent regulatory tightening in the financial sector and greater recognition of bad assets in the financial sector;
  • ensure macroeconomic sustainability by focusing more on the quality of growth and less on quantitative targets; and
  • improve policy frameworks so that the economy can be better managed.

The fund particularly recommends accelerating the reform of state owned enterprises by moving social functions away from them and opening their protected sectors to more private and foreign competition.

There will be a cost to that which will strain the financial system. Bankruptcies will rise with the elimination of blanket state guarantees and lenders that have made uncreditworthy loans will get into trouble. The political concern is that strain on the financial system turns into social stress.

IMF China reforms scorecard August 2017

As this Bystander has noted before, policymakers have been steadily if cautiously managing down the GDP growth rate for several years, mostly by reducing too high investment and too rapid credit growth. They have been less active in opening up replacement sources of growth, notably by opening up to the private sector.

The fund also lays great importance on the need to liberate private savings for consumption by increasing public spending on health, pensions and education, three areas in which its spending is well below the OECD average, and by increasing social transfers to the poor, who are disproportionately greater savers than the poor in other countries,

Again as this Bystander and many others have noted before, the longer China delays tackling the structural underpinning of its debt load, the longer resolving them will take and the greater the risk of not doing so becomes.

This is an opportune moment from an economic point of view to do so. Growth in the first half of the year was more robust than expected with both the global economy and financial conditions being benign. Domestically, the effects of cutting industrial capacity are starting to work through, bolstering profits and areas of the private sector where state-owned enterprises are largely absent, such as e-commerce are showing exemplary dynamism.

Also, balance-of-payments and exchange-rate management have been adept while some old-school fiscal stimulus six to nine months ago has also kicked in.

Markus Rodlauer, deputy director of the IMF’s Asia and Pacific Department, put it this way:

The situation at this point right now…should be used as an opportunity…to bear down and to buckle down and continue with this financial sector adjustment, which is really the Achilles’ heel now of the economy.

Once the 19th Party Congress due to be held in October or November is out of the way, and assuming it has not changed politics appreciably, that may happen more visibly.

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IMF Sees Increases In China’s Growth And Debt

THE INTERNATIONAL MONETARY Fund (IMF) has upgraded both its economic growth forecast for China in 2018 and the downside risks of debt.

In its July update to its World Economic Outlook, the Fund says its projections reflect the strong first quarter growth this year and expectations of continued fiscal support.

It now says it expects growth next year to be 6.7%, the same as this year and in 2016, and 0.1 percentage point higher than previously forecast. Growth in 2018 is expected to slow by 0.2 percentage points less than previously projected, to 6.4%.

This the Fund believes will be because authorities will sustain high public investment to achieve the target of doubling in real terms 2010’s GDP by 2020. This, in turn, implies that debt levels will not be attacked as actively as needed and financial reforms delayed.

The National Financial Work Conference, the high level policymaking agency chaired by President Xi Jinping that concluded its quinquennial meeting on July 15, emphasized that policymakers’ priority was to deleverage state-owned enterprises (SOEs) within its focus on limiting systemic financial risk.

First, though, Xi has to get through the forthcoming Party plenum, which should provide clues to the strength of his position to tackle the politically powerful interests that control the SOEs.

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China’s Growth Spurt Provides Scope To Tackle Debt

TALK OF A hard landing for the economy seems distant, now. China’s economy grew by 6.9% in the second quarter year-on-year, the same as in the first quarter and well ahead of the official target of 6.5%, the National Statistics Bureau reports.

Quater-to-quarter growth quickened to 1.7% from 1.3%. Industrial output (up 7.6% in the first half) and consumption (retail sales were up 11% in June year-on-year) picked up while investment remained strong, suggesting that measures to control the frothy housing market have not yet worked through, or perhaps are not working as effectively as policymakers intended. Property investment increased by 8.5% year-on-year in the first half.

The extent to which property prices cool over the rest of the year will be closely watched. If they do, despite the solid underpinnings of the recovery, the growth rate may moderate in the second half, though not to the extent the official target will be threatened.

The long-term build-up of structural imbalances, manifest in the growing levels of debt, remains, but the latest growth figures give the leadership some scope for pushing through financial reforms at the party plenum later this year.

Some of those, notably the expansion of bond markets to allow direct financing of local governments and enterprises in place of policy lending by banks, will have been thrashed out at the two-day National Financial Work Conference that ended at the weekend.

That this quinquennial meeting chaired by President Xi Jinping was convened a year late this time indicates how politically contentious economic reform remains, not least because they also intend to rein in the debt of state owned enterprises, themselves powerful political fiefdoms.

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China Invests Abroad

CHINA IS NOW the second largest investing economy. This reflects Beijing’s ‘Go Global’ policy that delivered a surge of cross-border M&A purchases in manufacturing and services by Chinese firms last year while individuals stepped up their purchases of real estate in developed countries. Chinese firms accounted for 8% of inbound cross-border M&A in the United States last year, worth a record $29 billion.

But China is also the world’s third favourite destination for foreign direct investment (FDI) after the United States and the United Kingdom. According to the UN Conference on Trade and Development (Unctad)’s newly released World Investment Report, 2017, China had FDI inflows of $134 billion last year. That was 1% down on the previous year, mostly because of lower inflows into the financial sector.

However, Unctad notes that:

In non-financial sectors, [China] recorded 27,900 new foreign-invested enterprises (FIEs) in 2016, including 840 with investments above $100 million. In addition, 450 existing FIEs significantly expanded their businesses, undertaking additional investment above $100 million. Non-financial services continued to underpin new FDI, with inflows in the sector growing by 8% while foreign investment into manufacturing continued to shift to higher value added production. In March 2017, for example, Boeing started to build an assembly facility in China, the first such project outside the United States.

Inflows via Hong Kong fell much more sharply, from $174 billion to $108 billion over the same period, though 2015 was an exceptional year and 2016 represented something of a return to trend.

China’s outflows increased to $183 billion in last year from $128 billion in 2015. Those via Hong Kong slowed slightly, from $72 billion to $68 billion.

The Unctad report identifies state-owned multinationals as major players in global FDI. China is home to the most — 257 or 18% of the total, way ahead of second-ranked Malaysia (5%). In 2016, the report notes, greenfield investments announced by state-owned multinationals accounted for 11% of the global total, up from 8% in 2010.

The investments of China’s state-owned multinationals “are instrumental in the country’s outward FDI expansion strategy”, Unctad says. It notes that generally the investments of state-owned multinationals tend to be weighted more heavily in financial services and natural resources than those of multinationals as a whole.

Seven of the 10 largest financial state-owned multinationals are headquartered in China, as are four of the 25 largest non-financial ones — China National Offshore Oil Corp. (CNOOC), China COSCO Shipping Corp., China MinMetals Corp. and China State Construction Engineering Corp. (CSCSC).

China remained the largest investor economy in the least developed economies, far ahead of France and the United States, and showed more interest than most in investing in transition economies, and particularly landlocked ones like Kazakhstan and Ethiopia, though the sums remain relatively small. However, state-owned oil firm Sinopec acquired the local assets of Russian oil company Lukoil for $1.1 billion.

A future focus of China’s investment will be via its One Belt One Road (OBOR) initiative. Beijing has already signed around 50 OBOR-related agreements with other nations, covering six international economic corridors. FDI to Pakistan, for example, rose by 56% year-on-year last year, pulled by China’s rising investment in infrastructure related to the China-Pakistan Economic Corridor, one of the most advanced OBOR initiatives.

Unctad notes:

Stretching from China to Europe, One Belt One Road is by no means a homogenous investment destination. However, investment dynamism has built up rapidly over the past two years, as more and more financial resources are mobilized, including FDI.

A number of countries located along the major economic corridors have started to attract a significant amount of FDI flows from China as a result of their active participation in the initiative.

Central Asia, unsurprisingly, is at the leading edge of this. The implementation of OBOR is generating more FDI from China in industries other than natural resources and diversifying the economies of various host countries.

Chinese companies already own a large part of the FDI stock in extractive industries in countries such as Kazakhstan and Turkmenistan. The ongoing planning of new Chinese investments in the region, however, has focused on building infrastructure facilities and enhancing industrial capacities. In addition, agriculture and related businesses are targeted. For example, Chinese companies are in negotiation with local partners to invest $1.9 billion in Kazakh agriculture, including one project that would relocate tomato processing plants from China.

South Asia benefits from the development of the China-Pakistan Economic Corridor.

This has resulted in a large amount of foreign investment in infrastructure industries, especially electricity generation and transport. For instance, Power Construction Corporation (China) and Al-Mirqab Capital (Qatar) have started to jointly invest in a power plant at Port Qasim, the second largest port in Pakistan. In addition, the State Power Investment Corporation (China) and the local Hub Power Company have initiated the construction of a $2 billion coal-fired plant.

OBOR also stretches to North Africa. Indeed, it seems decreasingly to recognise any geographic limits to its ambition and scope.

Egypt has signed a memorandum of understanding with China, which includes $15 billion in Chinese investment, related to Egypt’s involvement in the initiative. It is undertaking a number of cooperative projects under the One Belt One Road framework, including the establishment of an economic area in the Suez Canal Zone and investments in maritime and land transport facilities.

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OECD Sees China’s Economy Stabilising But Reform Still Needed

THE OECD QUIETLY prides itself on being the grown-up economic forecaster, eschewing the flash and razzmatazz of the International Monetary Fund or the World Bank for an understated mix of solid economic analysis and policy prescription.

The chapter on China in its latest Economic Outlook fits the bill to a tee: a sparse summary of an economy that is stabilising thanks to earlier policy support, but still needing structural reform if ‘rebalancing’ is to be advanced.

GDP growth for this year is forecast to be one-tenth of a percentage point above the official target of 6.5% and the same below in 2018 — ‘holding up’ despite considerable excess capacity remaining in the industrial sector. Consumption remains robust supported by housing-related purchases, e-commerce and overseas tourism.

While infrastructure investment is being sustained, monetary policy is tightening in response to the risk of financial instability, particularly via the shadow banking sector, and other risks that are mounting. Fiscal policy remains expansionary, however. The headline fiscal deficit will be held at 3% of GDP this year and next, the OECD reckons, but policy lending to prop up growth will also slow the rate of rebalancing.

That will also be slowed by the lack of reform, for example to the social safety net, that is diverting monies that individuals could spend on domestic consumption to precautionary savings. Longer term, the OECD says, corporate deleveraging and working off excess capacity “will be crucial to avoid a sharp slowdown in the future.”

It also quietly but firmly makes the point that longer the debt problem is left unaddressed, the larger it will get, and, by implication, the harder it will be to deal with it.

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