Category Archives: Economy

Anbang Nationalisation Underlines China’s Financial Stability Priority

Logo of Anbang Insurance Group. Photo credit: Mighty Travels. Licenced under Creative Commons.

WU XIAOHUI, THE politically well-connected chairman of the giant insurance group Anbang (his wife is Deng Xiaoping’s grand-daughter), has been in detention by authorities since last June. Now he is to stand trial for economic crimes, code for fraud and embezzlement, and the company run by personnel from the China Insurance Regulatory Commission for a year or two, an extraordinary move. The state assuming control of a private-sector business, and particularly one of this size and prominence, is unusual.

Anbang has been on an aggressive international acquisitions drive, buying such foreign trophy investments as the Waldorf Astoria in New York and a string of other luxury US hotels. Chinese firms, with official encouragement, have ‘gone global’ in recent years, rapidly expanding their international mergers and acquisitions activity.

In 2016, China overtook Japan to become the world’s second-largest overseas investor. Non-financial outward direct investment that year exceeded $170 billion, a 44% increase from the previous year, according to the Ministry of Commerce. However, such activity entails tremendous financial risk from the leverage taken on, a risk exacerbated by Chinese firms’ lack of experience with the integration and management challenges that M&A brings, especial in deals that cross national and cultural borders.

Anbang appears to fall squarely in this camp. On some estimates (its finances are notoriously opaque), it has encumbered itself with debt to the point that it is fast approaching technical bankruptcy despite having more than $300 billion of assets.

That also makes it ‘too big to fail’. State administration will provide the funding to keep its core life and non-life insurance business operationally solvent. The insurance regulator says the company’s current operations remain stable but that its solvency is seriously endangered by its ‘illegal operations’ unspecified but which presumably include its investments in prestige prime US real estate.

Last August, authorities announced a list of sectors hat should be off-limits for Chinese firms as the foreign investment spree into things like European football clubs and Hollywood entertainment businesses was exacerbating debt concerns.

More broadly, in the drive for financial stability and to forestall any systemic financial shocks, President Xi Jinping has been asserting greater control over state enterprises and reining in sprawling private conglomerates, notably the ‘big four’ — Angbang plus Dalian Wanda, Fosun International and HNA Group — that have expanded rapidly via debt-fuelled foreign acquisitions.

That quartet that accounted for 20% of Chinese foreign acquisitions in 2016. Also, there has always been a nagging suspicion that, given the quartet’s political connections, some of this M&A acted as a conduit for senior officials to get their money out of the country.

All have been ‘urged’ to sell assets and pay down their debt while state banks were told to rein in their lending to them. In January, the chairman of the Banking Regulatory Commission, Guo Shuqing, warned that ‘massive, illegal financial groups’ posed a grave threat to financial reforms and the stability of the banking system and that China would address the issue ‘ in line with the law’.

Taking Anbang into state control may be the prelude to a series of moves against the layer of private conglomerates below the ‘big four’, a group of some 25-30 companies said to be in the regulators’ sights. Despite or perhaps because of his connections, Wu’s treatment, in particular, is intended to show that no tycoon is immune from being ‘deterred’ from risky borrowing and investment overseas, or from being reminded that private M&A strategies should be integrated with national investment priorities.

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China’s Economy: Normal Slowing Will Resume in 2018

THE ECONOMY STORMED along in the second half of last year, taking growth for the year to 6.9%, comfortably outstripping the official target of ‘around 6.5%’.

It was riding the coattails of the fiscal stimulus introduced in the first half of the year and also the pick-up in global trade, partly helped by the robust growth in the United States and some recovery in Europe, which boosted China’s exports. At 8.7% of China’s GDP growth, net export volumes made their largest contribution to growth since 2008.

Policymakers have been managing a slowdown from the giddy decades of double-digit growth. The overall lesson from last week’s figures is that economy is fitfully rebalancing and that there was some slowdown in credit growth as official efforts to cool the property market, deleverage and upgrade industrial capacity gained some traction.

That last year turned out to be the first acceleration since 2010 should prove to be an anomaly. Normal slowing will resume this year. And especially if policymakers push ahead with measures to control financial risks.

The most recent forecast from the World Bank, which recently upped its estimate of GDP growth in 2017 to 6.8% (a 0.3 percentage point increase from its forecast a year ago and reiterated in June) says it expects 6.4% growth this year (a 0.1 percentage point increase from its previous number).

Beijing has plenty of headroom in meeting its 2010 target of doubling aggregate and per capita growth by 2020. The economy needs to average no more than 6.3% growth to achieve that.

That headroom will also let Beijing tackle its most pressing economic-related problems: curbing escalating debt; cutting excess heavy industrial capacity; becoming environmentally cleaner; and dealing with the risk of unemployment as the economy is rebalanced towards domestic consumption and higher-value-added manufacturing.

Where the margins of safety are considerably thinner is if there is a trade war with the United States.

As we noted recently, US President Donald Trump is itching to impose tariffs on Chinese steel and aluminium imports into the United States. More recently Washington has said that an investigation into intellectual property transfers to China has been launched, with Trump warning that China is in for “a very big intellectual property fine”.

His self-restraint because he needs Beijing’s help with North Korea is wearing thin. Nor will it have been helped by the revelation that an ex-CIA officer arrested in New York this week may have been the mole responsible for passing information to Chinese intelligence that led to the dismantling and death of the CIA’s intelligence network in China between 2010 and 2012.

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World Bank Ups Its Prospects For China’s Economy

THE WORLD BANK has become more bullish on China, at least for the near-term. In its newly published annual Global Economic Prospects, it has upped its estimate of GDP growth in 2017 to 6.8% (an 0.3 percentage point increase from its forecast a year ago and reiterated in June) and said it expects 6.4% growth this year (an 0.1 percentage point increase from its previous number).

China benefited, the Bank now says, from the recovery in world trade last year, fiscal stimulus and the rebalancing of the economy, which eased the drivers of the economy away from state-led investment. Inflation rose but was still within target and housing price increases moderated in response to policy measures.

The current account surplus continued to narrow, but the clampdown on capital outflows meant that exchange-rate pressures eased and foreign-exchange reserves recovered modestly.

On the flip side, non-financial sector debt continued to grow, reaching 260% of GDP, regardless of further monetary and regulatory tightening. Credit growth still outpaces nominal GDP growth.

The Bank says that financial sector vulnerabilities — particularly high corporate indebtedness in sectors with overcapacity and deteriorating profitability — are one of the key downside risks to growth.

Others include the possibility of protectionist policies in advanced economies (for which read the United States) and rising geopolitical tensions (for which read mainly North Korea).

The Bank also expects the economy to continue its measured deceleration, averaging 6.3% growth in 2019 and 2020, and less beyond that as adverse demographics kick in over the next decade.

A steeper-than-expected slowdown or debt- or geopolitical-driven financial stress would have impacts well beyond China’s borders.

The Bank’s view is that authorities have substantial ‘policy buffers’ to absorb financial shocks. Nonetheless, it, like others, calls for further structural reform to reallocate economic activity towards more productive sectors.

This would include financial and corporate sector reform as well as greater efforts to deleverage and improve the fiscal sustainability of provincial, municipal and local government.

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A Better Quality Economy

WHAT CAUGHT THIS Bystander’s eye from the annual Central Economic Work Conference, the key closed-door economic policy meeting of the year held in the PLA’s Jingxi Hotel in Beijing last week, was that economic policy priorities were set for the next three years rather than the usual one.

That will take policymaking to the midpoint of President Xi Jinping’s second term and the start of what should be the next cycle of leadership regeneration. It likely signals that there will be no alternative economic path than the one that leads to making good on Xi’s promise to build a “well-off society” by then.

The work conference was the first gathering of the Central Committee since the 19th party congress. It marked a start to translating Xi’s concepts of the next stage of China’s development being a transition from ‘rapid growth’ to ‘high-quality growth’ into plans and targets that each province and ministry will then have to turn into tasks and initiatives.

Xi has greatly tightened his grip over economic policy since taking power five years ago.The State Council, the mechanism through which the prime minister had formed economic policy, has become an implementation agency. The Central Leading Group of Financial and Economic Affairs, headed by Xi, is where the decisions that matter now get taken.

The outcome of the discussions at the work conference, which involved the 400 most important officials in the country, will not be disclosed until next March when they will be announced within the government’s work report to the annual parliamentary session as the economic targets for 2018.

All that is known at this point from state media is the already well-advertised transition from rapid to high-quality growth involving an economic model with “more focus on fairness, the environment and a joyful life”. The top three priorities for delivering that are alleviating poverty, pollution and financial risks.

Parsing that suggests that poverty relief will take precedence over maximising overall GDP growth, and financial stability over reform and liberalisation. Thus financial policy will focus on deleveraging through controlling credit growth rather than reducing existing corporate debt. Monetary policy will tighten in 2018; the external account will be kept stable, rather than opened up.

Systemic financial industry corruption will be tackled, particularly by cracking down on murky practice within shadow banking; more regulation in this area, particularly for asset management products, is likely next year. The introduction of a 3% value-added tax on some financial products will also provide a useful administrative tool for policymakers to bring shadow banking more in line.

It all adds up to a gamble on steering the real economy clear of financial risk through controlled growth and economic management. The gamble is probably most vulnerable to an external economic shock such as a deterioration in economic relations with the Trump administration in the United States.

The concern for Beijing is not the general macroeconomic one from US monetary policy ‘normalising’ but the danger that Washington’s China hawks get the upper hand in the administration and attempt to constrain China’s access to and trade in technology thereby crimping the innovation so necessary to rebalancing the economy.

What is less uncertain is that Beijing’s efforts to tackle environmental problems, and particularly air pollution, will be driven forward aggressively, regardless of the cost. That is for reasons of domestic stability, new-industry development and international leadership.

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Putting Financial Stability Ahead Of Growth

IN THE SIX years since the International Monetary Fund last published a Financial System Stability Assessment of China, credit has boomed, spreading shadow banking has added complexity to the system, and moral hazard has grown as belief in the implicit state guarantee to firms and investors has remained unshakeable.

In short, financial instability risks have grown rapidly.

Within the constraint of maintaining growth and employment, authorities have responded to mitigate the risk and to put the expanding financial system on the right footing to support the ‘rebalancing’ of the economy from being led by infrastructure investment and export manufacturing to being more consumption and service driven.

There is much more to do, however, as the Fund outlines in its latest assessment.

Some of that will be politically challenging, notably allowing firms to fail, markets to fall and investors to lose money, which will be the consequences of removing the implicit guarantee that the state stands behind financial loans and products. They will also require detailed technical work on bankruptcy procedures, financial education and even social security safety nets.

Political priorities will also need to be adjusted to put financial stability ahead of economic growth. That is already starting to happen as job losses, particularly in heavy industry and primary production, and slowing economic growth more generally shows. However, the tolerance for both is greater at the higher levels of government than at the local one, where the expectation among officials that promotion depends on creating good economic growth numbers is proving hard to break. The massive task of reforming local government finances is probably a multi-decade, not just multi-year endeavour.

China Financial System Growth

Improving the supervision of the financial sector is an easier piece to bite off, and authorities have been systematically expanding that for banks, insurance companies and securities firms in recent years. The Fund recommends setting up an umbrella regulator focusing solely on financial stability to coordinate the oversight of systemic risk across sectors.

This regulator, which would be an institutional version of the recently established Financial Stability and Development Committee, will need authority and independence over the sector supervisors and an improved flow of data given the scale and complexity of the country’s financial system, especially in some of the murkier areas of shadow banking. As was seen in the West with the 2008 financial crisis, failure to monitor risks outside the regulatory perimeter can be the most damaging failure of all.

The Fund also suggests that the well-advertised rapid growth of debt requires banks to hold a plumper cushion of capital, and particularly at the larger banks that are systemically important. Greater capital reserves would not only provide a buffer in the event of a sudden or severe economic downturn, but also against the particular risk with Chinese characteristics of the extensive off-balance-sheet borrowing, notably for wealth management products, that the banks implicitly guarantee.

In the same vein, banks and financial institutions should be nudged through lending rules to stop using short-term borrowing to finance their investments and instead both lend and fund longer-term. Should it come to it, and a financial institution goes under, regulators should have their powers expanded in line with international standards to let the firm to ‘fail safely’ rather than prop it up with public funds.

Another area that the Fund urges oversight is digital finance, or fintech, which as expanded significantly in China as elsewhere. Existing oversight frameworks are often ill-fitting for the innovation that comes with fintech, though the need for systemic safety and soundness is not diminished.

The Fund calls China ‘the global centre of fintech’, noting the growth of peer-to-peer lending and the emergence of payment systems run by internet retailers such as Alibaba that are competitors to the banks’. Smartphone app WeChat’s WeBank is already a competitor to banks’ lending.

The scale of this is still small compared to the overall size of the banking system and thus not a systemic risk — yet. Nonetheless, they will need to be brought into the regulatory and supervisory scheme of things. This is starting to happen following the State Council last year launching an overhaul of internet finance oversight.

 

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China’s Collectivisation of Capital

THERE IS A vacuum in the state’s control of the economy. The combination of powerful private companies arising in new areas of economic activity from which state was absent, such as within the tech industry, and the breaking up of the patronage networks within state-owned enterprises (SOEs) as a consequence of President Xi Jinping’s anti-corruption campaign has created it.

The Party abhors a vacuum and has stepped in to assert its control as the state’s wanes. Under Xi, the People’s Daily opined in June, the Party has sought to address the “weakening, watering down, hollowing out and marginalisation” of party leadership at state enterprises.

Two months ago a government statement made it clear that private-sector business should follow Party guidance, including ‘patriotism’, ‘observing discipline’ and ‘serving society’ within its definition of entrepreneurship.

The mechanism for exercising Party control is the Party branch within companies. These have long existed within SOE’s (they are present in 93% of the 147,000 SOEs big and small) and have become prevalent in the private sector. Qi Yu, deputy head of the Central Organisation Department, said in October that 68% of 2.73 million private businesses had Party branches as of the end of last year.

Party cells are also becoming more common in joint ventures with foreign firms, and are being pushed on foreign firms with wholly owned local operations as part of the ‘new era’. Qi said 70% of foreign-funded firms in China – or 750,000 – have set up Party branches and 106,000 foreign-invested companies, against 47,000 in 2011.

Samsung and Nokia are two foreign companies who have acknowledged publicly that they have set up Party branches in their local operations; The medical systems division of Japan’s Toshiba has had a branch since 2007. The US chemicals multinational DuPont had one when it set up in Shanghai in the 1990.

The influence of Party cells varies greatly between companies and industries. At their best, or at least as portrayed by authorities, they promote goodwill and communication between the company and the Party. They run companies’ internal labour unions and be a source of labour through the agencies that coordinate them.

Some are little more than a cost irritant (the company foots the bill for Party branches’ activities). In joint ventures, especially with SOEs, they can make operational decision making more opaque and cumbersome. At the other end of the spectrum, they can seek to determine strategic and operational investment and business decisions.

Some SOEs listed in Hong Kong have gone as far as changing their articles of association so as to give the party a leading role in management decisions. And there are reports circulating of joint ventures being pressed to rewrite their terms of agreement to give the Party a more formal say in operations and management, including a final say over investment decisions.

It is that direction of travel — expanding the party’s presence in areas where it has previously had a limited role, such as in private and foreign joint-venture companies and the boards of listed firms, that is exercising foreign multinationals operating in China.

In late July, executives from more than a dozen top European companies in China met quietly in Beijing under the aegis of the EU Chamber of Commerce in China to discuss their concerns about the Party’s growing role in the local operations firms like theirs. Last month, the Delegations of German Industry and Commerce in China, representing German chambers of commerce, also raised their concerns and said some German companies might consider withdrawing from the market if the Party’s influence on their local operations grew.

Part of their argument was that companies from multi-party democracies should not be bound to promote a particular party, especially one that claims a monopoly on political power. However, the concern is that once Party presence is written into governance, commercial management autonomy is lost for good. In addition, Party members are subject to the Party’s disciplinary procedures, which, of course, is beyond any internal policies a company may have.

A statement from the State Council Information Office earlier this year, saying that “company party organisations generally carry out activities that revolve around operations management, can help companies promptly understand relevant national guiding principles and policies, coordinate all parties’ interests, resolve internal disputes, introduce and develop talent, guide the corporate culture, and build harmonious labour relations” is less reassuring to foreign investors than the Office probably intended.

The other end of the telescope is that the Party should intervene to assert the collective interest of the whole over the that of the part, the whole, in this case, being the state capitalist class.

An old-school Marxist ideologue might describe the presence of Party units in companies, and the guidance and discipline they would provide, as a precursor to the collectivisation of capital, in which individual companies become units of a state corporate whole.

In these more pragmatic days, this Bystander sees it just as the Party extending an strengthening its presence and control over all sectors of society, even in areas where it has previously had a limited role, which might be much the same thing.

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