Category Archives: Economy

One Belt, One Road To Rule Them All

Belt and Road International Forum, Beijing, May 2017. Photo credit: The Russian Presidential Press and Information Office. Licensed under Creative Commons.IT IS NOT just General Secretary Xi Jinping’s ‘Thought’ that has been inscribed in the Party’s constitution. So, too, has his grand vision and signature policy, the Belt and Road Initiative, or OBOR for its original designation, One Belt One Road.

This will give political longevity to the ambitious scheme Xi announced in 2013 to transverse the Eurasia landmass and beyond with a network of roads, railways, ports, pipelines and other infrastructure projects carrying China’s surplus industrial and services capacity westwards and food and energy resources in the opposite direction. Opposing or obstructing it, just as with opposing or obstructing Xi, will henceforth equate with betraying the Party itself.

Few, if any infrastructure projects can boast either such prestige or protection. As Xi indicated at the Party Congress just concluded, OBOR will be central to China’s development until at least 2050, the date Xi has set by which China is to be a leading global power (neatly coinciding with the 100th anniversary of the founding of the People’s Republic on October 1, 1949).

So great is the ambition of this combination of commerce, construction and capital that it is impossible to put an accurate cost or timetable on it.

Bloomberg counts more than $500 million the China has so far spent or committed to OBOR. There is a $40 billion Silk Road Fund and much of the $100 billion Asian Infrastructure Investment Bank (AIIB) will be directed towards it. No doubt some of the $300 billion National Pension Fund will find its way to OBOR projects as will investment from state-owned banks and enterprises and dutifully patriotic private companies.

The US investment bank Morgan Stanley has suggested that $1.2 trillion will be spent on OBOR-related infrastructure over the next decade. However, so loosely is it defined and so ambitious its scope that you can just about put any price tag on it, as long as it is in the many trillions.

Beijing lists 68 countries as OBOR partners spanning Asia, Africa, the Middle East, Europe and Oceania. They already account for one-third of global GDP and trade, two-thirds of the population and one-quarter of global foreign direct investment. The management consultancy McKinsey & Co.reckons they will contribute 80% of global economic growth and add 3 billion to the global middle class by 2050. Any number is going to be large.

For all the trillions of dollars of hard infrastructure that will be built — and as we have noted before, if even only a fraction of what is being talked about gets completed, it will still be huge — OBOR is also a geopolitical project. Whether you see that as 21st-century merchant hegemony writ large or the world’s largest platform for regional collaboration and future engine of trade and investment growth, there can be little argument that it will potentially give Beijing vast sway over a large part of the world.

It is a part of the world with lots of risks, however, both geopolitical and financial. One measure of both is that state-owned insurer China Export & Credit Insurance Corp. said it has paid out $1.7 billion in claims since 2013 on $480 billion of exports and investments it has insured in OBOR countries. The sort of risks the insurer covers are things like government seizures, nationalisation and political violence.

More than half of China’s outward OBOR investment since 2013 has been in countries whose sovereign credit rating is below investment grade — ‘junk’ in the jargon. Of the 68 OBOR countries, only 27 of them are not rated as junk.

It is easy to assume that the Chinese state and its own and private (and dutifully patriotic) companies will be pouring a lot of good money after bad. However, many of the OBOR countries have trade and growth potential that can be released by infrastructure development, especially on the scale and interconnectedness envisaged. That would generate some of the growth necessary to provide some return on the investment.

It will also give China a huge sphere of influence far beyond its near abroad, in which today’s superpowers will be marginalised.

The ‘America First’ economic and political nationalism of the Trump administration, which has caused the stalling of the TransPacific Partnership (TPP) and disengaged the ‘Asian pivot’ of its predecessor Obama administration, has given Beijing an unexpected window of opportunity to advance OBOR and its alternative arrangements to those that have governed the international order in the era since World War II.

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China Looks To Make A Razor-Sharp Deal For Saudi Aramco

Chinese Vice Premier Zhang Gaoli (L) meets with Saudi King Salman bin Abdulaziz Al Saud in Jeddah, Saudi Arabia, Aug. 24, 2017. Photo credit: Xinhua/Wang Ye

THIS BYSTANDER RECALLS a classic television advertisement from the 1970s in which US businessman Victor Kiam said he so loved using a Remington electric razor that he bought the company. China’s state-owned oil companies so love buying Saudi oil they are reportedly thinking of doing the same.

The Reuters news agency recently reported that the kingdom is evaluating the sale of 5% of its state oil company, Saudi Aramco, to a Chinese consortium comprising PetroChina and Sinopec, state-owned banks and China’s sovereign wealth fund. This would be as an alternative, or possibly a precursor to an initial public offering (IPO) of the Aramco’s shares on one or more stock markets, a listing that would likely be the biggest share sale ever and expected to raise $100 billion. The Chinese consortium would presumably have to come close to matching that number.

Ever since the Saudi government said it was looking to sell a small stake in Aramco in 2018 to kick start the funding of its economic diversification programme, Vision 2030, the world’s leading stock exchanges have been bidding for what would be both a large and a prestige bit of business. Some suitors have been ready to turn a blind eye to infringements of their own rules in their desire to get the listing.

A direct sale of a stake to China, the biggest buyer of Saudi oil, would make any eventual listing more likely to happen in Shanghai or Hong Kong than New York or London, which would be a considerable feather in the caps of either exchange.

Such a deal would also strengthen two-way Saudi-China trade and investment ties. In August, the Saudi energy minister said he expected to conclude a deal next year with PetroChina for the Saudis to invest in a new 260,000-barrels-a-day oil refinery in Yunnan that started operations in July. That investment was reported in April to be a 30% stake valued at $2 billion.

A similar arrangement could be struck with China National Offshore Oil Corp, (CNOOC), which is building a 200,000-barrels-a-day refinery in Guangdong province.

Vice Premier Zhang Gaoli (seen above on the left) visited Saudi Arabia in August, meeting Saudi King Salman (on the right) and Crown Prince Mohammed bin Salman in the Red Sea resort of Jeddah. This followed an exchange of official visits in 2016, with the king in March returning a visit by President Xi Jinping in January in which the two countries agreed to upgrade the bilateral ties to a comprehensive strategic partnership.

China is already Saudi Arabia’s largest export market, at $23.6 billion (2016 figures), all but a slither of it crude and refined oil and petrochemical products, and accounting for 15% of Saudi export volumes. China is also the kingdom’s leading source of imports, at $18.7 billion, accounting for 14% of total import volumes. Machinery accounts for 36% of Chinese imports, followed by metals (13%) and textiles (12%).

However, since late 2015, when China changed its rules on where independent refiners could buy crude, Russian suppliers have been vying with the Saudis to be China’s leading source of crude. That generates competition that will be welcome in Beijing for the effect it will have on prices, but another reason that Saudi might be prepared to cut investment deals to secure its exports.

 

Update: Aramco’s chief executive, Amin Nasser, told the US business news TV channel CNBC in an interview broadcast on October 23 that an IPO was on track for the second half of 2018. Nasser also denied a Financial Times report that Aramco was talking to ‘the Chinese or others’ about delaying the share sale. He was not pressed, however, on whether a separate deal with investor groups could co-exist with a public share sale.

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IMF Again Warns China Off Growth For Growth’s Sake

THE IMF’S NEWLY published World Economic Outlook projects a 0.1 percentage point increase in GDP growth this year over last, to 6.8%. That is an upward revision of 0.1 percentage point to its July forecast, based on policy easing and stimulus to domestic demand earlier in the year.

However, the Fund sees the glide path of managed slowing growth resuming next year, with GDP growth forecast at 6.5% in 2018 (again up 0.1 percentage point from July’s forecast, and up 0.2 percentage points from its April forecast) and thereafter slowing further to 5.8% by 2022.

By that point, the IMF expects China to be growing more slowly than the emerging and developing Asia average, forecast at 6.3%. That would a phenomenon not seen since China started its double-digit growth spurt.

That, in its way, would be a mark of success for the rebalancing of the economy towards being more consumption-driven and less dependent for growth on infrastructure investment and exports. The IMF is projecting that China’s current account balance will have shrunk to $28.8 billion by 2022, against $196.4 billion last year, and almost one-tenth of the level it was a decade ago. As a percentage of GDP, the effect will be even more dramatic: a projected 0.2% in 2022 against 4.7% in 2009.

All neat projections, but realizing them is not without risk, most notably in managing debt:

Over the medium term, dealing with financial sector challenges will be essential. Minimizing the risk of a sharp slowdown in China will require the Chinese authorities to intensify their efforts to rein in the credit expansion.

The conundrum is that 6%-plus growth is necessary for China to have met its target of doubling real GDP between 2010 and 2020. To make sure it does, Beijing will be in no hurry to withdraw its stimulus.

However, as this Bystander and others have noted before, delay comes at the cost of further increases in debt, making the issue more difficult to resolve through the necessary measures of tighter supervision, reined-in expansion of credit and writes down of the underlying stock of bad assets.

This, in turn, would slow rebalancing and reduce the policy space available to respond in case of an abrupt shock to the system, internal or external.

Such shocks are not difficult to imagine, and are detailed by the Fund:

a funding shock in the short-term interbank market or the funding market for wealth-management products; the imposition of trade barriers by trading partners; or a return of capital outflow pressures because of a faster-than-expected normalisation of US interest rates.

The political dimension to this, unaddressed by the IMF, not surprisingly given its sensitivity, is whether President Xi Jinping will emerge from next week’s Party Congress in a sufficiently strong position to be able deemphasize near-term growth targets and implement more reforms that would enhance the sustainability of growth. Without doing so, he will be unable achieve his long-term goal of maintaining the Party’s monopoly grip on power while transforming China’s economy to its next phase of development.

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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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