Category Archives: Economy

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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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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