Category Archives: Markets

Politics, Not Debt Will Drive The Deleveraging Of China’s SOEs

MOODY’S CREDIT DOWNGRADE of China caught the attention of the public prints, ever ready, in some quarters at least, to see the prophesied hard landing just around the corner, with the economy crumpling under the weight of an oncoming rush of bad debt. S&P did much the same as Moody’s back in March with much less general notice. In its commentary, Moody’s falls over itself to emphasise the long-term nature of the risk.

As this Bystander has argued before, while China’s debt-to-GDP ratio is large, and has grown in recent years, it remains manageable by Beijing, even in the event of a crisis, and the risk of external contagion is small.

That is not to say it is not of concern to policymakers. It is. It is concentrated in state-owned enterprises (SOEs) and local authorities. SOE debt, at 115% of GDP is concerning. (In Japan and South Korea state-owned corporate debt is about 30% of GDP). And the finance ministry has noted that some local authorities, caught between paying for shutting down loss-making state industries or subsidising them to keep them going, and no longer able to rely on land sales to square their books, are struggling to cover operating expenses.

All this is also a sign, widely commented on by the likes of the IMF, World Bank and the OECD, that the old-school means of state-led infrastructure investment to keep growth going are persisting to the detriment of ‘rebalancing’.  Those two points come together politically.

The political event of the year is, self-evidently, the Party plenum to be held later this year. This is no ordinary plenum, as it is the scene-setter for the next generation of leadership. President Xi Jinping’s legacy is at stake.

Vested interests lying in the way of economic reform have not been fully removed by the anti-corruption campaign. Many of those same interests would also end up on the wrong side of any aggressive debt resolution, given both the individual companies that would be involved and the structural reforms necessary to governance and financial markets.

So, for now, authorities are biding their time over the debt question. The economy has stabilised sufficiently to buy them a few more months of inaction; candidate Trump’s threatened trade war has been headed off; the razzmatazz around One Belt, One Road sustains hopes of new export markets for excess capacity.

Once Xi has consolidated his political control at the plenum, then the debt busters will start to move in.

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China Can Now Rattle Global Markets With The Best Of Them

Shanghai Stock Exchange seen in 2009. Photo credit: Aaron Goodman. Licenced under Creative Commons.

BOTH LAST YEAR and early this, global stock markets were fazed by a sharp fall in prices on the Shanghai and Shenzhen exchanges. Chinese equity and currency movements are having an increasing impact on investors everywhere. A new working paper published by the Bank for International Settlements, ‘the central bankers’ central bank’, suggests that China’s influence in this regards is rising to the level of that of the United States in some circumstances.

Market moves in China no longer reverberate just in Asia, the authors argue. However, the growth of financial and economic linkages within Asia raise questions about the pace and extent of financial market spillovers in the region and whether there are substantive differences in those flowing out of China to those from the United States.

Empirical study is only starting in this area, though the anecdotal evidence of the effects of financial market shocks is growing steadily. Chang Shu and her colleagues in the bank’s Monetary and Economic Department conclude that China’s influence in this regard has been growing significantly in recent years. This is especially true of equity and currency movements, as increasing financial linkages supplement extensive trade ones established by China’s central position in Asian supply chains.

A working paper from the IMF published last month came to a similar conclusion.

However, that has not diminished the importance of the United States, which also has impact across all asset classes including bonds, and particularly at times of market stress. China’s global financial linkages, though growing, remain modest compared to the United States’ not least because China’s capital account is not fully liberalised. Chinese monetary policy is nowhere near as potent a driver of global liquidity as the US Federal Reserve’s.

For investors, the implication of the work is that diversification of portfolios through Asia investment is becoming less effective at mitigating risk because Asian market movements are now driven by external factors to a greater degree than before.

For regional policymakers, the findings pose the challenge that yield-seeking capital flows to their country (and their exit) will be driven by developments in both Chinese and US financial markets, often in a mutually reinforcing way that could undermine macroeconomic and financial stability in vulnerable economies. It will likely take the emergence of intraregional institutional investors to weaken that linkage.

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Time For A Poacher Turned Gamekeeper At The Exchanges?

LIU SHIYU, who has replaced the ill-starred Xiao Gang as China’s top securities regulator, is a former chairman of the Agricultural Bank of China. Liu is the China Securities Regulatory Commission’s eighth head, a job he will combine, like Xiao, with being the Party chief in the Commission. Six of Liu’s seven predecessors also worked in state banks.

And therein lies a clue to the innate contradiction in China’s attempts to control the animal spirits of financial markets by old-school administrative measures, which, like Xiao’s ‘circuit breakers’ can end up embarrassingly making matters not better but worse.

State bankers whose careers have been spent within the confines of a highly protected banking system where administrative guidance has long made the need for risk management a redundant skill are unlikely to have that gut feel for how markets work and what reinforces or undermines investor sentiment. Even Liu’s spell at the People’s Bank of China was mostly concerned with the bailout of the state banks in the early 2000s.

While having someone from the securities industry regulating the markets would no doubt come with its own mixed bag of connections and conflicts, it might be time for Beijing to consider appointing a poacher turned gamekeeper to oversee the exchanges.

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Markets Expose China’s Inherent Economic Contradiction

100 yuan notes

THE RECENT VOLATILITY in financial markets has brought into question the capacity and nerve of China’s policymakers when confronted with variables they cannot control politically. This heightens concern not so much about the gathering pace of the economic slowdown as about the country’s prospects for the next stage of the economy’s d development, ‘rebalancing’ away from export and capital investment-driven growth and towards domestic consumption.

In what was mostly a closed economy, policymakers had relatively few monetary and fiscal levers to pull, but they were effective when yanked. Administrative guidance was particularly efficient. As the financial system has been opened up, the less guidable animal spirits of market forces have come more destabilisingly into play. The new tools to control them have arrived piecemeal, an inevitable consequence of the deliberately measured pace of financial-sector liberalization.

The currency has been in the vanguard of the reforms in lockstep with freer capital flows, moving steadily along the path of full convertibility, whose final destination has allowed the yuan to achieve the accolade of inclusion in the International Monetary Fund’s basket of reserve currencies.

The People’s Bank of China has a deserved reputation in financial circles around the world for the high calibre of its officials. But even their competency has been questioned following their uneasy and unexpected guided devaluation of recent weeks and their attempts to bring the tightly managed onshore and market-driven offshore exchange rates into alignment, a move undertaken for SDR-related reasons as much as currency management, but done with a tin ear for timing.

The central bank’s switch to managing the yuan’s value against a basket of currencies was both poorly signaled and sent mixed signals to investors, who tend to focus on the exchange rate against the dollar.  If investors lose confidence in the central bank’s effectiveness in the execution of monetary policy, it will only feed the volatility of the equity markets, where officials have already revealed a far from sure touch in their attempts to stabilize the markets.

While it may be virgin territory for many of them, policymakers clearly miscalculated the linkage between tumbling equity prices and speculative pressure on the currency, and how quickly the currency would become the focal point of market unease about China’s economic prospects among investors. It also says something about how the world has changed that the competency of Chinese policymakers has supplanted U.S. monetary policy as the primary determinant of global investor sentiment.

It is the nature of financial markets to be volatile in greater or less degree. Policymakers will learn by experience the limits of their reach in such an environment. Three decades of history will have left them more naturally inclined to intervene than not, which will make that learning painful and slow — last summer’s lessons from the mishandling of the stock-market plunge were clearly not well learned this most recent time round.

However, the broader concern to this Bystander is that financial-market turbulence will encourage Beijing to backslide on further financial-sector reform and more broadly on rebalancing. For some months, it has been dialing back on talking up the need to reduce government intervention in the economy. The third Party plenum at which the top leadership pledged to give market competition a decisive role in the economy seems longer ago than the 30 months it was.

Similarly, the notions that powerful bureaucrats can be a panacea for all economic ills and that the state can trump the market are fading. With that will come doubts in the some senior minds that the Party can pull off the unprecedented trick of liberalizing China’s economy without doing the same to its political system, unacceptable to the Party though the later is.

The certainty that state control provides versus the benefits that free markets bring is the inherent contradiction that may have been manageable for the past 30 years of the economy’s modernization but which, as Japan and South Korea have shown on a smaller scale, becomes more not less contradictory as an economy advances and becomes too big and complex to answer to political imperatives — and to the bureaucrats imposing them.

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China’s Turbulent Rebalancing

DAMNED CUSSED THINGS, stock markets.

After last summer’s plunge in equities prices on the Shanghai and Shenzhen exchanges, authorities put in place measures to prevent a repeat. Share sales by large shareholders were choked off for six months and ‘circuit breakers’ put in place to halt trading if prices fell by more than 7% in a session to give time for excited animal spirits to calm down.

Yet this week has seen a rerun of last June.

The circuit breakers kicked in twice this week, the second time after just half an hour of trading. The circuit breakers themselves have now been suspended, and sales restrictions on large-scale shareholders extended.

Applying rational explanations for stock price movements always risks being a fool’s errand. What is being said is first that investors at the beginning of the week were rushing to sell stocks in advance of the end of the initial restriction on large-shareholder sales, which was expected to push prices down. Second, that the People’s Bank of China’s repeated setting of the yuan’s exchange rate at the lower end of its band was effectively a managed devaluation of the currency. Third, that weakening the yuan signaled a recognition that the economy was slowing more rapidly than thought and that a beggar-thy-neighbour round of competitive regional currency devaluations was in prospect.

All this has wider implications for the global economy. Equity and commodity prices, particularly of oil, tumbled around the globe.

The bigger concern is that markets are underlining how China’s transition towards more consumption and services-based growth is moving too gradually, and thus domestic consumption is not growing enough to offset the slump in exports caused by the decline in global demand.

On January 6, the World Bank in its newly published Global Economic Prospects forecast that China’s GDP growth would slow to 6.7% this year and 6.5% next, down from 6.9 % last year and 7.3% in 2014. Manufacturing and real estate have borne the brunt of the slowdown. The Bank also warned of the risk that the slowdown could gather pace faster-than-expected.

Sticking a finger of administrative guidance into the dyke of financial markets rarely has a happy outcome. Instead, fiscal and monetary policy will have to stem the flood. We expect to see further lowering of interest rates  and required reserve ratios and additional liquidity injections.

More infrastructure investment by central government is also likely. The fiscal deficit widened to 2.3% of GDP last year, a six-year high, as Beijing’s spending offset cuts in spending at the local government level in the second half of the year. There is still room for manoeuvre on that front.

China’s foreign reserves remain plentiful, too, at 33% of GDP. The current account is in surplus. The rebalancing is underway, as the World Bank’s charts below show, and the growth slowdown is, for the most part, orderly. However, the market turbulence is not, and will continue not to be so for as long as equities are overvalued, no matter how much some authorities think markets should bow to guidance.

China economy graphs

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China’s Corporate Disappearing Acts

WHEN TOP EXECUTIVES and financiers of any stripe go awol, it rarely ends well. When it is Fosun’s Guo Guangchang, one of China’s richest and highest-profile chief executives, that drops from sight, the conclusions quickly jumped to are inevitably nefarious ones.

Trading in the shares of Guo’s fast-expanding media-to-asset-management-to-Club Med conglomerate was suspended in Hong Kong ahead of a company announcement confirming that Guo was assisting authorities with their enquiries. Beyond that, the company did not say why police in Shanghai, where the group is based, had detained its chief executive. Guo was reportedly picked up at an airport. Local media reports suggest he has been held in connection with an investigation into Ai Baojun, director of the Shanghai free trade zone and a former deputy mayor of the city.

Earlier this year, Guo was found by a Shanghai court to have had ‘inappropriate connections’ with Wang Zongnan, a businessman who had once headed a number of state-owned enterprises, most notably the Shanghai Friendship department store chain. In August, the court sentenced Wang to 18 years in jail for misusing 195 million yuan ($30.2 million) in corporate funds. (Fosun has denied any impropriety in its relationship with the Friendship group.)

Guo is not the first senior company officer in recent months to disappear for a few days before being revealed to have been either under investigation or asked to assist authorities with their investigations.

Two investment bankers at Citic Securities, China’s largest securities brokerage and which overstated its over-the-counter derivatives business by 1 trillion yuan earlier this year causing its chairman to resign, went missing earlier this month. Something similar happened to Guotai Securities’ Yim Fung last month and in September, Li Yife, head of the China unit of Man Group, dropped out of sight for a few days, too.

It is clear that the anti-corruption operation — it has continued for too long to be labelled a campaign anymore — is now reaching deep into financial services.

This has been true since at least the beginning of the year, when Mao Xiaofeng, president of China Minsheng Bank, was detained to assist with the investigation into former President Hu Jintao’s aid, Ling Jihua.

That, at least, smacked of old-fashioned factional politics. But the anti-corruption operations have intensified in the wake of the summer’s stock-market crash, which reawakened concerns in some high levels of the Party about the lack of discipline that could be exerted on markets and their participants.

However, what makes the Guo case so unsettling for business and investment is not that there are unwritten political rules to doing business in China; those exist in many countries. It is that the rules have suddenly become more unpredictable.

Update: Guo has reemerged, chairing Fosun’s annual meeting in Shanghai on Monday, and without giving any explanation for his reported absence over the past few days. Trading in the company’s shares has resumed.

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Chinese vs US Equity Markets: A 5-Year View

Shanghai Composite Index vs S&P 500, 5-year view. Source: Bloomberg

ONE PERSPECTIVE ON the recent slump in equity prices on the Shanghai exchange (chart courtesy of Bloomberg). Where’s the real bubble?

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