Tag Archives: China

More Trouble Beyond China’s Western Reaches

PARTS OF YUNNAN’S border with Myanmar have been closed following a flare-up of fighting on the Myanmar side. Deadly exchanges between government forces and Kokang ethnic rebels in north-eastern Shan state have sent thousands of refugees fleeing into Yunnan province.

The Myanmar army has reportedly bombed around the town of Laukai leading locals and Chinese traders to seek safety in Zhengkang and Namping on the Chinese side of the border barely 5 kilometers away. Beijing has sent PLA troops to patrol the border and has created a camp to feed and shelter refugees. A foreign ministry spokesman told Reuters news agency that the refugees ‘had been looked after’. The group involved in the fighting is the Myanmar National Democratic Alliance Army, formerly part of the China-backed Communist Party of Burma.

There has been sporadic fighting in the mountainous area since December between government forces and the rebels. The Kokang have been trying to regain ground around the town lost in 2009, when a long-standing truce broke down and there was a large-scale exodus from the region into China caused Beijing some consternation.

A broad ceasefire agreement between the Myanmar government and some 17 armed ethnic groups in the north of the country seeking greater autonomy remains deadlocked. Achieving one is part of the political and economic reforms Naypyidaw committed to in 2011 to bolster its case for the lifting of international sanctions.

China has played an active role in truce talks between the various parties, particularly those involving the Kachin Independence Army that remains at open war with Naypyidaw, and which controls territory in which Chinese jade miners operate. Beijing again called for talks to resume after the latest clashes. It wants stability along its western reaches and control over what is thought to be smuggling routes for arms to dissidents in Tibet and Xinjiang and drugs into China’s heartland.

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China Takes Small Steps In Limited Local Judicial Reform

CHINA HAS INAUGURATED its first two circuit courts, one in Shenyang and the other in Shenzen, to spread the workload of the Supreme Court. This echo of Imperial China is one of the early pilot schemes as judicial reform kicks off in one-third of the country’s 33 provinces.

The most intriguing aspect of the proposed reforms is President Xi Jinping’s gamble on increasing the independence and professionalism of the judiciary, which has hitherto been an extension of the Party’s legal arm. But trusted courts are one of the essential requirements if the Party is not to corrode from the inside.

As this Bystander has noted before this first step in judicial reform will only effectively apply at local and municipal levels. The Party will retain its sway over national and provincial courts through the Central Politics and Law Commission, the Party body that oversees the legal system in its broadest sense — from police to prosecutors, judges, internal security, surveillance and prison administration.

Nor should anyone be under any illusion that judicial independence even at local level heralds the introduction of the rule of law. Xi is pursuing rule by law, altogether a different thing. No legal proceedings on which the Party has a national interest will be left to the vicissitudes of independent judges. Judges will be expected to declare their loyalty to the Party, and to take preemptive action in cases of threats to state security.

Where judicial reform will make an impact is that local judges will no longer be appointed and funded by local officials but by provincial or national authorities. That should break the commonly cosy relationship between local officials and local courts. It would then be more difficult for corrupt local officials to remain immune from accountability, a widespread popular grievance.

Not only would that give Xi’s anti-corruption drive some mass support but it will also provide some ‘flies’ whose squashing would warn a new set of ‘tigers’ now Xi is pushing his anti-corruption drive against police and security officials including Zhou Yongkang, the former and much feared head of the country’s security apparatus and the most senior official to date brought down by Xi’s anti-corruption drive.

More independent local courts would also provide a safety valve for the social unrest that has been escalating to the Party’s concern, without the reforms going nearly far enough to satisfy legal activists. It could also create courts that are more robust in their handling of commercial disputes, which would be to the benefit of foreign businesses operating in China and which have long felt local courts to be stacked against them.

As with all reform, it will proceed slowly; what is starting now is the first pilot schemes. The target date for broad based implementation of judicial reform is 2020. The goal is to reinforce the Party’s legitimacy to maintain its monopoly on political power by showing it can govern cleanly and fairly.

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Will Unravelling China’s VIEs Pull The Rug Out From Under Alibaba?

IS THE LAW of unintended consequences — or intended ones — in play with the new draft revisions to China’s foreign investment law? And if the later, whose intentions need to be examined?

What may be at stake is control of three of the fastest growing sectors of the Chinese economy — the internet, e-commerce, and cloud computing. Privately owned companies, not state-owned enterprises dominate all three. More to the point, these are about the only sectors of the economy to create large privately owned Chinese companies and from which state-owned behemoths are absent.

As Steve Dickinson of the China Law Blog points out, Baidu, Sina, and Alibaba are at risk of getting their wings clipped. To be fair, that is not the wording he uses. However, this Bystander sees it as a consequence of the significant implication he does note will result from the draft foreign investment law newly published by the commerce ministry: it will end a corporate governance structure known as the Variable Interest Entity (VIE).

All three companies and hundreds of others, particularly technology and telecoms firms, use VIEs to get round the investment regulatory rigidities of sectors of the economy the government deems strategically important and so proscribes or limits foreign investors.

The new draft revisions specifically set out to end VIEs. The revisions’ other main goals are:

  • to lessen the red tape for foreign direct investors wanting to own businesses in China;
  • to switch to a system of monitoring foreign investors via annual reports from pre-approvals for new foreign investments, save for in sectors of national significance; and
  • to put Chinese companies with foreign investors under the same legal regime as domestic companies.

China’s foreign investment law is outdated, so modernisation is to be welcomed — even if the draft law runs to a weighty 179 articles across eleven chapters.

VIEs are a loophole that has let foreigners operate businesses in the country through Chinese front companies. They are a corporate sleight of hand by which an investor controls a company through contractual legal agreements rather than through share ownership.

In short, VIEs say to authorities in country A ownership resides in country A while at the same time telling investors in country B that ownership resides in country B. This Bystander doesn’t need to be a lawyer to see that doesn’t pass many smell tests for good corporate governance.

There have been a number of VIE-related scandals, including involving Alibaba, Sina.com, and New Oriental Education, as VIEs open too many creases along which any or all of regulatory, ownership and operational risk can spread.

Nevertheless, VIEs have become widely used. At first, they were a way for inward foreign investors to enter parts of the Chinese market otherwise closed to them. Increasingly they have been used by privately-owned Chinese companies that list overseas, especially those from industries in which having any foreign shareholders is forbidden or restricted, such as tech and telecoms.

They circumnavigate regulatory rigidities: the constraints on Chinese firms raising capital domestically and the need for private firms to get permission to invest overseas, and restrictions on foreign investors and firms having ownership of Chinese enterprises in certain sectors of the Chinese economy. But given those restrictions on foreign investment exist, VIEs aid and abet in breaking the spirit of the law, if not its letter.

The straightforward solution would be to remove the regulatory rigidities. However, Beijing is not going to abandon keeping sectors of the economy ‘off-limits’ to foreign investors. Its new draft foreign investment regulations use where ‘effective control’ of a company resides to determine ownership.

At a stroke of the legal drafting pen, VIEs becomes irrelevant. Any business that authorities determine to be effectively foreign controlled will be breaking the law if it operates in a restricted or prohibited industry.

All of which would leave the likes of Baidu, Sina and Alibaba and all the other internet businesses that operate as VIEs in China, in a pickle. So, too, foreign investors who bought into the initial public offerings with such gusto and who could end up holding the paper of a company that is illegal.

Now, we don’t doubt that between drafting and final promulgation of a new foreign investment law, accommodations will be made to resolve any such discomforts. While the regulators appear to have rejected lobbing from the companies to, in effect, grandfather them into legality, the draft regulations would let a VIE that is controlled by Chinese to be considered a Chinese company. That determination would be made by authorities on a case by case basis. It would be incumbent on the VIE to show it should be exempted from being put out of business like every other VIE.

Beijing has to walk a fine line if it is not to discourage the development of those industries in which Baidu, Sina and Alibaba operate. All of them could play critical roles in encouraging domestic consumption and thus help meet the government’s goal of rebalancing the economy away from infrastructure investment- and export-led growth. On the other hand, it can’t be too blatant in showing that there is one rule for the powerful and well connected and another for all the rest.

Such companies could also switch their governance to a two-share-class model, and keep the relationship between investors and owners as effectively separated as they are with a VIE. (We don’t approve of companies having A and B shares as a matter of good governance, but that is a topic for another day.)

However, the cost of that will be greater government regulation over them and possibly the promotion of state-owned enterprises to rival them, though perversely it may also give the big, established players some protection from new entrants who won’t be allowed to go the VIE route or anything that looks like it (though opening the capital account would mitigate the need to).

There are several parts of the political establishment, from the security and propaganda arms to the state-owned enterprises themselves, who would welcome reining in the big private Internet groups. Abolishing VIE’s might be intended primarily to kill a lot of flies, but, intentionally or not, there are some endangered tigers, too.

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China’s Slowing Economy Offers Slightest Glimmer Of Social Unrest

CHINA’S GDP GROWTH for 2014 came in at 7.4%. That is about as close to the fudgy official target of ‘about 7.5%’ as you can get. Props to accelerated infrastructure projects for that, giving construction output a late boost. Fourth-quarter GDP growth, at 7.3% year-on-year, beat expectations by 0.1 of a percentage point.

Further deceleration towards 7% growth seems likely this year as the double-digit growth rates of the past 30 years recede into the past. Slowing growth as the economy rebalances is the ‘new normal,’ a phrase much bandied about in public of late by senior officials.

As this Bystander has noted before, it was not so long ago that growth slowing to 8% was said to be a harbinger of social unrest because of the pressure it would place on employment. That is nowhere to be seen in the official unemployment numbers. These have steadfastly performed their patriotic duty by staying within a narrow band, 4.0%-4.3%, for more than a decade, and have been immovable at 4.1% for the past five years. Unpublished official unemployment numbers put last year’s rate at 5.1%, according to the Financial Times. An EIU-IMF-ILO estimate had the number at 6.3%.

The critical political question is what is the number, if any, that triggers the much-feared labour unrest. While demographic and structural changes to the economy are relieving some of the pressure on unemployment, there are straws in the wind that the economic slowdown is starting to have an effect at the margins on labour activism.

The China Labour Bulletin (CLB), a Hong Kong-based NGO that advocates for workers’ rights, recorded 569 strikes and protests by workers in the fourth quarter, more than three times as many as in the same quarter year earlier. That said, even allowing for the constraints Chinese workers find themselves under, that is not a huge total for a workforce approaching three-quarters of a billion strong.

Pay arrears, wage increases and compensation were behind almost nine out of ten of the incidents. The CLB’s strike map shows southern Guangdong province to remain the epicenter of labour dissatisfaction, accounting for one in five incidents. However, Jiangsu, Shandong, and Henan all saw a jump in strikes and protests last year, according to the CLB’s count.

Manufacturing accounted for 36% of incidents, but last year saw a jump in protests among construction workers. They accounted for 31% of the total in 2014, likely a consequence of the slump in the property market which has left uncompleted projects and unpaid workers along with them. Mining also saw a rise in protests. The industry has consolidated, and demand for its output  sagged.

One notable new set of protestors were teachers, angry at pension reforms proposed last year that would require them to pay contributions equivalent to 12% of their salary. This month, authorities said wages and pensions of public-sector employees would rise to offset any losses caused by the plan.

Other responses to labour activism have taken a harder line with both workers and the NGOs supporting them. In one instance last month in Shenzhen, paramilitary police were sent into the Artigas Clothing & Leatherwear factory to strike break. Such actions suggest there is just a glimmer of official concern at the social consequences of the slowing of the economy, though much will turn on the pace at which it happens.

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Investing On The Margin

THERE IS NO better indication of how global stock markets are being moved by what some older readers will recall as “the weight of money”. On January 19, Chinese equities fell by 7.7%, the most in a single day since the midst of the global financial crisis in 2008. The previous Friday, regulators reined in margin trading, recently at record levels in the Shanghai and Shenzhen exchanges. Speculative money turned tail.

Regulators are worried that the recent piling in by individual investors on the back of borrowed money is getting too risky. Outstanding margin loans totaled 1.1 trillion yuan ($177 billion) as of January 16th, up from some 400 billion yuan at the end of June. That is equivalent to 3.5% of the stock market’s overall capitalization.

Investors have been egged on by the Shanghai and Shenzhen exchanges, which last September expanded the number of stocks available for margin trading to 900 from 695. That helped make Chinese equities amongst the world’s biggest gainers last year.

Securities regulators have slapped a number of brokerages over the wrist, including China’s two largest listed securities firms, Citic Securities and Haitong Securities, for unauthorized lending to new clients who want to trade equities and to investors with less than 500,000 yuan in investable assets. The banking regulators are stopping banks lending to companies that borrow to invest in traded financial assets.

The securities regulators say that they are not trying to curb equity trading, but have acted to “protect investor’s rights and support the healthy growth of margin trading.” All true as far as it goes. Yet money goes where it can but only stays where it is welcome. Even if regulators haven’t taken away the punch bowl, they have swapped it for a smaller one.

Chinese investors now have a less than sanguine choice of where to put their money. It could go into a stock market they are being told looks too frothy, a housing market bubble that is being deflated, and financial products being sold by shadow banks, another potential disaster waiting to happen.

Each of the latter two has offered examples of what can weigh upon a market when liquidity drains away, and the fundamentals reapply. Now the first has, too.

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Take China’s 2014 Annual Growth Rate For What It Is

AN ECONOMY EXPANDING at an annual rate of 7%-7.5% would be a cause for celebration in many economies right now. In China, it is more likely to be a cause of handwringing than bell ringing.

The annual GDP figure for 2014 is due to be announced on Tuesday. The consensus view of economists whose views get polled for these sorts of things is that fourth-quarter growth will come in at 7.2%, which would put the number for the year at 7.4%.

That would be less than the official target of 7.5% although that has been turned into ‘about 7.5%’ over the course of the past year as the economy has slowed. Anything above 7% would be close enough to count as ‘about’. It is inconceivable, to this Bystander at least, that government statisticians won’t deliver a number that doesn’t have a seven to the left of the decimal point.

The sky probably won’t fall when China’s annual GDP growth falls below 7%, as it one day will. The sky didn’t fall when growth fell below 8%, similarly said at the time to be the rate below which only chaos could ensue.

However, to look at the likely performance of the economy in 2014 and only see one of the two slowest growing years of the past quarter of a century, a period that for decades routinely saw double-digit annual growth, is more than looking at the glass half empty. It is looking at the wrong glass.

The pace of growth that China has enjoyed for nigh on 30 years is no longer sustainable. That is partly a consequence of the law of large numbers. Even at current growth rates, China’s economy expanded by an estimated $680 billion last year, which is more than the entirety or Africa’s largest economy, Nigeria, or a European economy like Switzerland.

To move to its next phase of economic development, China’s economy needs to rebalance towards domestic-demand driven growth and away from investment- and export-led growth. A more moderate pace of growth is inevitable, as it was for Japan and South Korea at similar points in their economic trajectories. President Xi Jinxing has repeatedly signaled that. Only last week Prime Minister Li Keqiang called during a highly symbolic ‘Southern Tour’ for growth “within a proper range”.

The leaders’ only concern is that the economy does not slow too rapidly in case job losses or other economic or social dislocations undermine, first support for the measures needed to rebalance, and second, but far more importantly the legitimacy of the Party’s claim to monopoly rule which is based on delivering a rising standard of living. McKinsey, the international management consultancy, forecasts that salary rises this year will be the lowest in a decade. Nor can China’s burgeoning middle-class look to flip real estate now the property market bubble has been deflated.

Authorities took a series of targeted measures to stimulate the economy across the course of last year — a surprise interest rate cut, lower reserve requirements and looser loan restrictions. Such measures have continued into this, such as with the latest wad of loan money being made available to banks to lend to rural and small businesses and the ‘direction’ given to the private sector to invest in infrastructure projects.

The accelerated timetables being given to such projects means capital spending, a reported 7 trillion yuan ($1.1 billion) of projects approved in 2014, is greater than the 4 trillion yuan of stimulus monies that were thrown at the economy in the wake of the 2008 global financial crisis. That underlines the continuing struggle the government has in maintaining a balance between its long-term goals of structural economic reform, its medium-term need for fiscal discipline (there is still a shadow banking and local government debt bomb ticking, if less loudly than before) and its short-term imperative to keep the economy – and Party rule – humming along.

The number to the right of the decimal point that we will learn on Tuesday is relatively immaterial to all that.

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China Breaks New Ground By Putting Boots On The Ground In South Sudan

IT HAS LONG been expected that China would deploy troops in Africa, even though doing so would mark a shift away from Beijing’s long-held policy of keeping itself, in public at least, at arm’s length from involvement in African conflicts.

State media said last year that Beijing would send 700 infantrymen to take part in the UN peacekeeping mission in South Sudan, UNMISS. The first of those boots are now on the ground. The rest — including a small contingent of female soldiers — will be there by March, complete with other staples of ‘self-defense’ — armored personnel carriers, drones, anti-tank missiles and other weapons.

China already contributes more personnel to UN peacekeeping missions than any other permanent member of the Security Council. But most of its some 2,000 blue hats, mainly sent to Africa, are engineers, medical staff and other civilian workers, not, as in the case of South Sudan, a battalion of combat troops.

China has invested heavily in South Sudan’ oil, which accounted for 5% of China’s total crude oil imports as recently as December 2013. However, renewed civil war has since cut production by a third to some 160,000 barrels a day.

The troubled situation in the country, which separated from Sudan in 2011, has worsened since last December when the president accused his sacked deputy of attempting to orchestrate a coup. A potential humanitarian disaster threatens to make it worse still. Some 2.5 million people are facing famine; that is on top of 1.9 million already displaced by the conflict, in which at least 50,000 have been killed.

Oil-producing regions have seen some of the worst of the most recent violence, but Chinese oil workers in South Sudan and Sudan have been particular targets of kidnappings for several years. State-owned China National Petroleum Corp. (CNPC) owns 40% of the consortium that dominates South Sudan’s oil industry. Late last year, it signed a deal with Juba to stabilize then increase oil output.

Putting troops in the country will stiffen Beijing’s ability to push for a diplomatic end to the conflict, which, in a rare example of cooperation, it has agreed to work closely with the West towards resolving.  In this sense, the arrival of Chinese combat troops, even if they are wearing blue hats, underscores not just an international power willing to protect its overseas interests but also one willing to shoulder more international responsibility — for which, it should be said, the U.S. and others have been calling for some time.

This foreshadows, though, what will be a gradually increasing shift towards Beijing being far more of a global actor, albeit taking on a role it will want to play to its own script. As President Xi Jinping said in late November, “We should conduct diplomacy with a salient Chinese feature and a Chinese vision.”

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