ANZ agrees to sell its 20% stake in Shanghai Rural Commercial Bank

ANZ today announced it had reached agreement to sell its 20% stake in Shanghai Rural Commercial Bank (SRCB) to China COSCO Shipping Corporation Limited and Shanghai Sino-Poland Enterprise Management Development Corporation Limited for A$1,838m, equivalent to ~40bp. They say there is no material impact on overall profitability from the sale. However, in the financial year 2016 ANZ recorded a post-tax profit of A$259m (full year profit) associated with its 20% stake in SRBC.

This underscores the re-balancing of ANZ back to Australia as mentioned in the earlier results.

The agreement will see COSCO and Sino-Poland Enterprise each acquire 10% of SRCB for a total consideration to ANZ of RMB9,190 million (A$1,838 million). The sale price represents a price-to-book ratio of approximately 1.1 times SRCB’s net assets as at December 2015.

The sale will increase ANZ’s APRA CET1 capital ratio by ~40 basis points.

ANZ’s relationship with SRCB has been a successful financial and commercial transaction since the investment was made in September 2007.

  • ANZ has invested a total of A$568 million in SRCB. Since 2007, ANZ has recognised A$1.3 billion of equity accounted earnings and received A$178 million in dividends. In the 2016 Financial Year the SRBC investment contributed A$259 million to ANZ’s post-tax profits.
  • ANZ’s minority investments in China have also helped provide ANZ with a stronger understanding of the Chinese banking system which has supported the expansion of ANZ’s branch network in China and the approval of ANZ’s full banking licence in China in 2010.

ANZ Deputy Chief Executive Officer Graham Hodges said: “This partnership has been beneficial for both ANZ and for Shanghai Rural Commercial Bank. SRCB is now a strong, successful bank with a prosperous future.

“As we have previously stated, the sale reflects our strategy to simplify our business and improve capital efficiency.

“The sale will also allow us to focus our resources on our Institutional Banking business in Asia. This includes a significant commitment to China over the past 30 years with 100% ANZ-owned branches in Beijing, Shanghai, Guangzhou, Chongqing, Chengdu, Hangzhou and Qingdao serving our institutional clients,” Mr Hodges said.

After transaction costs and taxes, the sale price is broadly in line with the carrying value of the investment in ANZ’s accounts as at 30 September 2016. This includes accumulated equity accounted profits and foreign currency translation reserves over the period of investment. However, if completion occurs after the end of the first half of the 2017 financial year, accounting timing differences will result in a negative impact to net profit after tax in the first half, and a largely offsetting positive impact at completion.

The sale, agreed on 31 December 2016, is subject to customary closing conditions and regulatory approvals and is expected to be completed by mid-2017.

China Hits a Fork in the Road

From The Automatic Earth

The end of the year is always a time when there are currency and liquidity issues in China. This has to do with things like taxes being paid, and bonuses for workers etc. So it’s not a great surprise that the same happens in 2016 too. Then again, the overnight repo rate of 33% on Tuesday was not exactly normal. That indicates something like a black ice interbank market, things that can get costly fast.

I found it amusing to see Bloomberg report that: “As banks become more reluctant to offer cash to other types of institutions, the latter have to turn to the exchange for money, said Xu Hanfei at Guotai Junan Securities in Shanghai. Amusing, because I bet many will instead have turned to the shadow banking system for relief. So much of China’s financial wherewithal is linked to ‘the shadows’ these days, it would make sense for Beijing to bring more of it out into the light of day. Don’t hold your breath.

Tyler on last night’s situation: ..the government crackdown on the credit and housing bubble may be serious for once due to fears about “rising social tensions”, much of the overnight repo rate spike was driven by the PBOC which pulled a net 150 billion yuan of funds in open-market operations..”. And the graph that comes with it:


It all sounds reasonable and explicable, though I’m not sure ‘core leader’ Xi would really want to come down hard on housing -he certainly hasn’t so far-, but there are things that do warrant additional attention. The first has to be that on Sunday January 1 2017, a ‘new round’ of $50,000 per capita permissions to convert yuan into foreign currencies comes into effect. And a lot of Chinese people are set to want to make use of that, fast.

Because there is a lot of talk and a lot of rumors about an impending devaluation. That’s not so strange given the continuing news about increasing outflows and shrinking foreign reserves. And those $50,000 is just the permitted amount. Beyond that, things like real estate purchases abroad, and ‘insurance policies’ bought in Hong Kong, add a lot to the total.

What makes this interesting is that if only 1% of the Chinese population -close to 1.4 billion people- would want to make use of these conversion quota, and most of them would clamor for US dollars, certainly since its post-election rise, if just 1% did that, 14 million times $50,000, or $700 billion, would potentially be converted from yuan to USD. That’s almost 20% of the foreign reserves China has left ($3.12 trillion in October, from $4 trillion in June 2014).

In other words, a blood letting. And of course this is painting with a broad stroke, and it’s hypothetical, but it’s not completely nuts either: it’s just 1% of the people. Make it 2%, and why not, and you’re talking close to 40% of foreign reserves. This means that the devaluation rumors should not be taken too lightly. If things go only a little against Beijing, devaluation may become inevitable soon.

In that regard, a remarkable change seems to be that while China’s always been intent on keeping foreign investment out, now all of a sudden they announce they’re going to sharply reduce restrictions on foreign investment access in 2017. While at the same time restricting mergers and acquisitions by Chinese corporations abroad, in an attempt to keep -more- money from flowing out. Something that has been as unsuccessful as so many other pledges.

The yuan has declined 6.6% in value in 2016 (and 15% since mid-2014), and that’s probably as bad as it gets before some people start calling it an outright devaluation. More downward pressure is certain, through the conversion quota mentioned before. After that, first there’s Trump’s January 20 inauguration, and a week after, on January 27, Chinese Lunar New Year begins.

May you live in exciting times indeed. It might be a busy week in Beijing. As AFP reported at the beginning of December:

Trump has vowed to formally declare China a “currency manipulator” on the first day of his presidency, which would oblige the US Treasury to open negotiations with Beijing on allowing the renminbi to rise.

Sounds good and reasonable too, but how exactly would China go about “allowing the renminbi to rise”? It’s the last thing the currency is inclined to do right now. It would appear it would take very strict capital controls to stop the currency from plunging, and that’s about the last thing Xi is waiting for. For one thing, the hard-fought inclusion in the IMF basket would come under pressure as well. AFP continues:

China charges an average 15.6% tariff on US agricultural imports and 9% on other goods, according to the WTO.

Chinese farm products pay 4.4% and other goods 3.6% when coming into the United States.

China is the United States’ largest trading partner, but America ran a $366 billion deficit with Beijing in goods and services in 2015, up 6.6% on the year before.

I don’t know about you, but I think I can see where Trump is coming from. Opinions may differ, but those tariff differences look as if they belong to another era, as in the era they came from, years ago. Lots of water through the Three Gorges since then. So the first thing the US Treasury will suggest to China on the first available and convenient occasion after January 20 for their legally obligatory talk is: let’s equalize this. What you charge us, we’ll charge you. Call it even and call it a day.

That would both make Chinese products considerably more expensive in the States, and open the Chinese economy to American competition. There are many hundreds of billions of dollars in trade involved. And of course I see all the voices claiming that it will hurt the US more than China and all that, but what would they suggest, then? You can’t leave this tariff gap in place forever, so what do you do?

I’m sure Trump and his team, Wilbur Ross et al, have been looking at this a lot, it’s a biggie, and have a schedule in their heads for phasing out the gap in multiple steps. Steps too steep and short for China, no doubt, but then, I don’t buy the argument that the US should sit still because China owns so much US debt. That’s a double-edged sword if ever there was one, and all hands on the table know it.

If you’re Xi, and you’re halfway realist, you just know that Trump will aim to cut the $366 billion 2015 deficit by at least 50% for 2017, and take it from there. That’s another big chunk of change the core leader stands to lose. And another major pressure point for the yuan, obviously. How Xi would want to avoid devaluation, I don’t know. How he would handle it once it can no longer be avoided, don’t know that either. Trump’s trump card?

One other change in China in 2016 warrants scrutiny. That is, the metamorphosis of many Chinese people from caterpillar savers into butterfly borrowers. Or gamblers, even. It’s one thing to buy units in empty apartment blocks with your savings, but it’s another to buy them with money you borrow. But then, many Chinese still have access to few other investment options. That’s why the $50,000 conversion to USD permission as per January 1 could grow real big.

But in the meantime, many have borrowed to buy real estate. And they’ve been buying into a genuine absolute bubble. It’s not always evident, because prices keep oscillating, but the last move in that wave will be down.


If I were Xi, all these things would keep me up at night. But I’m not him, and I can’t oversee to what extent his mind is still in the ‘omnipotent sphere’, if he still has the impression that in the end, come what may, he’s in total control. In my view, his problem is that he has two bad choices to choose from.

Either he will have to devalue the yuan, and sharply too (to avoid a second round), an option that risks serious problems with Trump and other leaders (IMF), and would take away much of the wealth the Chinese people thought they had built up -ergo: social unrest-.

Either that or he will be forced, if he wants to maintain some stability in the yuan’s valuation, to clamp down domestically with very grave capital controls, which carries the all too obvious risk of, once again, serious social unrest. And which would (re-)isolate the country to such an extent that the entire economic model that lifted the country out of isolation in the first place would be at risk.

This may play out relatively quickly, if for instance sufficient numbers of people (the 1% would do) try to convert their $50,000 allotment of yuan into dollars -and the government is forced to say it doesn’t have enough dollars-. But that is hard to oversee from the outside.

There are, for me, too many ‘unknown unknowns’ in this game. But I don’t see it, I don’t see how Xi and his crew will get themselves through this minefield without getting burned. I’m looking for an escape route, but there seem to be none available. Only hard choices. If you come upon a fork in the road, China, don’t take it.

And mind you, this is all without even having touched upon the massive debts incurred by thousands upon thousands of local governments, and the grip that these debts have allowed the shadow banks to get on society, without mentioning the Wealth Management Products and other vehicles in that part of the economy, another ‘industry’ worth trillions of dollars. I mean, just look at the growth rates in these instruments:


There’s simply too much debt all throughout the system, and it’s due for a behemoth restructuring. You look at some of the numbers and graphs, and you wonder: what were they thinking?

China Must Quickly Tackle its Corporate Debt Problems

From The iMF Direct Blog.

China urgently needs to tackle its corporate-debt problem before it becomes a major drag on growth in the world’s No. 2 economy. Corporate debt has reached very high levels and continues to grow. In our recent paper, we recommend that the government act promptly to adopt a comprehensive program that would sacrifice some economic growth in the short term while rapidly returning the economy to a sustainable growth path.

Let’s first take a look at the dimensions of the problem. From 2009 to 2015, credit grew very rapidly by 20 percent on average per year, much more than growth in nominal gross domestic product. What’s more, the ratio of non-financial private credit to GDP rose from around 150 percent to more than 200 percent, or about 20-25 percentage points higher than the historical trend. Such a “credit gap” is comparable to those in countries that experienced painful deleveraging, such as Spain, Thailand, and Japan (see Chart 1).

china-corpdebt-chartThis corporate credit boom reflected the government efforts to stimulate the economy in the wake of the global financial crisis, largely through lending for infrastructure and real estate. The outcome: overbuilding and a severe overhang of unsold properties, especially in lower-tier cities, along with excess capacity in related industries such as steel, cement and coal. The combination of heavy borrowing and falling profits led to excessive debt loads. The problem has been worst among state-owned enterprises that benefit from preferential access to financing and implicit government guarantees, which lower the cost of borrowing.

High-level decision

So what is the solution? First, the government should make a high-level decision to stop financing weak companies, strengthen corporate governance, mitigate social costs and accept likely slower growth in the near term. It needs buy-in at every level—state-owned enterprises, local governments, and financial supervisors. Here are the other steps China’s government can take:

  • Triage: Identify companies in financial difficulty and distinguish between those that should be restructured and those “zombie” companies that have no hope of survival and that should be allowed to exit. Because of the existing links between state-owned banks and corporations, a new agency could be created to perform this role.
  • Recognize losses: Require banks to recognize and manage impaired assets. So-called shadow banks—trust, securities and asset-management companies—should also be forced to recognize losses.
  • Share the burden: Allocate losses among banks, corporates, investors and, if necessary, the government.
  • Harden budget constraints—especially on state owned enterprises—by improving corporate governance and removing implicit guarantees to prevent further misallocation of credit and losses.

To make the program work and limit the short-term economic pain, other supportive measures are needed:

  • Improve the legal framework for insolvency: But large-scale and expedited restructuring also requires out-of-court mechanisms to complement the existing framework.
  • Ease the transition: Broaden unemployment insurance coverage, provide income support for displaced workers and help them find new jobs. The social safety net should be improved because closing or restructuring loss-making companies in industries such as coal and steel could result in substantial layoffs.
  • Facilitate market entry: Dismantle monopolies in services such as telecommunications and health care and foster greater competition.
  • Improve local government finance: Ensure sufficient taxing powers and revenue sources for local governments to discourage off-balance-sheet borrowing.

Risks appear manageable if the problem is addressed promptly. Indeed, it is encouraging that the government has recognized the problem and is taking action to address it. The comprehensive strategy we have outlined would allow China to reduce leverage, limit vulnerabilities, and return to a strong and sustainable growth path over the medium term.

Read our recently published working paper for more information.

China’s Housing Market Isn’t a Bubble, Says One Strategist

From Bloomberg.

A financial crisis in China is no more likely in the coming decade than it was in the past 10 years, and pessimists predicting one have long done so without regard for fundamentals.

So says sinologist Andy Rothman, a San Francisco-based investment strategist at Matthews International Capital Management LLC, which oversees $26.1 billion. Before joining in 2014 he lived in China for two decades, working in the U.S. Foreign Service, including as head of the macroeconomics and domestic policy office of the U.S. embassy in Beijing. He later was a Shanghai-based strategist in CSLA Ltd., an investment banking arm of Credit Agricole SA.

China has no housing bubble and there’s no looming banking crisis, he says. His optimism rests on his view that the housing market is on a solid foundation. Leverage is the most important precondition for a bubble in any asset, and home buyer indebtedness in China is very low because down payment requirements are high, unlike in the U.S., he says.

“This isn’t like speculating in Las Vegas with zero money down,” he says. “China has a lot of problems, but they don’t tend to be the apocalyptic, catastrophic problems that we often read about. They’re more mundane, longer-term problems like how do you develop a rental market.”

While the country’s overall debt situation is serious, it’s still unlikely to lead to a financial crisis or economic hard landing, he says. That’s because potential bad debts are in state entities, which allows the government to manage how or whether they go bad, Rothman says.

He projects new home sales may fall 10 percent next year after rising about 30 percent in 2016 as the government continues to curb prices. While bears may see that as evidence of impending disaster, Rothman says it would still make 2017 China’s second-best year ever for new home sales because the base has grown so big.

Why capital is fleeing China and what it means for Australia

From The Conversation.

Foreign reserves at the People’s Bank of China (PBoC), China’s central bank, fell for the fifth consecutive month in November, dropping by US$69.1 billion to US$3.1 trillion. This is a level not seen since 2011, with reserves shrinking more than US$500 billion this year alone.

The Chinese government has moved to clamp down on capital flight, by introducing restrictions on foreign investment and curbing gold imports. But it could go further as the yuan stares down its worst year since 2005, making it harder for Chinese companies to borrow and repay debt.

The decline in China’s foreign reserves is not a blip, but has roots that go deep and could affect the ability of Chinese consumers and companies to be our customers. So the introduction of currency controls, especially if China revisits the quotas for Chinese individuals to spend on foreign goods or travel, is something to watch.

Why China is bleeding foreign exchange

The story goes back to August 2015, when China devalued the yuan in an apparent attempt to boost exports and growth. The devaluation probably would not have drawn so much attention if not for the fact that it appeared to trigger a huge outflow of capital from China.

It all has to do with historical patterns of borrowing by Chinese companies (and some wealthy individuals). During the boom years of export-and-investment-led economic growth, investing in China offered a good return (especially compared to what was available in Western economies). China’s shadow banking system grew and flourished – offering even greater returns to Chinese firms and individuals.

At the time it made sense to borrow at near-zero rates in the US and Europe, convert the money to yuan and invest in China. But the Chinese government brought this trade undone when it devalued the yuan back in August 2015. Borrowing in US dollars then selling those dollars to buy yuan-denominated assets no longer works.

It is now happening in reverse – yuan-denominated assets are being sold at record rates to buy US dollars in order to pay back old loans before it becomes too late. This outward flow of yuan generates downward pressure on the Chinese currency, which recently fell to its lowest levels in years. This is creating a feedback loop.

Before 2015, the PBoC bought dollars from Chinese companies that earned export income, printing lots of new yuan to do so. This money then circulated within the Chinese banking system and supplied the credit for China’s huge expansion.

But now the PBoC is selling down its reserves of US dollars to prop up the yuan. This also places pressure on Chinese banks, and may force the PBoC to allow banks to free up more of their available capital. These deteriorating conditions in the banking sector, along with China’s fast-rising private-sector debt, increase the cost of capital and put further pressure on foreign exchange reserves.

The economy isn’t helping

Further adding to the pressure since 2015 has been Chinese government encouragement for local companies to “go global”. Often such investments have been supported by subsidised loans or grants from China’s Export-Import Bank (China Exim Bank). At the same time, foreign investment into China has dwindled as labour and other costs have risen.

Both of these phenomena have been part of the Chinese government’s overall strategy of internationalisation, while moving away from an economy dependent on exports and towards an economy based much more on services and domestic consumption. The problem is, however, that the hoped-for rise in domestic consumption has not eventuated at anything like the rate necessary.

A crackdown on luxury consumption – seen as a sign of corruption by senior Communist Party members and officials – has further detracted from the desired growth in domestic consumption.

What all this means for us

Even with the restrictions put in place, there isn’t a total yuan lockdown. It is hard to prevent the movement of yuan out of China through the offshore yuan market. The Chinese banking authorities have fewer ways of preventing such transfers, especially as the government pushes the yuan as an alternative to traditional US dollar settlements.

But it’s likely China and its people will be much less able to afford direct purchases of Australian goods (iron ore, coal) and services (education, tourism) in the near future. This does not mean that Chinese demand for Australian goods will fall, but things might have to change.

It means that instead of just “selling stuff” to China, Australia needs to engage with the Chinese economy – to understand what that economy really needs. Australia has know-how and technology in health care, education, agriculture and energy that China needs and wants.

With the limitations of Chinese currency and investment controls, Australia may need to be more generous in its willingness to transfer some of that technology and know-how. For its part, China has to be much better at ensuring that the intellectual property involved in such transfers and the returns from them are properly protected. This could be the start of something brand new.

Author: Alice de Jonge, Senior Lecturer, International Law; Asian Business Law, Monash University

As its economy changes, China is starting to export its real estate ideas too

From The Conversation.

When it comes to discussions about Chinese real estate investors, we tend to focus on the idea that they are buying up property in places like Australia, pushing up prices – even if that is somewhat questionable. But it also ignores the other side of the equation. The number of properties built by Chinese developers outside of China has grown significantly, even as residential construction within China slows.

The expansion of Chinese residential development outside China has impacts on a number of levels, from property prices through to regional diplomacy.

The shift to Asia

Country Garden, a property development company based in Guangdong, China, is constructing apartment buildings that would add more than half-a-million homes and house 700,000 people in Johor Bahru, in southern Malaysia. This project goes far beyond constructing apartment buildings, however. It is part of an even bigger project named “Forest City” that Country Garden plans to build on four artificial islands.

The idea is that Forest City will be equipped with schools, shopping malls, parks, hotels, office buildings and banks. All ensconced in rich greenery, clean water and a quiet transportation system.

This grand project is just one example of the recent surge of overseas investment by Chinese property developers. Total investment in the Chinese real estate sector was growing at a rate above 10% until 2014, then dropped to less than 1% in 2015. This indicates a significant shift in Chinese real estate investment.

All the while, Chinese investment in the real estate sector overseas has picked up strongly. It has grown from $US0.6 billion in 2009 to US$30 billion in 2015. Several Chinese property developers have identified overseas investment as their main business growth strategy.

Two reasons for the pivot

Chinese investors have begun looking offshore for a couple of reasons.

Chinese buyer demand for overseas properties is growing. Since China reformed its economy and started growing at a fantastic rate, households have accumulated significant wealth. They now want to diversify their investment portfolios, and so are seeking property elsewhere.

Volatility in domestic housing prices has intensified this trend, despite various government policies aimed at smoothing out price fluctuations. An oversupply of properties in third and fourth-tier cities such as Ordos and Qinhuangdao created “ghost towns” where property isn’t desirable. In first and second-tier cities, however, prices have skyrocketed. House price-to-income ratios of these cities are ranked highest in the world, making it difficult to invest in properties in China.

In recent years there has been a huge expansion of production capacity. In 2015, China produced 51.3% of the cement and 49.5% of the crude steel in the world. As production capacity grows beyond the demand from the domestic market and runs into overcapacity, it is natural that firms will seek returns overseas.

The impact of it all

Taking Country Garden as an example, it is worth noting that the developer is not just building residential property, but designing and constructing the entire infrastructure for a city. Transport, greenery, water and noise control are all being put in place. These are beyond the scope of a conventional property developer.

Therefore, one potential positive impact of this project is to help boost the quality of infrastructure in Johor Bahru and so nurture more business activities in the future. The economic and geographic relationships between Johor Bahru and neighbouring Singapore may develop into one similar to that between Shenzhen and Hong Kong.

It is, however, critical that the local government monitors and enforces strict environmental protection and regulation to ensure the project won’t damage the natural environment or disrupt the local market.

The huge influx of newly built apartments has resulted in the value of residential sales dropping by almost one-third in in Johor Bahru last year. Whether this is a short-run phenomenon and housing prices will rally in the long run depends on whether more business activities and job opportunities can attract population inflow to the city and hence create higher demand for housing. In the short run, the fall in housing prices may lower the cost of living and attract firms and workers into the city.

For the Chinese government, it will be important to nurture more talent with legal and financial expertise to help Chinese property developers go out and invest overseas. This expansion by developers is just one, early facet of China’s new diplomatic efforts to develop infrastructure overseas.

Author: Yixiao Zhou, Lecturer in Economics, Curtin University

Fitch On China’s Banking Sector

Fitch Ratings’ outlook for the Chinese banking sector in 2017 is negative,  as weak profitability and strong credit growth will keep capitalisation under pressure. High and rising leverage in the corporate sector remains a key risk facing China’s banks.


China’s debt-resolution timeline is being pushed back by measures to lessen the debt burden on corporate borrowers – including low interest rates, loan rollovers, debt-for-equity swaps and a loosening of prudential controls. Leverage will continue to increase, especially at the corporate level, as long as there is reliance on credit to support GDP growth targets. We have revised up our estimates for growth in leverage, with Fitch-adjusted total social financing/GDP now likely to reach 258% by end-2016 and 274% by end-2017.

The authorities’ attempt to boost household lending may help to diversify risks. Household lending is relatively safe compared with corporate lending – given low LTV for mortgages, low household leverage and a high savings rate. However, rapid mortgage growth is driving sharp increases in residential property prices, and has the potential to fuel a further increase in corporate leverage since corporate borrowers use real estate as collateral to secure lending. Furthermore, policy guidance for banks to extend lending to struggling borrowers in over-capacity sectors also weighs on the banks’ risk-management and governance.

Fitch expects NPL and ‘special mention’ loan ratios to continue rising in 2017. Bank profitability will remain lacklustre and under pressure, owing to another likely cut in the benchmark one-year lending rate and further migration of deposits toward wealth management products (WMPs). WMPs now account for 17% of system deposits, and are a source of funding and liquidity risks for the banking sector.

Our forecast of flat profit growth and a double-digit increase in risk-weighted assets suggests that capitalisation will remain under pressure. The amount of announced AT1 and T2 issuance is not enough to keep pace with banks’ balance-sheet expansion, while equity-raising will be difficult in light of falling ROEs and questions over China’s medium-term growth.

Fitch’s previous research estimates that a one-off resolution of the debt problem would currently result in a capital shortfall of CNY7.4trn-13.6trn (USD1.1trn-2.1trn) – equivalent to around 11%-20% of GDP. The capital gap could rise further if current rates of inefficient credit are sustained and no additional capital is raised.

The Viability Ratings (VRs) of Chinese banks range from ‘bb’ to ‘b’, which reflects Fitch’s base case of varying-but-significant risks to capital and asset quality. These risks will linger unless there is a shift to a more stable operating environment, characterised by slower credit growth and higher loss-absorption buffers. Fitch’s stable rating outlook reflects our expectation of state support, which remains the sole rating driver for Chinese bank IDRs. More corporate debt is ultimately likely to migrate towards the sovereign balance sheet beyond the local government swap programme.


Financial wizardry alone won’t stave off a Chinese debt crisis

From The Conversation.

China’s debt is beyond worrying. It’s credit-to-GDP gap, a measure employed by the Bank of International Settlements (BIS) as a way to gauge debt levels, stands at 30%. This is the highest of any country going back to 1995 and is three times the threshold the BIS uses as an early sign of unsustainable debt.


The government has a plan to help ailing companies burdened by heavy debt levels. They will be allowed to give their creditors equity stakes in their companies in return for reducing debt. But while this may seem like a solution to the growing debt crisis, it is no more than a temporary lifeline.

China needs real market reform to avoid a debt crisis. Companies undergoing difficulties need to be restructured, hard budget constraints imposed, and losses and unprofitability revealed.

Buying time for zombies

The problem is China’s “zombie companies” – state owned corporations (SOEs) that operate in industries that are over capacity and have poor growth prospects, such as steel. For political reasons these companies can’t be shut or allowed to fail. The zombies are only kept afloat through loans (often at below market rates) from the state-owned banks. They have no prospect of repaying these.

This is where the plan comes in.

China is attempting to restructure some of the zombies by allowing them to swap their bank debt for an equity stake in the company. But this loan-relief plan is only designed to alleviate pressure on the companies, by lowering the cost of servicing debt for those undergoing temporary hardship.

The guidelines for the swap emphasise they would be market orientated. But there is no clear reason for a bank to want an equity stake in a company facing difficulties, nor for an SOE with only temporary cash flow issues to part with valuable ownership stakes.

These kinds of swaps have been done before, but not like this

Converting debt to equity is a technique that has worked in other countries but could deepen the debt problem if used by China’s zombies. In its current form it is little more than buying some breathing room for the SOE and transferring the risk to the bank.

It is essential that the new equity comes with some control by the entity receiving equity, so they can reform the zombies. The proposed debt for equity swap appears to be a temporary measure only, and there is little detail on whether the asset managers gain any control or can push through a reform agenda.

Further, the debt for equity swap will be facilitated through asset management companies which are predominantly subsidiaries of the state owned banks. It is unlikely that they would have any more skill in managing these assets than the banks do. Unless there is a clear change in the corporate governance and transparency of the SOEs then there is little likelihood of change.

There needs to be real reform

This is some hope that China is moving ahead with some reform measures. A number of planned debt to equity swap plans have been successfully rejected by creditors. Dongbei Special Steel, for example, was forced into bankruptcy by creditors. And there has also been a sharp rise in the number of SOE defaults. But the heart of the debt problem needs to be addressed.

Chinese debt is now closing in on 300% of GDP and a recent Reuters survey found a quarter of Chinese companies generated insufficient profits to cover the interest payments on their debt.

The International Monetary Fund has suggested a comprehensive reform strategy involving identifying companies with difficulties, recognising losses and burden sharing. They specifically note that restructuring SOEs and imposing hard budget constraints is vital to the reform.

However this reform will be expensive both politically and economically and will likely result in slower growth and great volatility in the financial markets. The debt-for-equity swap program is a temporary measure where a real solution is needed. Unless China undergoes tough reforms it is heading for a hard landing.

Author: Kathleen Walsh, Associate Professor of Finance, Australian National University

China’s Proposal to Revise Banks’ Off-Balance-Sheet Exposure Regulations

Moody’s says on 23 November, the China Banking Regulatory Commission (CBRC) published a consultation paper that aims to tighten regulations for commercial banks’ off-balance-sheet activities, which have grown rapidly in recent years. If implemented, these measures would be credit positive because they would reduce risks in the banking system and curtail incentives to engage in the regulatory arbitrage that has accelerated the growth of China’s shadow banking activities.

moodys-chinaThe proposed guidelines provide a more comprehensive set of definitions for off-balance-sheet exposures to better capture the latest innovations. When the CBRC formulated the current regulations in 2011, they mainly addressed the guarantee and commitment businesses. The new rule will expand to include entrusted services (which includes entrusted loans and investment, non-guaranteed wealth-management products, agency transactions, agency issues and bond underwriting) and intermediary services (including agency collection and payments, financial advisory and asset custody). These new services have grown rapidly in recent years, raising concerns about the expansion of China’s shadow banking system.

We estimate that the shadow banking sector grew by an annualized rate of 19% in the first half of 2016 to RMB58.3 trillion, or 80% of GDP, fueled predominately by the issuance of wealth management products. A China Banking Wealth Management Registration System report showed that RMB20.18 trillion of the RMB26.28 trillion of outstanding wealth management products at the end of June 2016 were non-guaranteed products usually kept off the balance sheet of the originating or distributing bank. By remaining off balance sheet, banks have been able to circumvent regulations on loan quotas and limits and dodge capital and provision requirements.

The proposed new guidelines require banks to set provisions on impairment losses on off-balance-sheet assets and retain risk-based capital on such assets. Although many wealth management products are off balance sheet, customers perceive banks as having provided an implicit guarantee for these products. The new rule would increase regulatory capital requirements that better capture banks’ actual credit risk.

The revised guidelines also ask for more detailed disclosure and more robust risk management of off-balance-sheet exposures, and banks would have to establish risk limits for off-balance-sheet exposures. Although the People’s Bank of China plans to include off-balance-sheet items in its macro-prudential assessment and the CBRC in July issued new draft rules on banks’ wealth management products, the new proposal offers a more comprehensive regulatory framework and complements other measures already in effect. The tighter rules will help contain off-balance-sheet risks and improve financial system transparency.

Banks with higher off-balance-sheet exposures will be most affected by the new regulation. Small and midsize banks will likely be most affected by the revised measures because they have been the more active issuers of wealth management products, which at some banks have become a key revenue source.

Although the revised rules focus on general risk-management principles, they fall short in providing details on actual execution, and leave a few key questions unanswered. For example, it remains unclear which off-balance-sheet assets’ credit risks are deemed retained by the banks themselves. Also lacking are specifics about the supervision for the risk conversion factor of off-balance-sheet assets or any details on the level of capital and reserves required. Additionally, a lack of uniformity across banks remains because banks’ boards of directors are responsible for approving off-balance-sheet business, risk management and imposing risk limits. Consequently, implementation by each bank will vary.

Trump hasn’t derailed Chinese homebuyers’ obsession

From South China Morning Post.

Donald Trump’s presidency won’t hurt the rising tide of Chinese investment into the United States – in fact, the level of cash may actually increase, according to Knight Frank.

Trump’s shock election last week rattled markets around the world and analysts continue to disagree on what the Republican candidate’s victory means or how it will affect the US property market, the No 1 destination for Chinese capital. “The short answer is I am not worried about Trump’s impact on Chinese flows into America,” Knight Frank’s global capital markets head Peter MacColl told the Post during a visit to Hong Kong last week.

“Whilst he’s come out with a lot of rhetoric, what might be considered to be barmy ideas that might have an impact on the geopolitical scene globally, the American system of checks and balances through Congress, through all the advisory parties that any change has to go through, means any really radical things won’t happen overnight,” he said.

“I don’t think there will be a big downturn in the property market because of Trump, and if anything, there could be a bit of an upturn because of his policies towards business generation and self responsibility.”

In the short term, MacColl expects there to be a bit of “waiting in the wings and seeing what’s going to happen”.

“A bit of caution, a bit of a slowdown just in terms of making decisions – which is understandable – until maybe the new year when things start to pan out a bit.”

But MacColl said he didn’t see a lot of risk to mainland Chinese investors in the US from Trump’s presidency and expected the US to remain the favoured destination for Chinese capital.
There wasn’t just a pull factor, there was also a push factor, with Chinese investors keen to take their money out of the country as the yuan continued to be devalued, he said.

The total volume of Chinese outbound real estate investment between January and October is slightly down on the same period last year, according to Knight Frank research.

But not everyone was so positive. Jefferies equity analyst Mike Prew said the combination of a possible post-election Federal Reserve rate rise in December and rising bond yields compared with property yields could have an effect on the returns in the US’s $27 trillion residential market.

“Things could get messy for real estate,” he said.
He tipped Canadian residential markets of Toronto, Montreal and Vancouver to be the big property winners following the US election.

Simon Smith, head of research and consultancy for Savills, agreed that investors would stay cautious for the rest of this year and capital volumes might be more muted.

“The uncertainty continues to drive people to the United Kingdom,” he said, noting that Brexit had also worked out positively for the British property market thanks to the falling pound – something which hadn’t happened to the US dollar. “It looks like the UK remains a net beneficiary of what’s been happening.”

Trump’s indication that he would invest in infrastructure was judged as positive by investors, but question marks remain over the wider policy direction of his presidency.

“I don’t think the clouds have parted quite yet on Trump and what election promises he may or may not choose to enact. We’re still asking ourselves: is this soft Trump or hard Trump?”
New York real estate company CityRealty’s director of research Gabby Warshawer said it was difficult to predict the long-term implications of Trump’s presidency on New York property,
which was the top destination for Chinese capital investment in the first six months of this year.

“If the stock market were to be extremely unsettled for a long period of time, that would have a clear effect on real estate — for example, following the financial crisis in late 2008, it took more than three years for New York real estate prices and sales volume to bounce back,” she said in an emailed response to questions from the Post.

“That being said, analysts have not been predicting a protracted doomsday scenario for the markets following this election.”
She said it was unlikely there would be significant change in Chinese investment following the election as the buying spree had a lot to do with property market conditions in China.

“If there is significant turmoil and the United States is no longer considered as safe for real estate investments as it has been in recent years, then that would impact all international buyers,” Warshawer said.“The New York City real estate market is stable and exceptional enough that it is still generally seen as a safe long and medium-term investment by most buyers, regardless of campaign rhetoric.”