China has been running a current account surplus since 2000, which has been a policy issue regarding exchange rates and currency manipulation. A current account surplus means that China has been a net lender to the rest of the world. China’s current account surplus reached 10 percent of gross domestic product (GDP) in 2007 and then started to decline until 2011, when it fell to 1.8 percent of GDP. The current account surplus has been stable since then, with a slight tendency to increase in more recent years. In particular, in 2015, the current account was around 3 percent of China’s GDP, but it has not returned to the high levels reached in 2007. What are the main factors behind the decline?
The current account is composed of three main categories: (i) the trade balance (net earnings on exports of goods and services minus payments on imports of goods and services); (ii) the net income to foreign factors (compensation of employees, investment income); (iii) and transfers.
In China’s case, the main component behind the current account trend is a decline in its trade surplus. A trade surplus indicates that China has been earning more on its exported goods and services than it has been paying for its imports (i.e., it has had positive net exports). As Figure 1 shows, net exports in China, as a percentage of GDP, closely track the current account and have been declining since 2007. Indeed, the trade surplus was around 9 percent of GDP in 2007 and fell to 3.5 percent of GDP in 2015. This decline has been driven by both a decline in the surplus of traded goods and an increase in the deficit of traded services (Figure 2). However, the goods surplus has picked up again since 2011, while the services deficit has become more pronounced. Interestingly, trade in services was roughly balanced between 2000 and 2007 and later became a deficit, reaching around –1.7 percent of GDP by 2015. Thus, even though the value of China’s exported goods has exceeded the costs of its imports, China has been importing more services than it has been exporting. Even more interesting is the fact that the increase in China’s services deficit has prevented its current account surplus from rising despite the increased trade surplus in goods.
Figure 3 shows the main categories of China’s international trade in services. One category stands out: travel services, which includes mainly tourism. China’s increasing services deficit has been driven mainly by overseas tourism- related consumption. According to a recent report, two population groups in China have been driving tourism: Millennials (young people 15 to 35 years of age) and a growing middle class. The report indicates two primary reasons for increased tourism by these two groups. On the one hand, young people travel for exposure to overseas experiences. On the other hand, Chinese travel for shopping, which accounted for 30 percent of overseas Chinese spending in 2015. The prime shopping destination currently is Hong Kong, but new destinations such as Japan, Korea, and Europe are expected to become increasingly popular.
Overall, the increasing trade deficit in services, spurred mainly by the rise in tourism, seems to be an important factor in the recent trend in China’s current account. As a result, the current account surplus is increasing only slightly despite a larger increase in net exported goods in recent years. What factors could change this trend? Fluctuations in exchange rates in the main destinations for Chinese tourists could affect tourism. For instance, a depreciation of the yuan could slow the increase in the travel services deficit while concurrently increasing the earnings in exports of goods—all of which could generate a larger current account surplus.
The Australian bond market is likely to feel the effects of US President Donald Trump’s protectionist trade stance both directly and indirectly, writes Nikko Asset Management’s James Alexander.
The emergence of China is clearly of great importance to the economic fortunes of Australia, and as a result it may be tempting to downplay, or even overlook, President Trump’s agenda and its impact on Australia.
While our largest import and export partner is now China, Australia will still be impacted by US trade policy both directly and, perhaps more importantly, indirectly.
The difficulty for investors, however, is the general uncertainty around future US trade policy, and the impact the Trump administration will have on financial markets.
Uncertainty around trade
While most of President Trump’s comments so far have been directed at China and Mexico, we do know that he is not a fan of trade deals negotiated by others.
Trade deals he has criticised in which Australia has been involved include the Trans-Pacific Partnership (TPP), from which the US has just withdrawn, and the North American Free Trade Agreement (NAFTA).
The essential message here is that these are bad deals for the US, as opposed to future Trump-negotiated deals, which will of course be good for the US.
It is likely to be some time before we can reasonably assess the impact of changes to US trade policy with Australia directly, given their larger trade relationships are most certainly ahead of us in the queue.
This brings us to the indirect but significant impact of the US’ future trade relations with our biggest trading partner, China.
A tit-for-tat trade war is likely to be harmful to both the US and China, with Australia most certainly suffering some collateral damage.
It is too early to tell how this relationship will unfold but the early signs are not great, with President Trump taking every opportunity to criticise China.
These two economic heavyweights have plenty of tools to ‘penalise’ each other on trade, which could potentially hurt Australian trade in the process.
Rising bond yields
The other broad area where the impact of a Trump presidency is likely to be felt is in financial markets – more specifically, bond yields and foreign exchange rates.
Australia’s bond yields have historically been strongly correlated with US Treasury yields and this is likely to continue.
If the Trump agenda of lower taxes, increased infrastructure spending and more protectionist trade policy prove to be inflationary as we expect, US interest rates and bond yields are likely to be headed higher.
Australian bond yields will surely follow, as Commonwealth bond yields must remain globally competitive to ensure international investors continue to support our borrowing needs.
Another widely discussed by-product of Trump’s agenda is a stronger US dollar.
While the Australian dollar has fallen by around 2.5 per cent against the American currency, it has actually risen slightly on a trade-weighted basis since the presidential election in November.
This divergence, should it continue, will be one to watch carefully.
While a weaker Australian dollar would indeed help to counter any negative impact from higher bond yields, weakness that is mainly isolated to the US dollar is not nearly as helpful as weakness on a trade-weighted basis.
James Alexander is the co-head of global fixed income and head of Australian fixed income at Nikko Asset Management.
The Australian Transaction Reports and Analysis Centre (AUSTRAC) has reported that in 2015-16, around $1 billion in funds related to property and real estate were transferred between China and Australia.
Typically, AUSTRAC is notified of these matters via suspicious matter reports (SMRs) which are submitted by banks, money remitters and other financial institutions.
Suspicion may be warranted – and a report sent to AUSTRAC – in a number of circumstances including if a bank or institution thinks a person is not who they claim to be, the information given relates to evading tax law or aiding criminal activity, or there is a chance of money laundering or terrorist funding.
John Moss, AUSTRAC’s national manager of intelligence, told Australian Broker that these SMRs indicate a total of $3.36 billion of funds was sent between China and Australia in the stated time period.
“AUSTRAC data shows that the overall total amount of fund flows between Australia and China during 2015-16 was $76.7 billion,” Moss said.
The agency was constantly vigilant to identify increases in the number of suspicious transactions from a number of countries, including China, he added.
“We’re confident that the agency’s approach with our Chinese counterparts through a recently signed Memorandum of Understanding, as well as close collaboration with Australian law enforcement and other partner agencies – such as the ATO, ACIC and FIRB – is providing an effective response to protect the Australian community from such financial crime.”
China may permit more commercial banks to sell bad loan-backed securities in 2017 to help lenders cope with surging sour loans and deepening economic slowdown, according to global ratings agency Fitch Ratings.
Under the government’s regulatory support, China’s nascent structured finance market has seen a strong growth in 2016, with the total issuance of asset-backed securities up 42 per cent year-on-year to 865 billion yuan (HK$975.9 billion), according to recent statistics from Fitch.
Asset-backed securities are bonds or notes backed by financial assets, including loans, leases, company receivables etc. China’s asset-backed securities market was restarted in 2012 after three years of suspension. After a flattish start in 2012 and 2013, it gained strong momentum in 2014 and has expanded at a rapid pace since then.
In 2016, six Chinese commercial banks become pilot banks for issue of asset-backed securities products backed by non-performing loans, with a total quota of 50 billion yuan. These banks include the Industrial and Commercial Bank of China, China Construction Bank, Bank of China, Agricultural Bank of China, Bank of Communications, and China Merchants Bank.
The six pilot banks issued a combined 15.6 billion yuan of non-performing loans’ asset-backed securities products in 2016, according to recent data from China Government Securities Depository Trust & Clearing Company.
“We expect further issuances in 2017,” said Hilary Tan, director of Non-Japan Asia Structured Finance for Fitch Ratings.
Tan said the government is likely to expand approval to more commercial banks to help them deal with rising bad loans.
The bad debt ratio of Chinese banks has risen to 1.81 per cent by the end of 2016, the highest since the second quarter of 2009, according to recent data from the China Banking Regulatory Commission, the China’s banking regulator.
Statistics from Fitch also showed that 53 per cent of the asset-backed securities issuance in 2016 was under the asset-backed specific plan, regulated by the China Securities Regulatory Commission. These asset-backed specific plan products reached 459 billion yuan, representing a 134 per cent year-on-year increase.
About 45 per cent of the total issuance was under the credit asset securitization scheme, governed by the People’s Bank of China and China’s banking regulator. These issued credit asset securitization scheme products reached 391 billion yuan in 2016, slightly down 5 per cent year-on-year.
Fitch said the asset-backed specific plan attracted more corporate issuers due to the diversified underlying asset-classes it issued in the bond exchange market.
Chinese President Xi Jinping’s appearance at last week’s World Economic Forum shows global leadership is shifting, not drifting, toward Beijing. The most vigorous defense of globalization and multilateral cooperation was mounted not by an American statesman, but by the president of the People’s Republic of China.
“The problems troubling the world are not caused by globalization,” Xi declared. “Countries should view their own interest in the broader context and refrain from pursuing their own interests at the expense of others.”
As Washington greets a new administration disinclined to play a worldwide role, Beijing increasingly accepts opportunities to lead. Xi and his colleagues understand that their country’s domestic development and global ascendance require steady engagement and honest efforts abroad.
Yes, China has “done the right thing” before. It has restricted antibiotics in food-animal agriculture, created a new infrastructure-development bank for Asia, aided previously exploited African countries and promised to end its internal ivory trade.
But never before has China so forthrightly stepped up when the United States appears to be stepping away. As scholars of Chinese strategy and the intersection of science and politics, we see how Beijing’s ambitions and interests will affect its engagement on a range of important international issues.
The case of climate change
Climate change policy is one good example of this trend. Commentators warn that Trump’s pledge to withdraw the U.S. from the Paris climate agreement would let China “off the hook” for curbing carbon emissions. In fact, China put itself “on the hook” in Paris for reasons having little to do with the United States.
China’s most urgent atmospheric problem is not carbon dioxide. It’s combustion toxicity from burning coal, oil and biomass. The Chinese these days don’t look through their air; they look at it. And what they see, they breathe.
Combustion toxicity has degraded China’s air quality so much, by Chinese assessments, as to destroy 10 percent of GDP annually since the late 1980s and cause hundreds of thousands of premature deaths every year. And air pollution has become China’s single greatest cause of social unrest.
In response, China is closing its old coal-fired power plants, and the new ones it’s building are much farther away from its prosperous and politically influential eastern cities. Other fossil-fueled industries are being put farther away, too. China has also contracted with Russia to buy huge amounts of natural gas, whose combustion emits lots of CO2 but not a lot of toxic air pollutants.
These moves will expose fewer people, especially prosperous urban dwellers, to toxic air pollution. On their own, though, these moves will not do much to meet carbon targets and restrain warming.
In an even better bet to clear its air, China is moving to add more nuclear, hydroelectric, solar and wind turbine generating capacity. Greenpeace estimates that during every hour of every day in 2015, China on average installed more than one new wind turbine, and enough solar panels to cover a soccer field.REUTERS
China is already the world’s leading producer of renewable energy technologies. More remarkably, it is also the leading consumer. And in January, it announced plans to invest an additional US$360 billion in renewable power between now and 2020. That’s $120 billion a year.
These renewable power measures are being taken to fight China’s number one problem – air pollution – but they will also automatically cut China’s carbon emissions. If it can manage political rivalries among local power companies and upgrade its electrical grid to handle all that solar and wind capacity, then China is likely to meet its Paris commitments earlier than currently required.
Defecting from Paris would not help China address its air pollution problem. Defection would, however, reinforce the presumption that U.S. leadership is indispensable – a presumption Beijing is loath to perpetuate.
A savvier and more probable move is for China to assert – for the first time on a major global issue – moral authority. Chinese diplomats are already reassuring the world that China will keep and even expand its climate commitments. This message conveys Beijing’s resolve not to let to let multilateral greenhouse gas mitigation collapse, and show the way out of a crisis whose agreed solution is threatened by others’ malfeasance.
National interest in global leadership
If sustained, such action will mark a critical inflection point in China’s global role. It will become less a challenger to an established order, and more a champion of a common cause. The United States will risk being regarded as aloof and unreliable and, following its 2016 election, even politically unstable.
Likewise, Beijing is asserting greater leadership in other areas once led by Washington. With the demise of the Trans-Pacific Partnership, which Washington negotiated with 11 Asian countries excluding China, Beijing is promoting its own Pacific trade-and-investment framework excluding the United States.
Even more grandly, Xi is articulating an alternativevision for global economic growth. The model focuses on physical investment, especially in transportation and IT infrastructure. In this, it is linked to the new Silk Road project, through which China is expanding linkages across Eurasia by integrating railways, ports and information networks into transnational corridors. The Chinese approach also does not rely on portfolio investment and central banks exertions to drive growth – a sharp contrast to Western policies.
Ceding global moral authority to China would be a high price for America to pay for the pleasures of political posturing. Yet a China leading by example would have a greater stake in its own reputation, and the greater that stake becomes the more engaged China becomes. Such a China, we believe, could profoundly benefit the world.
Professor of International Affairs and Asian Studies, Pennsylvania State University; Associate Professor, University of Maryland
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.
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.
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 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).
This 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.
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.
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.
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:Senior Lecturer, International Law; Asian Business Law, Monash University