May 03, 2024 | Andrew Collier 

Executive Summary 

The Wall Street Journal reported that the U.S. is considering imposing sanctions on Chinese banks that are supporting the export of goods to for Russia’s war in Ukraine. The State Department has denied the reports but it would be logical for the U.S. to use its dominance of the US dollar financial system as leverage against China. But would sanctions work? The short answer is – yes, but it would take time because China’s vast banking system and large territory makes it easier for Chinese institutions to hide their support for Russia. 

However, the short answer is there is little that China can do in the near future to sanction proof its economy. It has far too many ties to the US dollar system and there is too little progress in the globalization of the yuan to turn China’s currency into an alternative to the US dollar. To discuss this issue in more detail we would need to break it into two parts: the technology of currency flows; and the political questions regarding China’s involvement in global trade and the degree of its control over the domestic banks and local governments. On the technical side, despite vast efforts to globalize the yuan, it still accounts for less than 5 percent of global payments and the bulk of those are with countries in Asia that are receiving financial support from China or are involved in loan programs such as the Belt and Road. To increase the global use of the yuan, the PBOC has negotiated bilateral currency swap agreements with at least 39 central banks, totalling close to 4 trillion yuan. Unlike the Federal Reserve swaps, though, these are not permanent and are not available in unlimited amounts.

Does Beijing have the structures in place to regulate bank support for the hidden Russian trade? 

The political question is — how much influence would U.S. sanctions have on Chinese banks? This is a tough question, namely because the Chinese banking system is complicated. The chart below tells the part of story. More than half of Chinese banks are state owned. They have a strong interest in maintaining links to the US dollar-centric world and have been quick to adhere to previous U.S. sanctions. One of the largest of the globally oriented Chinese banks (and my former employer) is the Bank of China. The BOC’s balance sheet indicates that their exposure to the U.S. dollar is growing, not shrinking. This is an indication they are wiling to adhere to U.S. policies regarding Russian sanctions. 

https://www.bloomberg.com/news/videos/2023-11-29/orient-capital-s-collier-on-china-s-economy-video

Andrew Collier, Managing Director at Orient Capital Research, discusses his outlook for China’s macro economy and property sector. He speaks with Haidi Stroud-Watts and Shery Ahn and on “Daybreak Asia”. (Source: Bloomberg)

Is China facing a “Lehman Moment” due to high shadow banking debt?

China’s shadow banking differs substantially from that of the U.S. before the financial crisis. There, the shadow lending funding the property boom consisted of collateralized and leveraged mortgage products that were highly liquid, traded instruments. Many official banks participated in this business, along with “shadow” non-banks such as insurance companies.

In contrast, China’s current shadow banking is funded mainly by the banks with few liquid instruments. Thus, the pace of decline is is more controllable compared with the U.S. crisis. Three-quarters of LGFV debt is bank debt, for example, with bonds and private investments accounting for the remainder. The recapitalization, or default process, is under the jurisdiction of the banks (with political input from the local governments and the PBOC).

Bank loans?

Where could China see a run on a bank or shadow bank? The one recent example in January 2023 of a near default by an LGFV, Zunyi Road and Bridge, was averted by a 20-year bank extension of 60 billion yuan in outstanding debt, and no repayment of principal for 10 years. It’s unclear if Zunyi will set a pattern. Regulators have hinted that it would not because they don’t want the banks to encourage the growth of bad debt or see bank margins hurt.

However, no LGFV wants to be the first to default as it could cause a chain reaction among all LGFVs, and possibly some local SOEs, and hurt the career advancement of the provincial or city party leaders.

There are many channels of debt in China’s property market. However, they all directly or indirectly go through the banks. That means that the PBOC and the Central Financial Work Commission in the Central Committee of the Politburo, along with lesser political actors in the provincial governments, have some ability to pull the strings—when the puppets threaten to dance their own tune. Significant losses will be absorbed by the weaker institutions, including poorer provinces, weaker rural banks (which may be absorbed by stronger SOE banks), and home-owners with few legal tools for compensation for lost property. The deleveraging process in the property market will be a series of lengthy, local battles, not a single war.

Global Source Partners

Beijing believes the risks of a US-style financial crisis caused by a property bubble outweigh the risks of an Evergrande default. But it is also encouraging a “soft” landing for the resolution of Evergrande’s debt problems that would avoid political unrest and a bank crisis. How will Beijing resolve this conflict?

Beijing plans to force the local governments to resolve debt issues locally. This passes the responsibility from the center to the periphery. The Politburo’s attitude is that the provinces have benefited from the success of companies like Evergrande, so it is up to them to solve it. This absolves the center’s financial responsibility.

More importantly, the geographic diversity of debt solutions is likely to avoid a systemic problem in the economy or financial system. One question is crucial: What is the capacity of local governments to absorb Evergrande’s debt?

Catalysts and transmission in the Minsky Moment

A rapid deleveraging of assets requires both a catalyst and a transmission mechanism. China differs substantially from the United States pre-crisis in that it does not have the large pool of securitized assets that led to the U.S. mortgage crisis. The majority of lending to the property market is through the banks. Liquid instruments in the shadow banks – through Trusts, wealth management products, and interbank loans – have been sharply curtailed over the past five years. Even for Evergrande, only about 10 percent of liabilities are WMPs.

The potential catalysts for a property-driven financial crisis include:

• A collapse in Evergrande’s outstanding WMPs that causes a run on WMPs across China.
• A rapid reversal in property prices that convinces buyers to sell, a pro-cyclical action that would accelerate the downturn in the property market.
• A widespread belief that the central government is no longer interested in supporting rising property prices and is willing to accept the collapse of the entire market (even before any specific policy actions have been taken nationally).

Global Source Partners

What does Xi Jinping’s “common prosperity” mean for the economy?

Andrew Collier | Aug 30, 2021

Executive Summary

Xi Jinping launched his vision for common prosperity officially in an internal meeting in the Politburo on August 17. This was a follow-on to the harsh regulations imposed on China’s technology sector. Although Xi has been using the term “common prosperity” for several years, its appearance in his speeches doubled in 2020, according to a Bloomberg analysis. What does this term mean for the economy and the markets? We draw several conclusions:

1. Targets related to inequality that enhance Xi’s popular appeal will be at the top of the list. This includes wealthy entrepreneurs and their companies and those deemed not contributing to the construction of a socialist society.
2. Luxury goods and those involved in “corrupt” consumption will suffer either from press campaigns or actual policy changes such as higher taxes, reduced profit margins, or other financial measures.
3. The property market will continue to be curtailed. This follows the reduction of risk through the Three Red Lines policy in 2020 (which I presume was launched by the central bank and not the Politburo and was a reasonable policy). However, a serious attempt to enact a property tax is unlikely.
4. Fundamental restructuring will not occur that could meaningfully contribute to improving income redistribution. This includes the state sector and the use of the VAT instead of general income taxes.

Xi Jinping is most determined to reduce the challenge posed by large, powerful companies (such as Jack Ma) but lacks the interest – or power – to alter the country’s underlying economic structure, particularly the state sector, which could significantly improve income equality in China. (For full report, contact Global Source Partners).

Orient Capital Andrew Collier on China’s Credit Risks, ‘Common Prosperity’

• Bloomberg Markets China Open

September 6th, 2021, 12:17 PM GMT+0800

Orient Capital Research Managing Director, Andrew Collier, discusses a potential default risks in China of indebted companies such as Evergrande and Huarong. Andrew also tell us what “common prosperity” term may mean for the country’s economy and the markets. Andrew is a former president of the Bank of China International USA, and the author of a book on shadow banking in China. He speaks with David Ingles on ‘Bloomberg Markets: China Open’. (Source: Bloomberg)

https://www.bloomberg.com/news/videos/2021-09-06/orient-capital-andrew-collier-on-china-s-credit-risks-common-prosperity-video

Global Source Partners

China’s Education Crackdown – How Far Will This Go?

Andrew Collier | Jul 27, 2021

Executive Summary

The new regulatory crackdown on the educational sector in China was a surprising move by China. New Oriental Education’s shares plunged 17.5% on the news. What really is a shock is how small the companies are in this sector – EDU has a market cap of just $6.6 billion. What is going on and how far will this go? Is China reverting to a 100 percent state-owned economy?

China’s “mini-decoupling”

There are a couple of micro reasons for the latest regulatory crackdown.

First, the education companies, as with many of the smaller tech companies, are listed in the U.S. China is intent on reducing the ability of Chinese companies to access capital in the west. This is to further the goals of financial decoupling. Eliminating the VIE structure and NASDAQ listings would reduce the power base of private entrepreneurs in China. In addition, education is focused on getting students into international schools and teaching them foreign languages, particularly English. According to the Chinese Society of Education, about seven in 10 students in kindergarten through 12th grade receive after-school tutoring in major cities like Beijing, Shanghai, Guangzhou and Shenzhen, the Wall Street Journal reported. This does include studying for the internal college tests but much of it is internationally focused.

This teaching of international studies is not something that Beijing wants to encourage. The party doesn’t want private domestic or foreign capital or foreigners controlling China’s educational system. The education ministry must pay attention to the propaganda department; every educational establishment has a party secretary, which controls the educational system. This has been going on the ground for some time but is now being formally instituted through the regulators.

Second, education in general is part of the data/information world. Xi Jinping would like to reduce the ability of any non-state actors to control anything to do with this sector. Education, loosely, falls within this camp. So between foreign listings and information control, Beijing gets to kill two birds with one stone. This follows the clear examples of state control over Ant Financial, Wepay and other financial and data-oriented firms.

U.S. IPOs are a problem for China. U.S. capital that is given to Chinese entrepreneurs provides a foreign capital base. This is now being discouraged. That’s not to say there wouldn’t be disruption to China’s financial system and to global investments if there is a continued cancellation of U.S. IPOs – what I would call a “mini-decoupling.” According to the U.S.-China Economic and Security Review Commission, in October 2020, there were 217 Chinese companies listed on NASDAQ, the New York Stock Exchange (NYSE) and NYSE American, with a combined market capitalization of $2.2 trillion. In 2020, Chinese- based companies raised approximately $11.7 billion in the United States through 30 initial public offerings.

The interesting question is whether private capital in China’s growth story really matters. If the state controls the regulators, does ownership of capital truly mean ownership of power?

The large pools of capital (trusts, local government companies, private funds, and even private companies) creates an incentive structure separate from the state. The PBOC, the CBIRC, and the State Council can reach into this network, but they have limits to their control. Such features as the huge pool of local debt cannot be eliminated without disastrous consequences for the economy. And this debt has many private strings to it. Thus, the death knell for the private economy in China should not yet be written.

• Bloomberg Markets
• TV Shows

June 11th, 2021, 12:12 PM GMT+0800

https://www.bloomberg.com/news/videos/2021-06-11/orient-capital-research-s-collier-on-china-s-credit-markets-outlook-video

https://www.bloomberg.com/news/videos/2021-04-16/orient-capital-research-andrew-collier-on-what-s-next-for-china-huarong-video

April 16th, 2021, 12:48 PM GMT+0800

Orient Capital Research MD Andrew Collier shares his views on the possibility of China rescuing its biggest distressed asset manager, Huarong. Collier, a former President of the Bank of China International USA, believes that China will protect Huarong, however smaller, local AMCs are more vulnerable. He speaks to David Ingles in Hong Kong and Tom Mackenzie in China during our special Huarong coverage. (Source: Bloomberg)

Global Source Partners

China’s State Council Tuesday issued a decree ordering a “deepening” of reform of the budget management system. The key point is an order to reduce financial risk and increase transparency of local government finance. This order follows the recent cancellation of the Ant Group IPO and stricter regulations of Ant’s online financial lending platforms, along with rising bond defaults. These events suggest an increasing trend toward de-risking and credit restriction in the economy. However:

1. Is the government serious this time about credit restriction or is this going to lead to new forms of “creative financing” for local governments?
2. Will holders of offshore USD debt issued by local corporations face a growing wave of defaults, as we have seen onshore with companies such as Huarong Asset Management?

The Huarong case is a real outlier. As far as I know, it’s the first central SOE to get to near default status. Bloomberg is reporting that a 600M bond due in Singapore is being repaid. Clearly this whole thing is political. I would, however, look at it from two frameworks. The first is the global investor reaction and attitude by Beijing, and the second is the systemic risk issue internally. 

Globally, I think Beijing is far less reluctant to allow USD credit to default now than they may have been two years ago. First, their success with Covid has given them a degree of confidence in their ability to weather crises. Second, there has been a rapid increase in foreign capital entering China, mainly into CGBs but also into other bonds and equities. The Russell Index inclusion was quite significant, for example. Their attitude internally seems to be, we are one of the most successful and largest economies in the world, why should we be concerned about international opinion? This is particularly true post-Trump, as he squandered what little leverage we had. 

That doesn’t mean they are unconcerned about global opinion or defaults in general. There are issues of pride, access to capital (less important in my view), and the fact that Huarong is centrally state owned (an embarrassment for the MOF). (I think I read that the MOF is transferring its stake to CIC but I may have that wrong — if that is true, that is an interesting development, as the MOF would clearly be trying to distance itself from this disaster). But what they may do is repay many of the bonds, particularly this first one coming due, to quiet the global concern, but let one or two others default, as a warning bell to investors to examine these credits more closely. Bottom line, this international analysis of domestic Chinese finance is way more important (at least to the PBOC) toward improving the financial system than the money itself. Similar to the WTO entry in 94.