Author Archives: Andrew Collier

New PBOC Hong Kong Appointment Key to Renminbi

New Hong Kong Appointment Key to China’s Currency
It is being overlooked in the noise about China but a key appointment was announced this week by the PBOC. Bao Mingyou was named a senior advisor to the Hong Kong Monetary Authority. His role will be to “offer advice and assistance in the areas of financial cooperation between Hong Kong and the mainland, and further develop the yuan businesses in Hong Kong, and promote Hong Kong’s financial services in the mainland.”

The story is a bit more complicated. According to former PBOC officials who alerted us to this development, Bao was handpicked by PBOC Governor Zhou Xiaochuan for the post to fulfill three functions. First, he is to stabilize the international value of the yuan, which has fluctuated due to international trading and perceptions of the China’s economy, much to the embarrassment of the leadership in Beijing. Second, he is to continue to promote the yuan internationally in line with the recent inclusion of the yuan in the IMF’s Special Drawing Rights basket. That inclusion is under threat of being sidelined due to the instability of the currency, the recent devaluation, and the growing problem of capital flight. Since the inclusion has been a strategic program of Xi Jinping and others in the State Council backpedalling would not be acceptable.

Third, and perhaps most interestingly, Bao will act as an “honest broker” in Hong Kong to report the city’s position back to Zhou in Beijing. Bao was handpicked among the PBOC’s thousands of employees for this role. Bao has an MPA from Harvard and studied at the London School of Economics. He headed the PBOC’s New York Bureau and most recently was in London. He is very good at skirting the path between the official pronouncements required of certain factions within the leadership and also performing the technical functions required of his job at the PBOC.

Internal Political Battles
He is stepping into a minefield. There is a conflict between the leftists on the political side and the rightists (pro free-market) on the right. Bao’s job is to strike a path between them while handling Hong Kong’s role as the global face of the currency. The Chinese Liaison office in Hong Kong headed by Zhang Xiaoming has become increasingly heavy handed in its approach to Hong Kong. There was even talk in 2012 about setting up a parallel “Party Organization” as a kind of a shadow cabinet. It is likely that Zhou Xiaochuan does not want to be reliant on a politicized organization for operations or information flow at a sensitive time of increasing globalization of the currency.

Given his international experience, academic training, and clout with the PBOC headquarters, he may be in a good position to help to stabilize the currency in future. We think this is a positive development for China’s management of the renminbi and further reinforces our view that Zhou Xiaochuan is an able official fighting a rearguard battle within the increasing politicized Chinese leadership. However, the importance of capital flight is likely to outweigh any policy changes within the HKMA.

Shadow Banking isn’t Dying — It’s Just Retreating into the Banks

Sara Hsu, a professor of economics at the State University of New York at New Paltz, wrote an excellent overview of Shadow Banking in the Diplomat (http://thediplomat.com/2015/11/the-rise-and-fall-of-shadow-banking-in-china/). She argues that Shadow Banking continues to be promoted by the State — despite claims that it is declining.

As she notes:

“If the Chinese government had wished to fully eradicate shadow banking at any point, it could have easily done so through regulation and directives. Yet the sector was and has been allowed to survive, taking on different forms that reflect existing economic and political conditions. This situation runs parallel to the more explicit relationship between banks and the government. Banks continue to reflect, to some degree, government objectives and the overall economic climate, focusing lending on particular sectors or entities.”

Shape Shifting
What is interesting is the new shape Shadow Banking has taken. While it was previously relatively transparent, through Trusts that published data on lending, and bank wealth management products that were detailed on bank financial statements, it is increasingly sub rosa. As examples, the insurance industry is one of the largest sources of capital for infrastructure, to the tune of Rmb 1.1 trillion, much of it in local government companies. Yet this funding is buried in their financials with no transparency.

Meanwhile, the banks are the largest source of shadow loans, but this time in a new form. The Rmb 3 trillion bond for loan swap by the banks is one example. The banks buy the bonds sold by local governments, pay them with cash, and are supposed to get the cash back from the local governments to pay down bank debt. But it’s not working that way. A portion – I estimate 20% to 40% — is kept by local governments. This means bank loans look like they are declining but in fact are just being shifted to the banks’ bond portfolios. This could amount to trillions of additional lending if the PBOC scales up the bond swap program.

Meanwhile, there appears to be no consistent policy regarding the sale of wealth management products, suggesting inconsistent policies from Beijing. At least for 2014, the Agricultural Bank increased WMP sales by 41%, but the Bank of China’s were only up 1%. Why is one state bank risk averse and the other isn’t?

The Investment Product as the New Shell Game
Another form of new shadow credit, and the largest, is being created through a whole new batch of investment products. The banks are devising a new kind of investment product that they purchase directly with their capital — instead of selling them to customers. The estimates are there are Rmb 8 trillion of these so-called investment products sitting on bank balance sheets, up from 1 trillion just a few years ago.

If you add all these behind-closed-doors source of new capital, it adds up to substantial funding, and could be as high as 50% of GDP. Almost none of it is readily transparent but it has to be estimated indirectly from financial statements. That’s not good. Clearly, the NDRC/State Council continues to run scared about slowing GDP growth and appears to be either unaware (and the stock market bailout would suggest many of the policymakers are clueless about economics) or unconcerned about rising debt. It is probably purposeful that there is no central accounting as policymakers can pretend it isn’t happening.

The Inevitable Move to Central Government Monetization
In the end, this central government monetization of debt is what everyone suspected would happen and now is. Increasingly, these shadow loans are cutting out the private sector and are coming indirectly from the state via the banks.The problem is it is all occurring non-explicitly and seemingly without central government accounting for overall debt levels.

I admire the ability of China’s political system to negotiate these capital flows between central and provincial governments, banks, and regulators. But I just wish there were more transparent methods of handling what is likely to be a significant debt crisis.