Author Archives: Andrew Collier

The Trade War – Chinese Response

The trade war – the Chinese response

Andrew Collier | Jun 07, 2019

Executive Summary

We analyze the response of China to the trade war in four buckets: politics, macro-economy, global supply chains, and technology. Of the four, China’s technological development and global supply chains are likely to suffer the most.

Xi’s political power is weakened

The political realm is the most interesting aspect of the impact of the trade war on China. Because Xi has established his central role in the country’s leadership, he thus will take full responsibility for the success or failure of the trade negotiations. His own policies have hindered his success.

Xi entered the trade negotiations with a weakened and more ineffectual bureaucracy due to the centralization of his power. To increase his direct control of the government, Xi created 29 new Leading Small Working Groups (LSG) on top of the existing 54. Xi personally controls at least a dozen. This has a) lessened the input of bureaucratic experts; and b) reduced the effectiveness of policy implementation. Among the casualties has been the trade war negotiations.

As a result, initial advice on the trade war came from just a few trusted advisors, who are far more powerful than the original top negotiator deputy, Commerce Minister Wang Shouwen. These include economics czar Liu He, briefly at Harvard, former PBOC head Zhou Xiaochuan. who studied at the University of California for two years, and CBIRC Chairman Guo Shuqing, who was at Oxford for a year. All three are part of what I call “globalists” who view the world in the rational terms of international trade. In turn, they reportedly relied on American advisors such as Hank Paulson and Henry Kissinger for advice on trade negotiations. The result was a disaster and a failure for Xi Jinping as neither the Chinese nor the American side had any insight into the Trump Administration.

Other foreign policy failures have further hurt Xi’s reputation. This includes the Belt and Road, which many domestic institutions view as a waste of capital, and the diplomatic opposition from many Southeast Asian nations to Xi’s clear attempt to broaden China’s economic and military reach. This has led to quiet grumbling internally among the elite, both at academic institutions, and among the Snancial and business crowd. These complaints include the following:

In October 2018, Peking University professor Zhang Weiying criticized the China Model for being both bad policy and bad facts: “(The China model) will mislead us and destroy our progress. If we single- mindedly emphasize the uniqueness of the China model, internally we will strengthen SOEs, enlarge the authority of the government, and rely on industrial policies, which will lead to a retrogression of reform

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and a total waste of the great strides in reform. The economy will lapse into a quagmire.” He was echoing other critics of Xi Jinping thought.
Xi’s assertive foreign policy is widely seen inside of China as a radical departure from Deng Xiaoping’s policy of keeping a low profile. More recently, public pledges of support for Xi within the State Council was viewed not as a sign of strength but of weakness – why ask for support if you are in a position of strength?

Deng Pufang, the eldest son of Deng Xiaoping, at a national conference of disabled persons, criticized the spirit of Xi’s policy and called for “seeking truth from facts … maintaining a clear head, knowing one’s own strengths and weaknesses, and avoiding overestimating oneself and behaving recklessly.” The speech was seen as an attack on Xi and quickly censored within China.
Long Yongtu, a former vice minister of commerce who negotiated China’s entry into the World Trade Organization (WTO) in the late 1990s, publicly criticized Beijing’s handling of the trade dispute with Washington.

What does this mean for the outcome of the talks? Short-term, not much. China’s closed media environment will prevent these incidents from reaching ordinary people and eroding Xi’s national power. However, longer term, Xi’s clear failure to manage the trade talks, along with his backSred attempts to create a more powerful global China, have damaged his inTuence within the elite in ways that are likely to come back to haunt him.

On the economic front, trade is just one factor

China is no longer as dependent on trade as it once was. Chinese exports to the U.S. account for only 3.6% of GDP, down from 7.3% of GDP in 2006. China has issued a rash of stimulus policies but it is not clear these are directed at the trade war as much as the slowing economy in general.

Pushing the economy

China has three mechanisms for controlling the economy: credit policy, Sscal policy, and the exchange rate. The state has focused its efforts on the Srst two by expanding credit and reducing taxes. There was a substantial increase in Srst quarter 2019 total social Snancing, whose effects we witnessed during our interviews in Fujian a week ago. Local investors said the property market said they had seen a sharp turnaround in the property sector, up from a 30% price decline in 2018. Credit growth has moderated since Q1 2019 but remains above GDP growth. On the Sscal front, the interest rate on corporate loans was cut by 1%, and Beijing has continue to encourage the issuance of local government bonds and corporate bonds for local government Snancing vehicles (LGFVs), as a way to put investment capital in the hands of local governments.

There was one policy clearly directed at the US tariffs. The Ministry of Finance announced two rounds of VAT rebates on a variety of products covering by the US$50 billion and $200 billion tariff lists. Along with other measures, the head of the Ministry of Finance, Kun Liu, said the total deductions would add up to Rmb1.3 trillion.

Despite these measures, Beijing appears to be digging in the for the long haul on handling the economic impact of the trade dispute on the domestic economy, and views it as part of a larger issue of keeping economic growth on an even keel.

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Propping up the yuan “behind the scenes”

Countercyclical factor

The one area that has not been touched is the value of the currency. Beijing is unwilling to broach the 7.0 level for the yuan. There are signiScant tools the state uses to maintain the stability of the currency. China has acknowledged this when in 2018 it introduced “counter-cyclical factor” to keep the yuan’s daily midpoint Sxed to a relatively stable value.

The PBOC said it would institute this retroactively to May, 2017. The PBOC’s China Foreign Exchange System (CFETS) requested banks to feature this factor in their daily Sxing to avoid “irrational Tuctuation” –- but not reveal their methodology. A more upfront policy was apparent when, in March 2019, China sold US$20.5 billion in US treasuries, the highest level since October 2016.

State support for the yuan

Yuan trading is dominated by the large, state-owned banks; foreign banks have low market share. SigniScant inTows have been managed by state entities to support the currency. According to SAFE, in 2018 the net foreign capital inTow grew 9% YoY to US$483.8bn, among which net FDI in the stock market rose 29% YoY. During the same period, the net purchase of domestic bonds by foreign institutions rose to US$96.6bn, up 68% YoY. Also, the net purchase of domestic listed stocks grew by 85% YoY to US$42.5bn. The strong momentum continued in 1Q19, with the net purchase of domestic bonds and stocks reaching US$9.5bn and US$14.9bn, respectively.

But much of this was probably not foreign capital. We estimate that 80% of this so-called “foreign capital” consists of domestic funds transferred to Hong Kong via back channels created by the Chinese government. This inward capital controlled by Chinese institutions is then required to be reinvested in the domestic markets under a new label: offshore capital.

These “back channel” routes for strengthening the currency support the dual role the state has played in promoting an image of the free markets while quietly propping up the yuan. Bottom line, we expect continued “hidden” support to keep the yuan above 7.0. “We have never taken any intentional measures that would cause depreciation of the yuan to offset [the impact] of conTicts over trade,” CBIRC head Guo Shuqing told state media in May.

Global supply chains are the wild card in the trade equation

The impact of the trade war on China’s integration in global markets is hard to predict at this stage given the uncertainty about the outcome of the discussions. China has a dominant capacity in a number of sectors, including telecommunications, which will be difScult for other countries to replicate in the short-term. Longer term, the cost advantages in Southeast Asia and India in particular, in addition to their lower political confrontation with the U.S., will make them attractive alternate sources of manufacturing capacity.

Already, there is signiScant movement of production to Southeast Asia. For the top two manufactured goods, China has greater than 35% market share and more than 20% for the rest, which makes it difScult for other

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nations to challenge in the short run. ASEAN trails China except in electrical machinery. Vietnam’s economy has been boosted by almost 8% due to a shift in production from China, resulting from the US-China trade war. The majority of Vietnam’s gains came from additional imports of goods covered by US tariffs on China, including electronic equipment for telephones, furniture, and automatic data process machines, because multinationals were able to move production to Vietnamese factories.

China’s tariffs mainly target commodities (soybean and oil) and, to a lesser extent, high-tech products that ASEAN economies hardly produce or for which they do not have any relative comparative advantage

The altered supply changes have been underway for some time, however. China’s inward FDI declined from 62% of total global FDI in 2006 to only 27% by 2017.

China’s hoped-for dominance in tech is at risk

Huawei is the bellwether for China’s foreign policy failures

It is in technology that China has mishandled the trade war particularly badly. President Xi Jinping’s aggressive posture on creating global giants, has backSred, as the U.S. has had signiScant support from Europe against China’s ambitions. This is not only a blow to China’s transition from low to high-value-added goods, but to the country’s personal prestige as a force in global tech.

Huawei is the poster child of China’s problems in the tech sector.

China’s global market share exceeds 40% in the telecommunication sector as well as in ofSce machinery. Ericsson and Nokia respectively hold 27% and 22% of the 2G/3G/4G gear market against 31% for Huawei. According RWR Advisory Group, Chinese state-owned banks have lent Huawei and Huawei’s customers up to £7.5 billion. More than 70% of Britain’s 4G infrastructure was built by Huawei.

Huawei, itself, has shot itself in the foot by misrepresenting its ownership. The company’s chairman claims it is owned by employees. But in a careful note, legal scholar Donald Clarke of George Washington Law School and economist Christopher Balding argue persuasively that the company is either privately held by the chairman himself or by the state through proxies. If it is owned by a trade union, this is essentially state ownership. However, the ownership structure remains opaque. “Regardless of who, in a practical sense, owns and controls Huawei, it is clear that the employees do not.” If Huawei is a proxy for the state then its claims to be operating without following national security goals are unlikely.

Global supply chain problems

Huawei is highly dependent on U.S. suppliers for semiconductors and software. Huawei reportedly stockpiled a year’s worth of semiconductor inventory, but it can’t stockpile software updates, which would be the Srst step in harming its operations. ZTE suffered a similar fate when the Commerce Department embargoed its operations, as it could not upgrade the Oracle database in its mobile base stations.

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Huawei supplies carriers in more than one hundred countries around the world. It is also going to be the lead in rolling out China’s 5G networks, which is poised to lead the world in new technology. The embargo could be a catastrophe to China’s attempt to become a leader in 5G globally.

Huawei would also lose access to the key design chips produced by western Srms like Cadence, Synopsys and Siemens’ Mentor Graphics. Reliance on US semiconductor Srms in future years will be questioned due to the political nature of the attack on Huawei. In turn, however, the American embargo could backSre and harm the U.S. semiconductor industry that supplies circuitry to Huawei.

Undermining Beijing’s ambitions: the Tsinghua example

Although Huawei says it is a private company, there is signiScant state support for the technology sector in general in China. Among other Srms, Tsinghua Holdings, under the state-owned Tsinghua University, is a signiScant Snancial backer for China’s tech sector. As China’s top university, Tsinghua University is far ahead of its peers in terms of investments. Acting as the University’s investment platform, Tsinghua Holdings Co Ltd (Tsinghua Holdings) mainly operates in Sve specialized areas: advanced technologies (integrated circuitry, environmental protection and healthcare); innovation services; sci-tech Snance; creative and cultural industries; and online education. These operations are carried out by three major afSliated comprehensive groups such as Tongfang Co Ltd., Tsinghua Unigroup, and Tus Holdings Co Ltd.

After spending approximately US$5.19bn, Tsinghua Unigroup established its presence in the chip industry and was able to convince the Chinese government to appoint it the lead backer for China’s Tedgling semiconductor industry. Since then, the company has become the prime instrument for China’s strategic development of the domestic semiconductor business and has received substantial support from policy banks and the government’s VC funds. This state-supported model is under threat due both to the trade war and the security concerns in other nations, particularly in Europe.

Conclusions: What are we likely to see out of the trade dispute?

1) Weak domestic opposition. The internal pressure on Xi Jinping due to his foreign policy failures is unlikely to cause a dramatic change in the country’s leadership. The domestic media is heavily controlled, and the dissent by inTuential academics and former leaders is not enough to alter domestic power relations. Xi’s failures, however, are being noted domestically, which could accelerate his departure in the future.

2) No easy bargaining chips. The two main demands by the U.S., the end of state subsidies and new rules governing IP protection, are either impossible or unlikely given domestic nationalism. China could offer a “clawback” agreement, suggested earlier by the Trump Administration, whereby examples of stolen IP or other transgressions would be met with a resumption of tariffs. This could be mediated by a third party – if the White House would agree. This, although it would be met with resistance, would be achievable within China.

3) Focus on the economy. The trade war is only a smaller part of the larger problem Xi is facing of a weakening economy and excess debt. Therefore, Beijing is unwilling to make signiScant concessions that a) would weaken the perception of the leadership domestically; and b) fail to solve the larger problem of the economy.

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4) Quiet concessions. Despite the conTicting aims, Xi is likely to use Liu He and moderates such as Steve Mnuchin as a “back-channel” to make concessions such as:

a. An increase in purchase of US goods.
b. An agreement to pay Snes if IP contracts are abridged.
c. Quiet curbs on companies such as Huawei.
d. Continue to offer opening to the domestic market, as Guo Shuqing offered in a speech in May.

All of these discussions would have to be deniable. The collapse of the talks recently followed an exchange of documents – it is doubtful the Chinese backtracked from verbal commitments as the Trump Administration has claimed. Instead, the agreement, once on paper, was less than the White House had wished for. The Chinese do not traditionally lie in negotiations but prefer to issue vague statements to give them policy freedom.

This report can be found online at: https://www.globalsourcepartners.com/posts/the-trade-war-the- chinese-response

Copyright 2019 GlobalSource Partners. All rights reserved. This report is prepared for GlobalSource Partners’ clients and may not be redistributed, reproduced, stored in a retrieval system, retransmitted or disclosed, in whole or in part, or in any form or manner, without the express written consent of GlobalSource Partners. This report is distributed simultaneously to our website and other portals used by GlobalSource Partners. The information herein was obtained from various sources and is believed to be reliable but GlobalSource Partners does not warrant its completeness or accuracy. Neither GlobalSource Partners nor any Country Analyst, officer or employee accepts any liability whatsoever for any direct, indirect or consequential damages or losses rising from any use of this report or its contents.

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Ant Financial’s Aggressive Strategy

Microsoft Word – Ant’s Aggressive Strategy.docx

Ant Financial has got just enough bullets to cause a smallscale financial crisis.Economist with a State Owned Bank.

l Growing Market Share. Ant Financial has quickly taken market share from traditional banks, trust companies and other financial firms. Eventually, the regulators may reduce Ant’s consumer lending business to prevent losses by the bigger banks.

l Undercapitalized Bank.We estimate that Ant’s outstanding credit stands at 49x Ant Cash Now’s registered capital. This 2% capital adequacy ratio is far below the CBRC 8% requirement for commercial banks.

l Little Oversight. Ant Financial has lending data for Ant Credit Pay as it utilizes a “virtual credit card” and tracks user purchases. However, there is little data on Ant Cash Now’s loans issued directly to users. This raises red flags about potential defaults.

l Main Driver Behind Securitization. In 3Q 17, Alibaba and its finance units accounted for 82% of consumer credit ABS. This is a significant concentration of risk.

http://www.orientcapitalresearch.com/wp-admin/upload.php?item=790y

No QE for China

February 19, 2019

Executive Summary
There is a widespread expectation among western investors that China will enact quantitative easing to counter the effects of the trade war and the slowing economy. This is highly unlikely. Although there is substantial data indicating signiDcant pain in the economy, including defaulting SMEs, unemployment, and general declining economic activity, the policy statements and actions from the leadership suggest Beijing is intent on avoiding an open-ended stimulus package. They are doing this due to concerns about debt, inefDcient use of credit, and over-use of monetary policy for stimulus purposes.
Fine-tuning the policy response
The actions so far are targeted at specic areas of the economy as opposed to widespread loosening. These include:

  1. Perpetual bonds.
  2. Swaps: The creation of central bank bill swaps, which banks can exchange for PBOC paper.
  3. SME loans: CBIRC suggested targeted loans to private firms, which are supposed to compose
    one third of new loans of large banks, two thirds of new loans of small banks and no less than
    50 percent of new loans in the whole banking system after three years.
  4. Local bonds: 2019 Quota RMB 1.39 trillion.
  5. Tax cuts: Approximately 1.3T
  6. Increase in the fiscal deficit: This equates, however, to a relatively minimal increase of around
    RMB 300 billion (including other forms of deficit, such as bonds).
  7. The TMLF will have a maturity of one year, but banks can roll loans over twice, increasing the
    maximum maturity as long as three years, the central bank said. The one-year interest rate on the TMLF will be 3.15 percent, 0.15 percentage point lower than the rate on the medium-term lending facility (MLF).
    Many of these stimulus measures do not have a Dxed amount but are dependent on usage by the banks. By our rough estimate, they would supply roughly Rmb4.1 trillion to the economy.

The deeper issues – local fiscal problems and the property market

The bigger issue is that the de-risking measures so effectively implemented by the PBOC and other Beijing institutions have failed to address two problems:

  1. The unstable local fiscal economy.
  2. The continued importance of the property market to growth.

Both of these areas have relied increasingly on financial intermediation through the shadow market, which has been substantially curtailed.

For full report contact OCR.

China’s Winners and Losers

Summary

China has instituted several targeted stimulus measures designed to improve GDP growth and provide capital for small businesses, the country’s largest employment sector. These measures, however, are likely to be inadequate compared with the decline in capital due to the restrictions imposed on shadow lending. The results are likely to be:

  1. Difficulty maintaining land sales, which are already declining.
  2. A potential downward trend in the property market.
  3. Defaults of property developer bonds.
  4. Continued rise in defaults of local SMEs.

The key point is Beijing is responding to tighter credit conditions by picking winners and losers. It is lowering credit to certain regions in order to restrict the allocation of capital. While official policy via the Peoples Bank of China (PBOC) can affect credit flows, the political system has a significant say in how the process works out. And we are seeing a distinct preference in those allocation decisions.

These measures are likely to provide less of a stimulus than the capital that was raised by the shadow banking system prior to the earlier crackdown. Newly increased RMB loans only amounted to RMB 1.8 trillion, not enough to compensate for the decline of RMB 6.5 trillion in shadow banking, which is more than three times larger. Although loan growth remained steady at 13%, total social financing has slowed to 9.8% from 14% a year ago. The chart below shows the decline in non-bank lending through mid 2018.This figure only includes “official” shadow lending, such as Trusts, and does not include other forms of non-bank lending such as wealth management products, which have seen flat growth even though the outstanding amount remains high at around RMB 30 trillion.

China’s Broken Infrastructure Model

The widening fiscal deficit will restrict further stimulus efforts

Summary

China’s economic growth in the near term will depend on further investment in infrastructure, which has been the main driver in the past. The switch to consumption will take time. Our analysis suggests there are inadequate fiscal resources to continue to generate significant growth through investment expenditure. Local governments are spending above their official revenue and are clearly relying on non-tax revenue, either from one-off sales of assets (such as land) or additional debt.

As a result of these economic trends, by the end of 2018 local governments will have to pay more than Rmb500bn of interest on debt. Between 2019 and 2023, they will need to repay debt of approximately Rmb25.8trn, one-third of which consists of interest expense. Much of the capital raised by local companies (LGFVs) from bond sales will be required for interest expense. Attempts to raise private capital will be difficult due to the lack of reasonable returns from infrastructure projects. For these reasons, stimulus measures are unlikely to be effective in generating growth through the traditional Chinese infrastructure-driven model.

Can private capital provide the stimulus?

The answer is no. Although private fixed-asset investment has maintained 8.7% YoY growth, the primary industry has been the fastest growing sector with double-digit growth, compared to the low to mid-single digit increase within the secondary industry. “Because of the low profitability of infrastructure projects, most private capital has stopped investing due to the large capex requirement at the initial stages. Now is a special period for China given tightened liquidity, weak investment sentiment, and little confidence in the government,” said the chairman of a medium-sized private company in Shanxi. “Unless we can refinance the infrastructure projects we have invested in, no one wants to provide capital to government.” Unfortunately, it is unlikely that private capital will be able to access “easy money” in the future due to current credit constraints.

China bank survey: The return of shadow banking

China bank survey: The return of shadow banking

Andrew Collier |

Conclusion

Beijing is returning to stimulus to prevent a decline of GDP at a time of the threat from the Trade War. We see this growth in lending, both on and off balance sheet, in our October bank survey. One policy that has been surprisingly effective is the increase in lending to small businesses, a key driver of employment and economic growth. We plan to follow up with further analysis of the implications of the data.

Key points

China’s ongoing economic slowdown has increased stress on banks as they are under pressure to reduce off- balance-sheet financing while increasing support for small businesses, both of which carry considerable credit risks. To find out how banks are faring amid policy shifts, we spoke to 15 banks in 10 cities during the second week of October. These comprised seven state banks, four joint-stock commercial banks, and four local and city banks.

Here are some key points:

  1. Many banks are reducing the pace of sales of off-balance-sheet assets because they are under less pressure from regulators to reduce leverage.
  2. Lending to real estate and infrastructure companies is tapering off because of concerns of credit risks among debt-laden local governments and real estate developers.
  3. Infrastructure investment is likely to increase due to the growth of loans through Public Private Partnerships.
  4. Small business loans are gaining in popularity thanks to policy support, but structural problems such as a lack of collateral could weaken the current growth in lending to SMEs.
  5. Bad debt risks are still under control. Yet they could increase in the coming months as banks began moving off-balance-sheet assets, a large portion of which could go default, back to their books.

China’s Belt and Road: Debt trap – for China?

China’s Belt and Road: Debt trap – for China?

Andrew Collier | Oct 15, 2018

I spent three days at the end of September in the city of Astana in Kazakhstan, at a conference that was part of a larger effort by Nazarbayev University to create a China Centre. Kazakhstan is feeling pressure due to its location between China and Russia and is seeking greater depth of knowledge on China from western experts, who are considered neutral players between Russia and China.

One large focus during the meeting was the impact of China’s Belt and Road policy on central Asia. Is China going to be helpful or controlling in the relationship? Is China going to contribute to the growth of Central Asia or simply use it as a dumping ground for excess domestic production capacity and as a means to extend its regional security capacity?

I left Central Asia with a few thoughts:

  1. Kazakhstan is the largest country in Central Asia. Due to its size and natural resources (mainly oil and gas), it is in a better position to meet China as a quasi-equal than many of its neighbors and even some countries on the belt and road route in Southeast Asia.
  2. Most locals view China’s BRI as a security policy. But, as sophisticated sinologists, they are aware that the BRI title has been thrown over a loose array of policies and investments and may be less concrete than the rhetoric would imply.