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China enters the capitalist citadel

BUSINESS SPECTATOR
NOVEMBER 17, 2015 8:12AM

Alan Kohler
[Image: alan_kohler.png]
Editor-at-large, ABR
Melbourne

[b]It is now just a formality that China’s currency, the renminbi, aka the yuan, will be included in the International Monetary Fund’s basket of special drawing rights (SDR) at the end of this month.[/b]
China has been trying to get in for a while, and in a statement last Friday that was overshadowed by other events, the IMF’s managing director Christine Lagarde said she and the staff supported the application.
It is most unlikely that the executive board will now vote against the renminbi’s inclusion in the SDR, making it the fifth currency in the basket (the others are the US dollar, euro, pound, and yen).
SDRs are an international reserve asset designed to supplement each country’s existing official reserves. They’re not exactly a currency but they can be exchanged for currencies, either by the IMF asking its members with strong external balances to buy them off those with deficits, or simply by voluntary trading among members of the IMF.
The main reason China wants in is for the prestige of it — to be included in the IMF’s SDR basket would be as big a deal as its joining the WTO in 2001.
That event, which marks the point at which China basically joined the global trading system, changed the world. It led China’s exporting deflation and low interest rate through its low labour costs, reshaped global manufacturing and produced the commodities boom that created Australia’s river of cash through the first decade of this century.
Acceptance into the SDR, marking China’s entry into the global financial system, may end up being almost as big a deal as WTO entry, but in a different way.
The SDR percentages are not officially used as a guide for foreign exchange reserves asset allocation, but they are a sort of unofficial guide.
It means the first effect of the vote this month will be to increase capital inflow into renminbi. Some analysts are saying that its SDR percentage will be 14 per cent, and that means global allocations to the China currency could be 10 per cent, which in turn means about $US1 trillion of new capital flowing into China.
That seems unlikely, at least for a while. According to the People’s Bank of China, foreign central banks currently hold less than 1 per cent of their assets in renminbi, so wiser heads reckon this could rise to 4 per cent, which means about $US300 billion in inflows, or $US60 billion a year — still quite a lot.
But the more important effects of the decision will be less tangible: China will be encouraged to continue and deepen financial system reforms within China, which could eventually have the sort of effect on global capital flows that WTO had on trade flows.
The PBoC and China’s political leadership have been tying reforms, including the devaluation in August and a move to greater flexibility in setting the exchange rate, to the application for SDR membership.
There were other reforms as well that were directly linked to SDR membership: the Ministry of Finance has been selling three-month treasury bills for the first time to help develop a domestic bond market, and the PBoC removed all limits on foreign central banks’ investment in Chinese bonds.
That second one was needed because central banks are the main holders of SDRs and need full access to renminbi assets to hedge their exposure to them.
So the Chinese authorities need a victory to show the reforms were, and are, worthwhile and to encourage more.
The next step will be to allow more volatility in the US dollar yuan exchange rate, which will be quite a big step.
When the band was widened in August the currency promptly devalued by 1.8 per cent, causing a massive panic on global financial markets — all markets, not just forex markets — because of a sudden fear that China may be about to devalue significantly.
That didn’t happen, but it meant the PBoC had to spend huge sums defending the currency over the following weeks, costing it a fortune.
The real problem in August was very poor communication from the PBoC about what it was doing, so perhaps it learnt about the need for transparency, as well as becoming more comfortable with foreign exchange volatility.
Ironically, with the prestige of joining the SDR will come the need to wear the indignity of devaluation, at least occasionally.
But that’s just part of being inside the global capitalist tent.

China hard landing means world growth would 'slow sharply'
DateNovember 20, 2015 - 12:59PM

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Malcolm Scott

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Were China to sneeze, the world may well catch a cold. Photo: Bloomberg

China's slowdown is already playing out across the world, dragging down commodity prices and weighing on trade partners.
And that's while the economy is still growing at about 7 per cent. So imagine what happens in a hard-landing scenario.
The crew at Oxford Economics have done just that in a new report that makes stark reading for anyone with a stake in the global economy.
China's economic boom of the past 30 years means it now accounts for 11 per cent of world GDP and around 10 per cent of world trade. For resources, it's an even bigger player, accounting for 11 per cent of world oil demand and 40 to 70 per cent of demand for other key commodities, according to the Oxford Economics research. Its financial system is massive, with its broad money supply now larger than the US's and amounting to over 20 per cent of the world's.
So were China to sneeze, the world may well catch a cold.
First to trade. The volume of goods imported into China have already fallen by around 4 per cent in the first three quarters of the year, after rising an average 11 per cent per year from 2004-14. That means China has cut around 0.4 percentage point from world goods trade growth in the nine months to the end of September, after having added an average 1 percentage point a year in the previous decade.
The biggest losers are those with the closest trade links and those whose economies are most open.
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For most advanced economies, their reliance on trade with China is lower, with Germany among the more dependent:
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Then there's the indirect effects as the drag on GDP of China's trading partners works through the global economy. For instance, Japan would not only suffer from weaker exports to China but also to Korea and other Asian trading partners affected by China's slowdown, the Oxford Economics research shows.
Another transmission is via commodity prices, with any further slowdown in Chinese growth leading to additional price falls, especially as supply has expanded significantly in recent years. That would be bad news for the likes of Australia and Brazil.
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And here's another spillover you may not have thought of: One consequence of the plunge in crude prices is that oil exporting countries and their sovereign wealth funds now have less money to invest in advanced economy financial assets. Another leg down would compound that, the Oxford Economics report says.
There is a silver lining: Lower prices, especially for food and energy, would increase purchasing power in countries which are net commodity importers, including many advanced economies, emerging Europe, India, and the industrialised Asian countries such as Korea and Taiwan.
"A slowing China redistributes global economic activity through the commodity channel as much as dampening it," lead economist Adam Slater wrote in the report.
Then we come to the financial channels.
One risk is that a further growth slowdown creates financial ripples in China that spread to the rest of the world. On this score, the closed nature of China's financial markets should prove a buffer.
Ownership of China's banks is largely domestic, limiting potential for a bad loan blowout to become a global problem. There are some economies that would feel a sting:
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There is also the blow to corporate profits around the world if China's growth slumps. The stock of foreign direct investment in China is now around $US1.5 trillion, so if returns on those assets slow, so do global profits, according to the report.
The bottom line: World growth would "slow sharply," in a China hard-landing scenario, according to Oxford Economics. Close trading partners and commodity exporting countries would bear the brunt, and advanced economies would be significantly affected too, with deflationary pressures intensifying.
Bloomberg

China busts illegal foreign exchange network

MARK MAGNIER
THE WALL STREET JOURNAL
NOVEMBER 23, 2015 12:00AM

China has busted the country’s biggest-ever illegal banking network.

[*]

Chinese police have announced a crackdown on an illegal foreign exchange network that it said handled up to $US64.25 billion ($88bn) in transactions.

According to a report by police in Jinhua, a city of five million people in eastern Zhejiang province, the network involved hundreds of people in eight separate “gangs” working out of more than two dozen “criminal dens.”
The operation routed money through hundreds of accounts held at financial institutions in China and Hong Kong to evade restrictions on moving currency outside the country, it said.
According to recent state media accounts and a detailed police report released at the weekend, police launched its crackdown on the network on December 15, 2014, after months of investigation. It was unclear why the clampdown was only being disclosed now.
The official People’s Daily newspaper said 69 people had been criminally charged and another 203 people had been given administrative sanctions.
The amount of money involved in cross-border transactions, 410 billion yuan ($88bn) raised questions among some analysts about China’s supervision of money outflows.
“The fact that multiple real banks were involved raises questions about oversight. They’ve just allowed $US64bn to leave the country without knowing,” said Fraser Howie, co-author of Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise.
“It’s very difficult for legitimate investors to get money in and out, but it’s obviously very easy for these guys to do it illegally,” he added. In August, China’s Ministry of Public Security said it was stepping up a campaign against underground banks, contending that “grey capital” spirited out of the country had worsened the nation’s stockmarket tumult.
Authorities said earlier this month that they have investigated more than 170 cases involving over 800 billion yuan in underground bank activity. .
Beijing has become increasingly concerned with capital outflows in the face of slower economic growth, an aggressive anticorruption campaign and expectations for an interest-rate increase by the US Federal Reserve in December — factors that have made it more attractive to hold assets outside China for investors and others.
Standard Chartered estimates that China has seen $US830bn in capital outflows, not counting outbound foreign direct investment, over the past 17 months.
In October, in a sign that the government’s bid to stem outflows was bearing fruit, such outflows declined to $US37.2bn compared with around $US150bn in both August and September, Standard Chartered said. China’s foreign exchange reserves rose during the month, after declining for five straight months, to $US3.53 trillion at the end of October.
Jinhua police said the anti-money-laundering department of China’s central bank noticed suspicious transactions in September 2014 and teamed up with local police and foreign exchange regulators in an investigation codenamed the “9-16 project” after its start date.
Under a mastermind whom police only identified by the surname Zhao, the network allegedly set up dozens of shell companies in Hong Kong. The group opened over 800 accounts in the former British colony and at least seven Chinese provinces to evade foreign exchange limits.
Zhao’s identity couldn’t be determined nor was it known. Police, the central bank and the currency regulator couldn’t be reached or didn’t immediately respond to written questions.
The government said the bust was the largest ever of an underground banking network in China. Police and the People’s Daily newspaper said the gangs used accounts held in China by overseas organisations to evade scrutiny and foreign-currency purchase limits. These allowed the money to leave the country on a “through train” without going through normal regulatory review, they said, for settlement abroad by the HSBC and other unnamed banks. Banks had since tightened their rules to close the loophole, the People’s Daily said.
An HSBC spokesman in Shanghai said the bank doesn’t comment on individual cases. “But HSBC has zero tolerance for money laundering and makes every effort to protect the bank, our customers and the financial system against criminals,” the spokesman added.
Additional reporting: Li Pei

Replacing China’s broken economic gauge

PETER CAI
BUSINESS SPECTATOR
NOVEMBER 24, 2015 9:15AM

[*]There are a lot of Chinese economic data doubters out there and many economists and analysts have turned to a variety of alternative measures to gauge the true state of the world’s second-largest economy. Some play with the GDP deflator, while others haggle over the level of factory activity. But one of the most famous indices is, ironically, named after the country’s premier Li Keqiang.

Li, when he was the party secretary of Liaoning province, reportedly told the American ambassador to China that he didn’t trust the official economic data. Instead, he looked to figures such as electricity consumption, railway freight and bank loans as more reliable indicators. The Economist created an index in honour of him.
Many analysts have used this index to analyse the Chinese economy. However, as the country’s economic structure changes, people have started to question the usefulness of the Li Keqiang Index. The most high-profile critic is none other than the premier himself. He argues in the latest edition of The Economist that China is undergoing significant change and the old index is less useful today.
“One byproduct is a fall in the relevance of indicators such as power consumption, railway cargo volume and new bank credit in gauging economic performance,” he says. In the same article, he points out consumption is now responsible for 60 per cent of growth in China.
Li is right in pointing out that China’s economy is going through a period of transition. Some old engines are sputtering and new ones are firing up. One of the best performers so far is consumer spending, which has been growing in double digits this year. As Mao might have put it: they’re holding up half the sky.
When Li confessed to the American ambassador about his lack of confidence in economic data, the services industry accounted for 41.89 per cent of GDP. At the end of 2015, the services sector accounts for nearly 50 per cent of GDP. Over the same period, the manufacturing sector dropped to 41 per cent of GDP.
So the Li Keqiang Index makes a lot sense when applied to China’s industrial economy rather than its growing services economy. Nicholas Lardy, a seasoned China watcher from the Peterson Institute of International Economics, explains this change convincingly.
“The services sector has grown continuously more rapidly than GDP, and its share of the economy now exceeds that of industry. Expanding demand for services such as healthcare, education, entertainment and travel generates little or no demand for industrial goods, electric power or freight transport. The demand for passenger transport, in contrast to freight, is soaring as domestic tourism booms,” Lardy says.
So, it seems that we need a new index to reflect the changing reality in China or at least other parts of the two-speed economy. So what should we look out for? Li has offered some clues in his past speeches. For example, Li said at the Hamburg Summit of the China-Europe Forum last year that the government was prepared to accept lower growth if the following conditions were met: strong employment growth, stable consumer prices, wages increases and better environment protection.
Back in April, Li reiterated that the unemployment figure, urban and rural income levels and structural reform were the three key goals of the government.
So, the new Li Keqiang Index should include data on unemployment, wage growth in both city and rural areas, the progress on reforms and, for a good measure I would throw in retail figures. Let’s start looking at China’s unemployment figure which, although it looks good on the paper, is deeply flawed.
Beijing knows this and wants to change the collection method in line with international practice. Li recognises the problem and says “the macro-economic policy of many countries is set according to the surveyed unemployment rate. We have come to a point, where this data is equally important for us”.
From July onwards, 15,000 interviewers have been surveying 120,000 households every month to gauge the true state of the employment situation. So far, to the best of my knowledge, they have not released this data. Some suspect the figures look worse than the official data and the useless urban registered unemployment rate.
China’s wage increase looks good. Both city folks and rural labourers are experiencing strong income growth. This is a key driver of the current consumption boom. When it comes to measuring the progress in structural reform, it is much harder. Fortunately, Caixin, a respected business publication in China, has developed an index that gauges the progress of reform.
It has identified 113 areas of reform and categorises them into three areas: the fast lane, the slow lane and the standing zone. It is disappointing to note that only 23 areas of reform are moving in the fast lane, 74 areas are in the slow lane and 16 reform areas are not moving at all. Analysts could use the Caixin index as a proxy for measuring the progress in reform.
China does not have monthly data on the growth of the services sector and monthly data on retail sales may not reflect the true state of private consumption. Maybe we should start using figures from e-commerce platforms such as Alibaba and JD.com in order to better understand the dynamism of China’s internet-savvy shoppers.
If we use the new Li Keqiang Index, wages and retail sales both look strong, while reform has more or less stalled and we are a bit unclear on the state of China’s labour market. So, the overall picture is less gloomy but nevertheless very challenging for Beijing to handle. China watchers need to observe the new index more carefully rather than obsessing over monthly manufacturing figures.

China reforms in slow lane as Xi Jinping roadmap is foggy

THE AUSTRALIAN
NOVEMBER 26, 2015 12:00AM
Rowan Callick
[Image: rowan_callick.png]
Asia Pacific Editor
Melbourne

[*]
The great aircraft carrier that is China is slowly changing direction, as its leaders have been urging for more than a decade.

But it’s happening even slower than expected and the new road map remains vague — in part, because few officials now feel sufficiently confident to propose comprehensive reform strategies.
President Xi Jinping has seized the central role in economic reform and many other initiatives, but so resoundingly that little space is left in the room even for professional or technocratic experts. The rhetoric remains strong, but the detail stays thin.
And as the anti-corruption campaign rolls on, almost the entire Chinese elite is seeking to maintain the lowest possible profile so they don’t attract the notice of the authorities, and thus reluctant to promote bold policies.
Even academics must mind their backs. For instance, a team of Communist Party anti-corruption inspectors moved into the Chinese Academy of Social Sciences this month, with a result that senior researchers are unable to leave the institution to attend conferences, make speeches or conduct research, until the new year.
Michael Komesaroff, the Australian principal of Urandaline Investments and an expert on China’s state-owned enterprises — he once worked for one — says the new broom drive under Xi means that “many traditional and profitable business models are no longer valid”, and that rather than developing and implementing a comprehensive economic strategy, “officials are fighting bushfires”.
This although the government is pressing on with finalising the 13th Five-Year Plan, set to come into effect following the National People’s Congress meeting in March.
The latest World Risk Developments report by the Australian government’s Export Finance and Insurance Corporation, published yesterday, notes that services have now reached half the Chinese economy, with the industrial sector’s contribution slipping to 40 per cent, and highlights the success of the recent Singles Day, set up as a promotion by e-commerce giant Alibaba, which raked in $20 billion, 60 per cent more than last year.
But the “rebalance” towards services and consumption still has a long way to go to catch up with many of China’s neighbourhood peers. It presents the conundrum that the related aim of doubling incomes in this decade, between 2010 and 2020, requires growth to be maintained at 6.5 per cent for the next five years — which may well require further fiscal and monetary stimulus, which in turn risks undermining key reform principles including marketising and liberalising.
And China’s working age population has been shrinking since 2012, further threatening consumption growth. The recent decision of the fifth “plenary” of the central party committee to extend the two-child policy should help alleviate the country’s demographic constraints, but probably only at the margins.
Leading Chinese financial publication Caixin has categorised 113 areas of national reform into the fast lane, the slow lane and the stopping lane.
It says that only 23 areas of reform are on track in the fast lane, while 74 are lumbering along in the slow lane, and 16 policy priorities have ground to a halt. Thus acceptable progress is only being achieved in 20 per cent of the ambitious reform program.
After three years in power, Xi is very popular, and the party is more entrenched than ever as it edges towards its centenary in 2021. But the wriggle room for adjustment becomes smaller and the need for greater technical expertise becomes greater in steering the economy as it becomes more sophisticated.
Leaders now worry that relaxing financial controls may allow people to shift money out of the country just when it is most needed to sustain growth.
They are concerned that allowing banks to set their own rates, a key element in introducing competition into the formal finance sector — which at a retail level is being skirted by consumers substituting the non-state online sites for banks — would risk deepening the bad-loans dilemma.
Much of this is missed in reports by Western financial analysts, who tend to be industry specialists, conveniently viewing globalisation as an exercise in convergence. But China isn’t becoming more “like us”, although it’s investing more overseas. It would be a mistake to assess its success or otherwise by gauging its Westernisation.
During and after the global financial crisis, China’s leaders were praised by many analysts for saving world growth by their busy printing of bank notes and their big spending.
Now Beijing is being criticised by analysts not only for maintaining a level of stimulus at the apparent expense of more whole-hearted reforms, but also for failing to do enough to boost demand. “Walk! Don’t walk!”
Moody’s ratings agency said yesterday that steel prices would continue to decline next year, due to “slow property investment, modest infrastructure spending and lacklustre manufacturing” in China.
Chinese steelmakers will seek new export markets but for commodity suppliers there seem few alternatives right now but to cop the current price levels as “the new normal”.
Komesaroff believes the extension — beyond a couple of pilot zones — of the relaxation of the ancient hukou system, which restricts where Chinese people can live, will drive a fresh burst of new building and thus steel demand.
But there is little appetite, as we have seen, for such attention-catching “boldness” in the elite.

Nov 26 2015 at 9:08 AM

China shifting gear in currency capers

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[img=620x0]http://www.afr.com/content/dam/images/g/l/5/w/t/2/image.related.afrArticleLead.620x350.gl8ax8.png/1448262291386.jpg[/img]Snowmen with Chinese national flag lines up on a security check point near Tiananmen Square in Beijing, China. AP
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by Karen Maley
How soon before Beijing again devalues the yuan?
The question is becoming increasingly urgent as the US dollar continues to gain ground against other major currencies, such as the euro and the Japanese yen. Overnight, the euro dipped further after reports that the European Central Bank could decide to push the region's deposit rate further into negative territory next week.
After its surprise devaluation of the yuan in August, which brought the level of the currency more into line with market reality, Beijing has kept the currency fairly steady at just under 6.40 to the US dollar.
But to do so, China has been forced to dip into its foreign currency reserves, which are mainly invested in US bonds. According to the latest US figures, China's holdings of US bonds fell $US12.5 billion ($17.2 billion) in September, to a seven-month low of $US1.26 trillion.

At the same time, Beijing has clamped down on capital transfers. Last week, the state-owned newspaper, the People's Daily, reported that Chinese authorities have uncovered 170 cases of money laundering or illegal capital transfers since the month of April, involving around 800 billion yuan ($173 billion). Altogether, a total of 1.3 million transactions were closely scrutinised and 3000 accounts were frozen.
Chinese authorities are also tightening the rules on credit card transfers. In August, police in Macao raided five money-lenders and arrested 17 individuals for using credit card transactions to mask foreign exchange transfers. The following month, Beijing announced a new limit on card withdrawals outside the country of 100,000 yuan a year, compared with the previous daily limit previous limit of 10,000 yuan.
At the same time, Beijing is continuing its long-running efforts to reduce another widespread practice of shifting capital out of the country by inflating the invoices issued by foreign suppliers.
Many analysts believe that Beijing has delayed efforts to drive its currency lower while it waits to see whether it has succeeded in its long-term ambition of having the yuan included in the elite basket of currencies used to decide the value of the International Monetary Fund's de facto currency.

Earlier this month, IMF staff recommended that the yuan be included in "Special Drawing Rights" (SDR) basket, with IMF head Christine Lagarde explaining that the yuan met the IMF's two main tests for inclusion – that it be "widely used" and "freely usable".
Beijing has been pushing to have its currency join the US dollar, euro, yen and pound in the SDR basket, because it confirms the yuan's status as major reserve currency.
TAKING ACTION
If, as seems extremely likely, the IMF board decides to include the yuan in its SDR basket at its meeting on November 30, China would likely trigger a political backlash, particularly in the United States, were it to devalue its currency immediately.

As a result, Beijing is likely to wait weeks, if not months, before taking action.
China's reference rate for the yuan is approaching the weakest level since an August devaluation and a breach of the low would likely fuel speculation that policy makers are prepared to let the currency depreciate, according to Societe Generale.

But the cost of doing so will continue to mount, particularly if the US central bank decides to hike interest rates at its December 16 meeting.
Higher US interest rates will punish debt-laden Chinese borrowers heavily because it will push up the interest rate they pay on their US dollar-denominated loans. Even worse, higher US rates will likely push the US dollar even higher, making it more making it more expensive for Chinese borrowers in local currency terms.
As a result, many Chinese borrowers likely to try to pay down US dollar-denominated debts, with some analysts estimating that around $US400 billion could be repaid. This demand by borrowers to sell yuan to buy US dollars will add to the downward pressure on the Chinese currency.

There are also strong economic reasons for China to embrace a lower yuan. Allowing the currency to fall would also make it easier for the People's Bank of China, to pursue an easier monetary policy to prop up sagging growth.
China's central bank has cut interest rates six times in the past year, as well as reducing the reserve requirements for banks, but this monetary stimulus has been reduced by its currency intervention, which has drained liquidity from the system.
Given the choice between easier monetary policy to boost growth and defending the currency, it's likely to be only a matter of time before Beijing opts for the former.

China’s economic rebalancing to services is ‘well under way’

PETER CAI
THE AUSTRALIAN
NOVEMBER 28, 2015 12:00AM

As the winter starts to bite in Beijing, the country’s transition to a services-based economy is well on track.

[*]

There has been a lot of pessimism around China lately, especially following the carnage on the country’s stockmarket and the sudden devaluation of the yuan. This is in addition to concerns about the property market, the stability of the banking sector and the growing pile of debt.

However, AllianceBernstein, a global asset manager with $463 billion in assets under management, says the pessimism is overdone.
“The good news about the structural rebalancing of the economy that’s well under way has yet to filter out to Western investors to any meaningful extent,” says Stuart Rae, AllianceBernstein’s chief investment officer for Asia Pacific.
Rae is referring to of China’s transition from a manufacturing powerhouse to a service-based economy. The service sector now accounts for 50 per cent of the economy, while the industry sector has fallen to 41 per cent.
The big question is whether the consumption boom is sustainable, especially in face of persistent weakness in its declining but still powerful industrial sector. Rae says it is dependent on whether the government can manage the migration of jobs from the old economy to the new economy.
“It depends on whether the jobs that are going to be lost from heavy industry can be recycled into services,” Rae says.
“If you start to see mass unemployment in the old industry, that would affect the overall wage growth and also consumer spending. But we are not seeing that today.”
The official unemployment figures are widely seen as unreliable and Beijing is yet to release new numbers which have been compiled according to international standards.
Rae thinks demographics works in the country’s favour: “There is less of a requirement on China to create new jobs; the working population is close to a peak as a result of the one-child policy. I think they will be able to recycle all these old jobs into the new economy.”
Many demographers agree that the country has reached the so-called Lewis turning point, the point at which when surplus labour from the countryside dries up. There are also labour shortages in some parts of the country, and this is partly responsible for strong wages growth in China, which is outpacing GDP growth.
The weakness in the property sector is seen as a concern for investors. However, the market has started to show signs of recovery.
“Sales volume has gone back into positive territory,” says Rae. “We are seeing pricing in larger cities, tier-one and tier-two, come back into positive territory. What we haven’t seen, yet, is new construction come back into positive territory because there is a large inventory overhang.”
Tier-one cities refer to huge metropolises such as Beijing, Shanghai, Guangzhou and Shenzhen and tier-two refers to large provincial capitals. Together these two categories account for 51 per cent of China’s housing market.
Investors are also concerned about banks’ balance sheets as bad loans pile up.
“We are seeing an increasing trend for bad corporate debt, it is part of the normal business cycle and that is more than priced into the (banking) stock,” says Rae. “The reason the stock is really cheap today is that people are concerned about a potential black hole on their balance sheets related to their infrastructure lending.”
Infrastructure-related lending forms 10 per cent of banks’ balance sheets. There is a good chance some of them will not get paid back as some of the projects are not economic. Beijing is trying to manage this risk through developing a municipal bond market.
Rae says this presents a good opportunity for investors. “You don’t have to take extreme risk in China to get attractive yield. Government bonds are still attractive compared to what you can get elsewhere in the world.”

November 25, 2015 2:10 pm
China’s most powerful weapon is trade
[Image: 6306d516-0950-11e1-8e86-00144feabdc0.img]David Pilling

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Commercial tussles are less dramatic than scraps in the South China Sea but may be more important
[Image: 6e3525db-e625-4752-a833-59ac853e3b3b.img]©Bloomberg
Li Keqiang, China's premier, left, shakes hands with Najib Razak, Malaysia's prime minister
T
his ought to have been an excruciatingly embarrassing time for Najib Razak, Malaysia’s scandal-engulfed prime minister, to meet the leaders of the free and not-quite-so free world. The development fund he helped set up, 1Malaysia Development Berhad, is linked with multiple international probes into suspicious transactions. Weighed down by $11bn in debt, it is fighting to stay afloat.
Instead, Mr Najib, fresh from the glow of finding $700m from an unnamed Middle Eastern donor in his personal bank account, appeared to relish the chance of hosting the US president and Chinese premier, both of whom were in Kuala Lumpur last week to attend regional gatherings.

DAVID PILLING

As well he might. Barack Obama, who badly needs Mr Najib to support a broad agenda, from counter-terrorism to free trade, went decidedly easy on a leader who stands accused of misappropriating state funds on a massive scale. Among other things, Mr Obama praised Malaysia as being “extraordinarily helpful” in fighting Isis with a counter-narrative of moderate Islam.
He also acknowledged Malaysia’s importance as a signatory of the Trans-Pacific Partnership, a trade pact Washington hopes will bind it to the world’s most dynamic region and complement its much-discussed (though not-so-much enacted) military pivot to the Pacific.
Li Keqiang, the Chinese leader, went one better. He showered Mr Najib with gifts — as if $700m was not enough. State-owned China General Nuclear Power Group coughed up $2.3bn to buy energy assets belonging to 1MDB, thereby relieving its debt misery. Mr Li talked glowingly about the potential for other big Chinese investments, including a planned high-speed rail link from Kuala Lumpur to Singapore. The two traded purchases in each other’s debt as lovers might trade poems.
The usual view of China’s rise is that it presents Asian countries with a tough choice. How, for example, should Australia balance its commercial interests with China, by far its biggest trading partner, against its deep security interests with the US? The answer is that it is not always easy. Australia, whose 24 years of recession-free growth owe much to China’s hitherto voracious demand for commodities, has a sometimes tetchy relationship with its economic benefactor. Canberra has been wary about Chinese investments in farmland, telecommunications and minerals.
Yet for less well-off countries there may be an alternative: play one off against the other for the best possible deal. A case in point is Pakistan. An on-again, off-again ally of Washington, Islamabad has consistently stuck close to Beijing. It has been rewarded with the promise of huge investments in its rickety power and transport sectors. China has talked grandiosely of building an 1,800 mile-long corridor linking Pakistan’s deep-sea port at Gwadar to its own restless Xinjiang region. If even a fraction of the $46bn Beijing has flashed comes good, it could be transformative.
Indonesia, too, has been canny. Recently, it played off China against not the US but Japan. After years of talking to Tokyo about a $5bn bullet train, at the last minute Jakarta took the Chinese shilling. Beijing offered a financing deal too good to pass up. Wrongfooted Japanese diplomats promised to redouble efforts to win the Kuala Lumpur-Singapore rail link also in Beijing’s sights.
This sort of soft commercial tussle, though less headline-grabbing than scraps over artificial islands in the South China Sea, may turn out to be more significant. If Washington has the TPP, Beijing has the Regional Comprehensive Economic Partnership. The US has the World Bank and Asian Development Bank. Now Beijing has the Asian Infrastructure Investment Bank, which could start funding projects next year.
Beijing’s trump card may be its One Belt, One Road plan to link China to Europe and the Middle East via railways, roads and ports spanning central Asia and the Pacific and Indian oceans. For the multiple countries that lie along those routes, from Myanmar and Kazakhstan to Indonesia and Sri Lanka, there is money and concrete to be had. And money talks. Even the UK is not immune to the pull of China’s red dollar.
Money can only buy you so much. Myanmar, Sri Lanka and the Philippines have each resisted the gravitational pull of China. Myanmar’s political reform and overtures to Washington were driven by the generals’ fear of being beholden to Beijing. Sri Lanka’s voters kicked out former president Mahinda Rajapaksa because he was seen to have cosied up too closely to China. And the Philippines has put its security concerns ahead of its economic ones, risking Chinese wrath (and banana boycotts) by taking Beijing to international court over a sovereignty dispute.
Yet the battle is on for the hearts and minds of Asia. It will be won as much by engineers as by military strategists.
david.pilling@ft.com

Nov 30 2015 at 3:46 PM

Yuan's entry into IMF club a blow to central bank interest in accumulating $A

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The International Monetary Fund is poised to confirm that China's currency has been awarded special drawing rights status - but it doesn't mean that central bank reserve managers will rush to top up their yuan holdings in response.
[img=620x0]http://www.afr.com/content/dam/images/g/i/9/7/2/o/image.related.afrArticleLead.620x350.glb8g8.png/1448858795769.jpg[/img]China's currency is about to win the imprimatur of the IMF. Seong Joon Cho
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by Vesna Poljak
The admission of the Chinese currency into the world's foreign exchange reserve basket is hugely symbolic for the yuan, but strategists are not confident that central bank reserve managers will rush to top up their yuan holdings in response.
Indeed, the yuan may depreciate in the short-term and is trading at around a three-month low.
The International Monetary Fund is poised to confirm that China's currency has been awarded special drawing rights status, joining the euro, Japanese yen, pound sterling, and United States dollar. In reality, few central banks match the SDR weightings dollar-for-dollar. For example, the US dollar is 41.9 per cent of the SDR but its representation within central bank reserves is closer to around 60 per cent.
It's still unclear what weighting the yuan would be allocated and the decision could have spillover effects for proxy currencies such as the Australian dollar in time, argues Ray Attrill, National Australia Bank's global co-head of FX strategy.

"Of all the existing currencies that might fall out of favour as demand for CNY" – the offshore traded yuan – "directly picks up, the Aussie dollar could be one," he said. The dollar was at US71.75¢ on Monday, trading slightly lower.
The Australian currency was more liquid than its Chinese counterpart and had been in favour with reserve managers as a proxy for China during the boom years. Since China's growth peaked, and the dynamics within the Australian economy changed, there have been signs the Australian dollar is less critical to central bank reserve inclusion.
In the meantime, Chinese officials may be more willing to allow further yuan depreciation now that IMF approval is imminent.
INTERVENTION TO STABILISE CURRENCY

The currency was devalued in August but since then, China has been busy defending its value to keep the yuan stable and avert a greater drop amid intense scrutiny of China's activity.
"They intervened quite heavily to stabilise the currency and there is a view that was partly done with a view to getting into the SDR," said Mr Attrill. "Now, they might not be as incentivised to keep the currency stable.
"You would think at the moment if market forces were allowed to prevail it would be weaker rather than stronger."
Monday's fix was set at 6.3962 against the US dollar, meaning one greenback buys 6.3962 yuan.

"One thing we don't know is what weight the CNY is going to get [within the SDR]," said Mr Attrill. "They say the weights are based on the share of that currency in global trade and its existing use as a reserve asset."
IMPORTANCE IN TRADE
The yuan is highly relevant to trade but represents only a fraction of reserves. NAB estimates the yuan's weighting could be between 7.5 per cent to 10 per cent. In the end reserve accumulation is entirely discretionary and the IMF's decision could have modest influence.
"You can give China a 20 per cent weight, but it doesn't mean that reserve managers are going to hold 20 per cent," the strategist said.

"The more central banks want to own the CNY, the less they're going to want to own other existing currencies. Will it be proportionate or will it be skewed towards the non-dollar currencies? On the other hand, central banks have had access to renminbi for many years… and there still needs to be a further development of the debt market, the capital market, to create the assets central banks want to own."

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