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21 октября 2013, 19:26

What does the Canton Fair tell about Chinese economy?

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I'd like to do an advertisement at the beginning of this post. Our Shadow PBOC seminar has set up a website: shadowpboc.com. It will not only include long analysis on certain topics of Chinese economy as I have been posting on this blog, but also have shorter but more frequent pieces on interbank market and some smaller events. We are also thinking about filming part of the seminar and the videos will be uploaded on the website as well when we finish doing that. Thank all readers for following this blog and please keep following us at shadowpboc.com in the future.  Last week I attended the first session of the 114th Canton fair. For a long time, the Fair held twice a year in spring and fall in Guangzhou is recognized as one of the most important trade fairs in the world. It is still the largest trade fair in China and China is still the world’s largest exporter with 13% of global exports, despite the increasing difficulties of selling goods abroad. When talking to Chinese exporters, there are three things that they complain all the time: rising wages, rising Renminbi exchange rate and weaker demand. Wage is growing quite fast and on average it has increased 10-15% from previous year. In Guangdong, wage level for a junior worker is 2500 yuan (400 USD) per month. For senior and skilled workers, it reaches 5000 to 6000 yuan (800-1000 USD) per month. In Jiangsu and Zhejiang (both are neighbours of Shanghai), monthly salary for a junior worker has reached 3000-3500 yuan (500-600 USD). In inland China, wage level is still low. A Chongqing-based motor manufacturer says monthly wage is about 1800 yuan (300 USD) for a junior worker.  Besides rising wages, exporters also express concerns that compared with the elder generation 15-20 years ago, fewer young people want to work in factories now.   It is nature that no exporter likes currency appreciation and the profitability of the exporters has been hurt, especially when the currencies of other emerging economies have depreciated again the US dollar.  but it seems that everyone has become accommodated to a moderate 3-5% appreciation every year.   Despite the rising trend of RMB Cross-Border Trade Settlement, only one out of two dozen exporters  I interviewed has used it and it is probably because most of his customers are based in Southeast Asia and Renminbi is better recognized in that region. For those who trade with Europe, Middle-East or Africa, RMB settlement is still not an option. What's more, RMB settled imports are 30% more than exports according to the PBOC's monetary policy report, as RMB appreciation expectation makes foreign companies prefer to hold RMB than sell it and the RMB pool outside China is also very small so that foreign companies do not have access to the Chinese currency even if they want to purchase Chinese goods in RMB. Sometimes exporters can avoid exchange rate risk by selling products to trading companies first and this transaction is settled in RMB. Despite the concerns on rising wages and RMB appreciation,  in the conversations I had last week most people, especially those who trade with Europe, Russia and the Middle East, say the biggest problem now is weaker demand as they receive fewer business cards this year compared with previous Fairs.   The New York Times has noticed that the Canton Fair has become less attractive. For the first time in recent record-keeping, the number of companies with exhibits has declined in both the spring and autumn sessions of the 56-year-old Canton Fair compared with a year earlier. Even during the global financial crisis in 2009, the number of exhibitors dropped in the spring but rebounded in the autumn. Buyers from all over the world still milled through the cavernous exhibition halls on Tuesday, but they appeared less numerous than during previous fairs. We can also find evidences from the number of visitors. 92,149 visitors attended the 114thCanton Fair in the past week and the exhibition hall looks extremely crowded, especially during lunch time. However, 92,149 is 8% less than the number in spring and 1.5% less than the number last autumn.As visitors in the first week account for half of total visitors, it is likely that total number of visitors would drop this autumn and it would be the second time in Canton Fair’s history after 1978 that number of visitors in the autumn fair declines for two consecutive years. The first time was autumn 2007 and 2008. Here is the key question: Does it mean China’s export is having another hard time, or the Fair is no longer a good indicator? In history, the Canton Fair tracked China’s export quite well. The number of visitors first started to drop in October 2007 and had two negative growths in both spring and autumn 2008, before China’s export actually started to fall in November 2008. In October 2009 the number of visitors to the Fair rebounded before export started to recover in December 2009. Thus, the current situation suggests that we should not be surprised to see very weak export growth next year. Canton Fair visitor number growth and China's export growth  While the number of visitors is falling, some exhibitors also told me that few of their businesses are made during the Fair and their long-term customers also rely less on the Fair to purchase products. Only new customers would make orders at the Fair. A company selling ladders to Europe told me that they spent 300,000 yuan (50,000 USD) for the exhibition in order to keep good relationship with their customers, as they would feel odd if someone does not present at the Fair. Although the importance of the Fair is declining, it would still be extremely difficult to get the space back if they give it up. A buyer from Lain America told me that the main purpose he came to Guangzhou is not to buy goods. Instead, he came here to visit his suppliers and their factories in person. What's more, the breakdown of visitors by country shows that the proportion of visitors from advanced economies to the Fair is much lower than the proportion of Chinese export to advanced economies. For instance, the United States and Japan account for 17% and 7.4% of China’s total export in 2012 respectively, but American and Japanese visiting the Fair only account for 4% and 2% of total visitors respectively. Thus the Fair perhaps does a good job tracking China’s export to Europe and emerging economies, but it may not represent the overall picture. Number of visitors in the first week World 92149 100% Germany 889 1% Asia 51883 56% UK 1143 1% Japan 1738 2% America 13345 14% India 4546 5% US 3937 4% Malaysia 4269 5% Canada 1424 2% Hong Kong 8849 10% Brazil 2615 3% Taiwan 3153 3% Oceania 3310 4% Europe 15578 17% Australia 2771 3% Russia 4586 5% Africa 7833 9% Italy 1023 1% Eygpt 1329 1% France 1151 1%       In addition, for those who sell products mainly to the Middle East, they have a specific reason for fewer visitors. The Eid al-Adha 2-day holiday starts on October 14 this year, which is the day that the Canton Fair opens. It is extremely difficult to answer the question I raised above and the both explanations are possible. It does not necessarily mean that export growth would be low next year, but at least it tells us that the trade environment is not very encouraging.  Shadow PBOC seminar Chen Long 

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15 сентября 2013, 11:32

Financial liberalization, reform and urbanization in INET Shenzhen

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This week, Chen Long and I were honored to be invited to the INET-Tsinghua conference in Shenzhen. Sharpest minds gathered at the conference to discuss the most concerned economic issues on China. Titled “The Good Life: The Challenge of Progress in China Today”, the conference addressed topics on China’s institution, shadow banking, financial liberalization and urbanization. Several speeches sparked inspiration in my minds, and I want to share the opinions in the post. First, institutional reform on capital allocation was strongly favored by the panelist. Mr. William Janeway pointed out that China was transforming from “catch-up” innovation to frontier innovation, which required the cooperation of the government, the capital market, and the capital owner. According to his opinion, it was the time for Chinese government to sacrifice part of economic growth to sponsor the innovation, which means to allocate less resources to low-risk investment and fund more of high-risk innovation. Adair Lord Turner supported Mr. Janeway’s view from another angle. He also said that China should change the way of credit allocation, and rely more on free market rather than interest rate management to adjust the investment. He recognized that under the current circumstances, extremely low interest rates stimulate more investment over consumption, which leads to more imbalance in the economy. Total social financing has been rising at a much faster pace than GDP and China is facing a rising debt problem. We completely agree. Some argue that there won’t be a debt problem in China because it is the state-owned banks lending to government and state-owned enterprises. Since both sides are state-owned, the government can tell them to write the debts off. This claim might look plausible at the first glance but it is fundamentally wrong, because banks owe debts to the depositors and if bad assets are written off from the banks’ balance sheets the depositors will either withdraw their deposits from banks or they will have to take the losses, and both scenarios will lead to crisis. That said, interest rate liberalization should be the pill to cure the disease. However Lord Turner also said that the steps towards interest rate liberalization have to be cautious given the large amount of debts at the current moment. What’s more he also argued that financial liberalization is not the magic stick to solve everything and China has to be careful dealing with issues like capital account liberalization. In a later speech, Mr. Frank Veneroso also expressed similar views that China has to be cautious moving towards financial liberalization. In another panel, Nobel laureate, Prof. Robert Engle introduced the idea of systemic risk in his speech. Systemic risk means that if every firm has a high leverage, a small disturbance in financial market will lead to spiral down and finally, collapse. According to his calculation, the systemic risk of Chinese banks was catching up with Japanese banks, which is very alarming.  Prof. Engle also raised the concerns about the inefficiency and the implicit guarantee of China's state-owned enterprises. This is a very important issue but unfortunately Prof. Engle did not go into details due to time constraints. The SOE problem is widely noted, but it is important to find out the fundamental reason so that the right reform would be made. If we assume that Chinese SOEs are less efficient than the private-owned companies, we have to identify whether it is because of its ownership structure or other reasons. If the SOEs are inefficient simply because they are owned by the government, the solution would be very easy - just privatize them. However, if their inefficiency is not due to the ownership structure but their monopoly status, the government should introduce more competitions. If the SOEs are inefficient simply because their sizes are too big, the solution would be much more difficult as too-big-to-fail has become a universal problem. There is no easy answer. Many argue that the ownership of SOEs led to the implicit guarantee by the government which caused the moral hazard and inefficiency, but apparently a company does not have to be state-owned to be implicitly guaranteed. The most recent financial crisis suggest that as long as a company, especially a financial institution, is large enough, it would be guaranteed by the government no matter whether it is owned by the state or by private entities. Moreover, it is also unclear that whether privatization can reduce risks. Some people argue that large US banks tend to take more risks than small US banks because they are too-big-to-fail, but it seems that small and medium sized banks are doing more risky businesses than large banks in China, because the state regulator has better controls over large state-owned banks and it does not allow large banks to get risky. If China privatize the large state-owned banks, it would probably increase financial risks because large banks are still too-big-to-fail and they might take more risks as the state regulators have weaker control over the large banks. Mr. Xiao Geng of Fung Global Institute also acknowledged that financial repression caused the rapid investment growth in China, and he offered two interesting reasons explaining why China did not have financial crisis in the past 30 years. The first he said was that most of the investments made in the first 30 years were guided by the central planning so that there were pretty successful. The recent sharp increase in debt and debt-funded investments was because of a weaker central planning. The second reason was that China has gone through a catch-up period, during which the capital accumulation was low enough that every penny of investment generated high return. Mr.Xiao argued that the two driving force, however, were gradually losing its power, and the new investment in China could no longer cover the cost of capital. We agree that the recent investments may not be enough economic viable to cover the cost, but his explanations about the 30-year growth sound a bit dubious. It is plausible that when a country is poor it usually needs a strong government to implement right policies to take off and in theory the investments at such stage tend to generate high returns. However, it is different from that central planning is key to success and less central planning causes troubles. History suggests that central planning usually failed to work. Steel is a sector that the government has strong controls, but it has experienced over-capacity problem for many years. After all the whole point of Chinese reform after the late 1970s is to get rid of central planning, not to highlight central planning. What’s more, it is also dubious to argue that since a country is poor any investment would be beneficial. If it is that easy, there would be no poor country in the world. In fact there is little evidence supporting that investments in poor areas must be more economic viable than investments in rich areas. Investments in poor areas can be very likely to be wasted simply because nobody can afford using it. A recent IMF paper suggests that investment in Chinese coastal areas are more economic viable than investments in the inland. The conference closed with the discussion of urbanization. Mr. Tom Miller of China Economic Quarterly delivered an interesting speech on cities of China. He attributed the scrupulous expansion of cities to the low price of land. Not like most other opinions, he did not emphasize that local government rely on land grant to fund their expenses. Instead, he raised the point that local government was also hungry of business tax, as they can keep 75% of it to themselves while turning over most of other taxes to the central government. In order to attract profitable firms to settle on their territory, local governments often provide cheap land for those firms to build their offices or factories. This accelerated the uncontrolled expansion of cities. One solution to this problem, according to his speech, was to introduce property tax in cities. He argued that if the government had an alternative source of income, they would not be so eager to collect business tax from local firms. This argument, however, is based on an implicit assumption that a government has a fixed target of fiscal revenue. Tom acknowledged that it would be really challenging to push forward the property tax due to the political pressure, but my concern is that there is no upper limit of local governments’ desire of fiscal revenue. There is little evidence suggesting that Chinese local governments would be satisfied with property taxes so that they would sell less land or charge less business tax, and it is very possible that local governments would still try hard to increase their fiscal resources. If this is true, it would be completely against rebalancing since the government should cut tax, not raise it, to lift household consumption as a share of GDP. The new semester has kicked off and our shadow PBOC seminar will resume this Saturday afternoon in Peking University. We will continue to discuss these issues and guest visits are very welcomed. Duan Wan

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03 сентября 2013, 10:51

The Debt Dragon

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I wrote two pieces responding to FT's recent debt dragon series but they were on the Institute blog site instead of here. So I am pasting the links below so that our readers can find them: China Economics Seminar: Understanding the Guizhou Paradox China Economics Seminar: The Real Risk In China’s Local Government Debt    

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21 августа 2013, 11:41

A Short History of China’s Doubtful GDP

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It is no secret that the quality of Chinese statistics, especially GDP, is far from perfect. Chinese GDP’s lack of volatility often looks surreal. Along with many other China analysts, I often feel frustrated by this. Perhaps I feel even more strongly because it is somehow embarrassing when foreign investors and scholars always ask me how authentic my country’s data is. Recently I reread American-Chinese historian Ray Huang’s book in which he argues that China failed to industrialize before Europe because the old empire was functioning on the basis of philosophical principles instead of solid numbers. For instance, 50 years after the Bank of England was set up, the 18th century Chinese emperor still had no estimate of the exact number of people under his rule. Some government officials even argued that it was not necessary to collect population statistics and that it would only increase the fiscal burden to do a census.   China paid huge costs for its inability to modernize and the old empire almost lost its sovereignty. Of course, things changed dramatically in the 20th century as China started to industrialize at a relatively fast pace. However, although GDP became the main tool measuring for an economy after the WWII, it was not until 1985 that mainland China started to calculate its GDP. Before that to calculate its economic output China was using Material Product System, which was a method adopted by the former Soviet Union and many other socialist countries before 1991 that is still used by North Korea and Cuba today. One of MPS's main distinctions is that it does not include any services. It was not until 1993 that China completely abandoned MPS and GDP became the only main measurement of economic output.  In other words, we actually have little idea about China’s actual GDP before 1985 because it was not even calculated back then. The pre-1985 GDP numbers we find in the economic databases today were rebuilt after 1985, so it is reasonable to argue that the data quality is not very high. Moreover, China's GDP numbers in late the 1980s and early 1990s were still not trusted by the World Bank, who published every country’s GDP in US dollars, because the official Renminbi exchange rate was very far from the market rate. The World Bank only started to use the official Chinese data after China’s first exchange rate reform in 1993. If the skepticism about GDP focused largely on methodology or the exchange rate before 1993, the concern later became whether the number was cooked because it had a lot to do with the “growth target”. China's growth target is very Soviet-style, but in the 1980s it was not as important as it later became in the 90s. There could be two reasons. First, China only started to calculate GDP in 1985, so it took time to become a widely accepted number. Second, the political events in the late 80s heightened the importance of economic growth. The 8th Five-Year-Plan released in 1990 only set the growth target at 6%, but two years at the 14th Party Congress the party decided to lift the growth target from 6% to 8%. The congress report says, “it is not only a major economic issue, but also a major political issue whether our economy can grow even faster”. The more well-known fact is that during the Asian crisis former Premier Zhu Rongji stressed that GDP growth had to reach 8%. But in reality 8% was mentioned 6 years earlier than that.  Why 8%? Many believed that only by growing at 8% would China avoid massive unemployment. But if that’s the case it would be hard to explain why the party set the growth target at 6% in 1990. Clearly in 1990 the party did not think that growth had to reach 8%, but later they figured that more political assets were needed and higher growth would help. To some extent it is fantastic to have a GDP growth target, as long as the target is considered to be reasonable, because the government can finally function on the basis of numbers instead of philosophy, moral standards, or relationships. The new GDP targets were also a big adjustment from Mao's chaotic era when economic output targets were largely based on his personal belief. In fact, China was not a Soviet-style planned economy before 1980s because it never had planning on a mathematical basis like the former Soviet Union. It was a one-man command economy that was different from both the Soviet Union, which used sophisticated mathematical equations to calculate general supply and demand, and the United States, which let the market decide most of the issues. Therefore, having a serious target is big progress in Chinese history and it helped a lot in achieving high growth. However GDP targeting also has a dark side, as it gives local leaders incentives to inflate their data. Data manipulation is natural in such a regime and becomes more severe during bad times. We saw ridiculous number cooking when Mao launched the “Great Leap Forward” movement in late 1950s and early 1960s and the cost was the lives of millions. The 90s were much better than Mao’s era, but when Zhu Rongji announced an 8% growth target during the Asian crisis, local governments started to cook numbers again simply because 8% was mission impossible. The numbers reported by local governments were so surreal that even the National Bureau of Statistics would not believe it. National GDP growth of 7.8% announced by the NBS was much lower than the sum of local GDP. Since then, it has become a common phenomenon that every year national GDP is lower than the sum of local GDP. Although the NBS data seemed closer to reality than the local governments’ figures, there were still many people challenging its quality. Their argument was that since the work of the NBS had to be based on the reports from the local level, it seemed impossible that NBS could make an accurate calculation if all the local data was inflated. Thomas Rawski’s 2002 paper largely summarised the debate on China’s data quality circa 2000, and he believed that China’ 7.8% growth in 1998 was overstated greatly. To counter the criticisms on quality of statistics, the NBS made another reform in calculating the national account in 2003. China Daily said: China will reform gross domestic product (GDP) calculation and statistics release based on international standards, so that the statistics objectively reflect the performance of the economy. Li Deshui, director of China's National Bureau of Statistics (NBS), said here Thursday that the reform plan had been approved by the State Council, and will be implemented by NBS. He pointed out China's GDP calculation method, initiated in 1985, had been improved gradually. However, the calculations still had some problems due to the lack of a regular adjusting and revising mechanism. Some traditional methods did not comply with international norms, arousing some criticism from the international community. The NBS’s efforts should get some credit. But the reform did not reduce skepticism about China’s statistics, though this time the doubts went in the opposite direction. After late 2003, economists started to argue that the official data understated real growth. The People’s Daily said: Official Chinese economic data has been viewed skeptically for decades, but one prominent Chinese economist is making a charge rarely heard before. …Wu Jinglian says the country's economy actually grew faster during the first half of the year than the official 8.2 percent announced by the government. Wu, who works for the States Council's Development Research Center, bases his statements on numbers from the country's statistics bureau. Wu’s argument for China's GDP being understated is very similar to some of the arguments we see nowadays. He pointed out that power generation and IP growth were much higher than GDP growth, which was exactly the same (but in opposite direction) as the arguments last year when analysts said that GDP growth was overstated because power generation growth was a lot lower.   Wu said an economy growing at 8.5 percent a year does not produce data such as the 16.5 percent industrial output growth recorded in the first three quarters of this year. He also said tax revenue growth, at 21.7 percent in the first nine months, and power generation growth of 15.6 percent were also out of kilter with the National Bureau of Statistics's top forecast. Wu was soon proved right, though the logic was quite different. In December 2004, China did its first national economic census and found out that actual national GDP in 2004 was 16.8% higher than the previous calculation. Bloomberg reported: A yearlong census revealed millions of companies previously unaccounted for, with combined output valued at about $284 billion in 2004, the National Bureau of Statistics said today in Beijing. Most of those companies are in service industries, which have been growing faster than manufacturing. Since then, every economic census ended up finding that overall GDP was a lot higher than previously estimated because the service sector was a lot larger than imagined. This is plausible, as every country has a so-called “underground economy” that largely consists of service industries. If China did another census tomorrow I would bet that GDP would again be higher than the number announced previously.    The latest and perhaps most persuasive evidence that China’s GDP is unreliable comes current Premier Li Keqiang. The Economist made a Keqiang index in 2010, saying: IF CHINA'S deputy Prime Minister, Li Keqiang, succeeds his boss, Wen Jiabao, in 2013, as is likely, he will become his country's top economic policymaker. But he may not pay much heed to the figures provincial officials feed him. In 2007 he told America's ambassador that GDP figures in Liaoning, where he was then party chief, were “man-made” and unreliable, according to a State Department memo released by WikiLeaks. In Mr Li's honour, The Economist has created a “Keqiang index” for China's economy, combining his three preferred indicators (see chart). It reveals an economy that is as dynamic as the official figures suggest, but a great deal more volatile. Electricity consumption and cargo traffic both shrank in the final months of 2008 and in early 2009, implying that China's economy suffered more grievously than the official figures allow. A loan surge in 2009 presaged the rapid recovery that followed. Indeed, the volatility matters much more than the actual size. It is not important to argue whether GDP is overstated by $1 trillion because property’s weight is too small in the inflation basket or if it is understated by hundreds of billions because many services industries or new technology sectors are not counted in. Even the growth does not matter too much now - what matters is the quality of growth. 20 years after the party set the GDP growth target at 8%, do we still need a GDP target? I doubt it. GDP targets can be very unrealistic and time-lagging, and they can cause local governments to waste a lot of resources simply to make their boss happy.  With soft budget controls and distorted pricing in the financial system, China’s local governments can invest endlessly. This investment would make GDP growth extremely high in the short term, but eventually the country (especially households) will have to pay for the imbalance caused by inefficient investments. Needless to say the numbers can be cooked. Many would still argue that China needs high GDP growth to absorb excess labor, but without unemployment data we do not even know whether it is worth polluting the environment to keep GDP growth high. It is said that China started to collect unemployment data in 2005, so why not publish it? We need more data to make the right judgment and now is the time to make another change.  Chen Long Central Banking Seminar  

12 августа 2013, 13:24

Current guidance is needed from the PBoC

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Recently, forward guidance has become a new fashion in the world of central banks and Bank of England is the latest one to join this club. In the news conference last Wednesday, Bank of England Governor Mark Carney said that the BoE would not raise Bank rates from the current level of 0.5% until the unemployment rate, currently at 7.8%, dropped to below 7%. The BoE’s historic move was following in the footsteps of the Federal Reserve and European Central Bank, who introduced forward guidance in December 2012 and July 2013 respectively.   Fed ECB BOE Unemployment threshold 6.5% N/A 7% Inflation threshold 2.5% 2% 2.5% Time frame of low rates through mid-2015 An extended period of time (not 6 or 12 months) Until 2016 Forward guidance is a non-traditional tool of monetary policy and the reason why central banks in the developed countries are adopting this tool now is probably because benchmark interest rates are already extremely low, which leaves little room for further downside adjustments. It could be very useful if the central banks communicate with the market well. As the Fed says, “By providing information about how long the Committee expects to keep the target for the federal funds rate exceptionally low, the forward guidance language can put downward pressure on longer-term interest rates and thereby lower the cost of credit for households and businesses, and also help improve broader financial conditions.” Weird enough, although forward guidance has caught the headlines in the English newspapers and triggered lots of discussions in the English blogsphere, I have seen very few discussions on this topic in Chinese media. It seems that the Chinese think forward guidance is something quite remote and no one believes the PBoC is going to join this club any time soon. I think people are right. In China it is still too unrealistic for China's central bank to discuss forward guidance, because we do not even have enough 'current guidance.' Forget about what will happen in 2015 or 2016. No one even knows what the PBoC will do in 3-6 months.  Many analysts and traders have complained privately that the People’s Bank of China does not like communicating with the market. It seems that the PBoC enjoys making the market guess in the dark, and it has probably never held the belief that it is important to communicate clearly with the market, which is held by many central banks in the developed markets. But is it a good strategy to be working in a black box? I doubt it. The most recent example is the interbank credit crunch in June. As I wrote previously, the PBoC failed to communicate properly with the market and it not only caused severe tension in the interbank market but also undermined its own credibility. The PBoC kept being very hawkish until June 24th when overnight repo surged to 30% and the stock market plummeted. On the next day its stance was completely reversed as an official announcement was released saying that the central bank had injected liquidity into the market. Its 2Q monetary policy report (in Chinese) told us that 416 billion yuan was injected to calm the market down. Apparently the PBoC learned that it could not let the repo rate spike to double digits again, as it injected liquidity by reverse-repos when money market rates rose again in July. However, the lesson might not be learnt in a good way, even though the PBOC says “The bank ... will reinforce communications with the market and the public so as to stabilize expectations and guide the stable operation of interest rates” in its 2Q monetary policy report. There were talks (in Chinese) that the PBoC was secretly managing the money market rate. When two rural cooperatives did a one-day repo at 5.92% on July 18th, the regulator asked them to cancel this transaction because “it was too deviated from the market price and had a bad influence”. As Reuters reported (in Chinese), repo rates could no longer reflect the real supply/demand of the interbank market as many banks turned to borrowing off-line from each other. The PBoC's routine open market operations can also confuse the market greatly. In July, the PBoC secretly rolled over 183.8 billion yuan 3-years PBoC bills while it provided short-term liquidity to large banks who bought those bills.It was not known until the PBoC’s 2Q monetary policy report was published on August 2nd, and the report described it as “innovation in open market operations.” But people still do not exactly understand its purpose.  This was not the first time we saw a major change in the use of open market operation tools without thorough explanations. The PBoC bill has been used frequently as a major instrument in PBoC’s open market operations since it was created in the beginning of this century, but its issuance was suddenly halted in December 2011 and no PBoC bill was issued at all in the year of 2012. Instead, the PBoC started to use reverse repos extensively to withdraw liquidity. The market had no clue about the purpose of this shift in open market operations and the analysts can only guess that the central bank might want to promote the significance of repo rates and that it might become the benchmark rate - just like South Korea setting 7-day repo as its benchmark rate - when interest rate is fully liberalized in China in the future. Since no bills have been issued in a full year, many were also speculating that the PBoC bill might have gone the way of history. These arguments all sounded very plausible, but all of a sudden the PBoC bills were issued again in May this year, after being absent for 17 months. This unexpected move made all the previous explanations and speculations look silly, but you can't blame the analysts, because the PBOC never told the market why they stopped issuing PBoC bilsl in 2012 and why they suddenly reissued them now.  This year, as GDP growth keeps decelerating, many were asking when the PBoC and the government will loosen their policies. Again, the PBoC offered little information and left the analysts debating with each other. The only thing that is close to a “current-guidance” is from Premier Li Keqiang, who said in July that 7% GDP growth is the bottom line of the government’s tolerance this year and the upper-limit for CPI growth is 3.5%. Is 7% GDP growth enough to keep unemployment low? Does it mean the government won’t ease its policy until the targets are missed? What exactly will his government do if it fails to reach its targets? We still don't know. And please don't ask about 2014.  Chen LongCentral banking seminar

08 августа 2013, 19:13

China's central government is paying for the AMCs

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Interbank crunch, GDP slowdown, worsened rebalancing, mysterious government debt … after so much frustrating news I finally found something inspiring: the Asset Management Companies (AMCs) are paying their bond principals! For readers who are not very familiar with the AMCs in China, this 2003 BIS paper would give you some background. Basically they are the Chinese bad banks. In the late 1990s and early 2000s, Chinese banking system had huge amount of bad loans and 4 asset management companies (AMCs) were created to purchase the bad assets of the big 4 state-owned banks at face value. In exchange of the bad loans, the banks received 10-year bonds from the AMCs. The total amount of bonds was as large as 810 billion yuan and by 2009 only about 100 billion were paid back according to a PBOC official. The Cinda bond held by China Construction Bank (CCB), Huarong bond held by Industrial and Commercial Bank of China (ICBC) and Oriental bond held by Bank of China (BOC), 720 billion in total, had not been paid by then. When those bonds were matured in 2009 and 2010, they were simply rolled over for another 10 years (see Caixin report). The reason was quite simple: the AMCs were not making enough money. However, the payments have suddenly accelerated since 2009. According to the 2012 annual reports of CCB and ICBC, their holding of the AMC bonds have declined substantially. Actually CCB’s holding of Cinda bond has fallen every year since 2009, when it was rolled over.   Table 1 AMCs bonds held by banks (in billion yuan)   2009 2010 2011 2012 Cinda bond by CCB 247.0 206.3 131.8 57.6 Huarong bond by ICBC 313.0 313.0 313.0 175.1 Oriental bond by BOC 160.0 160.0 160.0 160.0 Total 720.0 679.3 604.8 392.7 Remaining portion   94% 84% 55% This is very interesting. The AMCs were not profitable enough to pay any of the bond principals in the first 10 years so that the bonds were rolled over for another 10 years, but they suddenly started to pay large amounts right after the roll-over started. Why did the AMCs suddenly start to pay their bond principals after 2009? Logically there are only three possibilities and let me go through them one by one. 1.      They successfully recycled cash from the bad assets so that they had enough money to pay the bonds. 2.      They used their retained earnings to pay the bonds. 3.      Someone else helped them pay the bonds. The financial situation of the AMCs is not very transparent but it was said that Cinda was the only AMC who was able to pay the bond interests (5.56 billion yuan per year) on time and its net profits were only 4.4 billion yuan in 2009. Therefore there is no way that Cinda can pay bond principal as much as 190 billion yuan unless it suddenly made tremendous progress in selling those bad assets. What’s more, since Huarong and Oriental could not even pay interest on time,  tremendous progress would be required for Huarong to pay 140 billion in a single year. They did make some progress - Cinda’s net profits in 2012 rose to 7.27 billion yuan while Huarong’s net profits increased to 6.96 billion yuan - but this number is still too small. Can they use retained earnings to pay the bond principal? Given that Cinda's net profits were 7.27 billion yuan in 2012, even under the most optimistic estimation its retained earnings can hardly reach 100 billion yuan. So it is impossible for them to pay 190 billion principal with retained earnings. Since Huarong is even less profitable than Cinda, it is even more unlikely that it will pay 140 billion yuan in a single year.  There leaves the third option: someone else is paying for Cinda and Huarong. But who? In August 2010, CCB announced: China Construction Bank Corporation (“the Bank”) has recently received a notice from the Ministry of Finance (“MOF”) that the MOF and China Cinda Asset Management Co., Ltd. (formerly known as China Cinda Asset Management Corporation) (“Cinda”) have established a jointly managed fund to secure the payment of the principal of a bond issued by Cinda to the Bank with a book value of RMB247 billion (“Cinda Bond”). The MOF continues to provide support for the repayment of the interest under the Cinda Bond. The term of the jointly managed fund is from 1 July 2009 to 21 September 2019. The jointly managed fund is owned by the MOF and jointly managed by the MOF and Cinda during its term. The funding sources of the jointly managed fund include, among others, enterprise income tax payable by the Bank during the term and other appropriations made by the MOF. According to the announcement, the fund jointly-managed by MOF and Cinda will pay the bonds and the capital of this jointly-managed fund is from the enterprise income tax payable by CCB and other appropriations made by the MOF. We do not exactly know what the other appropriations are but it is reasonable to argue that it is from the fiscal revenue and the amount of appropriations could be quite large. CCB paid 57.8 billion as enterprise income tax in 2012 and even if all of it went to the joint-managed fund it would not be enough to cover all the bond payments. The MOF still had to add at least 16.4 billion to the fund. For Huarong we do not even know how its was paid because ICBC never publicly announced that a joint-managed fund was set up. But since it was impossible for Huarong to pay 138 billion in a single year by itself, the government must have stepped in as well. And the amount paid by the government here would be even larger. Table 2 Bond payments and enterprise income tax in 2012 (in billion yuan)   CCB ICBC Enterprise income tax 57.8 70 Bond payment received 74.2 133 Net profits 193.6 238.7 There is still one last question: why does the MOF help pay AMC bonds? When the AMCs were not able to pay the bonds before 2009, the MOF offered no help and the bonds were simply rolled over for another 10 years. If the AMCs still cannot pay, the bonds can either be rolled over again or the banks can write them off from their balance sheets. Why is the government (the taxpayers in fact) bailing them out now? To be honest, I don’t know the exact answer because it must involve with a lot of inside information and secret talks that I do not have access to, but I can make some guessimates based on the public information. There is a piece of news this morning on the Wall Street Journal saying that: China Cinda Asset Management Co. has invited bankers to submit proposals for its initial public offering in Hong Kong, which could raise about US$2 billion, people familiar with the situation said Wednesday. The IPO is expected to come in the fourth quarter at the earliest, with many of the banks that handled the IPOs of China's big lenders vying to run the offering. Cinda has planned for an IPO in Hong Kong for a long time, but if a company has 247 billion payable bonds that have been rolled over for 10 years, it is hard to imagine that investors won’t challenge the financial status of the company and make the public listing very difficult. Therefore, it is in Cinda’s interest to get rid of the 247 billion bonds as soon as possible and the MOF who owns Cinda decided to offer the help. The commercial banks also want to get paid as soon as possible, because they do not want to hold hundreds of billions in bonds with an annual return of only 2.25% while the benchmark lending rate is 6% and even the yield 10-year government bond is above 3.5%. Everyone seems happy with the solution, and it tells us again that central government will bail out large financial institutions when they are in trouble. Given that the AMCs are the legacies of the last banking crisis in China, I would be curious to know if the solution can be used again in the next one.    Central Banking SeminarChen Long

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08 августа 2013, 19:13

Central government is paying for the AMCs

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Interbank crunch, GDP slowdown, worsened rebalancing, mysterious government debt … after so much frustrating news I finally found something inspiring: the Asset Management Companies (AMCs) are paying their bond principals! For readers who are not very familiar with the AMCs in China, this 2003 BIS paper would give you some background. Basically they are the Chinese bad banks. In the late 1990s and early 2000s, Chinese banking system had huge amount of bad loans and 4 asset management companies (AMCs) were created to purchase the bad assets of the big 4 state-owned banks at face value. In exchange of the bad loans, the banks received 10-year bonds from the AMCs. The total amount of bonds was as large as 810 billion yuan and by 2009 only about 100 billion were paid back according to a PBOC official. The Cinda bond held by China Construction Bank (CCB), Huarong bond held by Industrial and Commercial Bank of China (ICBC) and Oriental bond held by Bank of China (BOC), 720 billion in total, had not been paid by then. When those bonds were matured in 2009 and 2010, they were simply rolled over for another 10 years (see Caixin report). The reason was quite simple: the AMCs were not making enough money. However, the payments have suddenly accelerated since 2009. According to the 2012 annual reports of CCB and ICBC, their holding of the AMC bonds have declined substantially. Actually CCB’s holding of Cinda bond has fallen every year since 2009, when it was rolled over.   Table 1 AMCs bonds held by banks (in billion yuan)   2009 2010 2011 2012 Cinda bond by CCB 247.0 206.3 131.8 57.6 Huarong bond by ICBC 313.0 313.0 313.0 175.1 Oriental bond by BOC 160.0 160.0 160.0 160.0 Total 720.0 679.3 604.8 392.7 Remaining portion   94% 84% 55%   This is very interesting. The AMCs were not profitable to pay any of the bond principals in the first 10 years so that the bonds were rolled over for another 10 years, but they suddenly started to pay large amounts right after the roll-over started. Why did the AMCs suddenly start to pay their bond principals after 2009? Logically there are only three possibilities and let me go through them one by one. 1.      They successfully recycled cash from the bad assets so that they had enough money to pay the bonds. 2.      They used their retained earnings to pay the bonds. 3.      Someone else helped them pay the bonds. The financial situation of the AMCs is not very transparent but it was said  that Cinda was the only AMC who was able to pay the bond interests (5.56 billion yuan per year) on time and its net profits were only 4.4 billion yuan in 2009. Therefore there is no way that Cinda can pay bond principal as much as 190 billion yuan unless it suddenly made tremendous progress in selling those bad assets. What’s more, since Huarong and Oriental could not even pay interests on time, a more tremendous progress is required for Huarong to pay 140 billion in a single year. They did make some progress. Cinda’s net profits in 2012 rose to 7.27 billion yuan while Huarong’s net profits increased to 6.96 billion yuan, but this number is still too small. Can they use retained earnings to pay the bond principal? Given that net profits of Cinda were 7.27 billion yuan in 2012, even under the most optimistic estimation its retained earnings can hardly reach 100 billion yuan so it is impossible for them to pay 190 billion principals with retained earnings. Since Huarong is even less profitable than Cinda, it is even more unlikely for it to pay 140 billion yuan in a single year.  There leaves the third option: someone else is paying for Cinda and Huarong, but who? In August 2010, CCB announced that China Construction Bank Corporation (“the Bank”) has recently received a notice from the Ministry of Finance (“MOF”) that the MOF and China Cinda Asset Management Co., Ltd. (formerly known as China Cinda Asset Management Corporation) (“Cinda”) have established a jointly managed fund to secure the payment of the principal of a bond issued by Cinda to the Bank with a book value of RMB247 billion (“Cinda Bond”). The MOF continues to provide support for the repayment of the interest under the Cinda Bond. The term of the jointly managed fund is from 1 July 2009 to 21 September 2019. The jointly managed fund is owned by the MOF and jointly managed by the MOF and Cinda during its term. The funding sources of the jointly managed fund include, among others, enterprise income tax payable by the Bank during the term and other appropriations made by the MOF. According to the announcement, the fund jointly-managed by MOF and Cinda will pay the bonds and the capital of this jointly-managed fund is from the enterprise income tax payable by CCB and other appropriations made by the MOF. We do not exactly know what the other appropriations are but it is reasonable to argue that it is from the fiscal revenue and the amount of appropriations could be quite large. CCB paid 57.8 billion as enterprise income tax in 2012 and even if all of it went to the joint-managed fund it would not be enough to cover all the bond payments. The MOF still had to add at least 16.4 billion to the fund. For Huarong we do not even know how its paid was paid because ICBC never publicly announced that a joint-managed fund was set up, but since it was impossible for Huarong to pay 138 billion in a single year by itself so the government must have stepped in as well and the amount paid by the government was even larger. Table 2 Bond payments and enterprise income tax in 2012 (in billion yuan)   CCB ICBC Enterprise income tax 57.8 70 Bond payment received 74.2 133 Net profits 193.6 238.7   There is still one last question: why does the MOF help pay the AMC bonds? When the AMCs were not able to pay the bonds before 2009, the MOF offered no help and they were simply rolled over for another 10 years. If the AMCs still cannot pay, the bonds can either be rolled over again or the banks can write them off from their balance sheets. Why is the government (the taxpayers in fact) bailing them out now? To be honest, I don’t know the exact answer because it must involve with a lot of inside information and secret talks that I do not have access to, but I can make some guessimates based on the public information. There is a piece of news this morning on the Wall Street Journal saying that China Cinda Asset Management Co. has invited bankers to submit proposals for its initial public offering in Hong Kong, which could raise about US$2 billion, people familiar with the situation said Wednesday. The IPO is expected to come in the fourth quarter at the earliest, with many of the banks that handled the IPOs of China's big lenders vying to run the offering. Cinda has planned for an IPO in Hong Kong for a long time, but if a company has 247 billion payable bonds and it has been rolled over for 10 years, it is hard to imagine that investors won’t challenge the financial status of the company and that will make the public listing very difficult. Therefore, it is in Cinda’s interest to get rid of the 247 billion bonds as soon as possible and the MOF who owns Cinda decided to offer the help. The commercial banks also want to get paid as soon as possible, because they do not want to hold hundreds of billions of bond with annual return of only 2.25% while the benchmark lending rate is 6% and even the yield 10-year government bond is above 3.5%. Everyone seems happy with the solution, and it tells us again that central government will bail out large financial institutions when they are in trouble. Given the AMCs are the legacies of the last banking crisis in China, I would be curious to know if the solution can be used again in the next one.    Central Banking Seminar Chen Long

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29 июля 2013, 13:07

Why is China auditing local government debt again?

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Here is what the FT says:  China will conduct an urgent audit of all government debt, underlining concerns over rising financial risks in the world's second-biggest economy. The National Audit Office said in a one-line statement on Sunday that it had been instructed by the state council, China's cabinet, to come up with a tally of how much money is owed by all levels of government from villages up to central authorities. So why do we ask the question in the title? Because this would be the third audit report on local government debt, only one month after the last report was published, and it comes much earlier than everyone expected, including the National Audit Office (NAO) itself. Two audits have been done on this subject so far. The first audit covering more than 3000 local governments was conducted from March to May in 2011 and the report was published in June 2011. The second audit was done on a much smaller scale as it only included 36 local governments. It was done during November 2012 to February 2013 and a report was published on June 10th, just a month ago. According to the information provided by the People's Daily, the official newspaper of the Party (in Chinese, for English see the FT report), the third round of the audit was required by the State Council and it will start immediately on August 1st. The NAO has called off other projects to focus on this one and many auditors were asked to cancel their holidays.  This news has raised tremendous discussions in China and apparently a lot of people are very worried about the local government debt as Shanghai Composite Index fell 1.72% today.  The People's Daily tried to calm everyone down by saying “it was just routine work”, but clearly it was not routine as the last report was just published a month ago and the state auditors have other jobs to do (and some are supposed to take vacations) if they did not get the call from the State Council. So why does the State Council want another audit only one month after the last audit report came out? My bold guess is that someone on top was not satisfied with the last report so this VIP wants another one to help him better understand the debt level. So the real question is, why wasn't this VIP satisfied with the last audit report? This table below can show you that the second audit was far less comprehensive than the first one and it is extremely doubtful whether the sample of 36 local governments can reflect the whole picture. In fact the last report could be misleading in many ways.   First audit Second audit Time End of 2010 End of 2012 Scale More than 3000 local gov'ts 36 local gov'ts Amount 10.7 trillion yuan 3.85 trillion yuan Growth rate on average 30% annually from 2000-2010 12% from 2010 to 2012 Why do I say this? The growth rate of debts in 36 local governments was 12% in the last 2 years, while it was on average 30% annually in the first decade of this century. If we believe the sample of 36 local governments is representative then we will see a very positive picture as local government debt growth has slowed down significantly in the past two years while GDP growth continued to be high. The first NAO report said that total local government debt was 10.7 trillion yuan and if we apply the 12% growth rate here, total local government debt would be 12 trillion yuan by the end of 2012, accounting for 23% of GDP, smaller than the ratio of 25% in 2010. Figure 1 Total local government debt (in billion RMB) if we believe in the last NAO report That local government debt totalled 12 trillion by 2012 simply looks too good to be true. Even the government officials won't believe it. Xiang Huaicheng, a former finance minister, said in April that China's local governments might have already borrowed more than 20 trillion yuan. Needless to say that research institutions also have various estimates. Three years after the government started the first audit, the total local government debt number still looks like a black box! And whether the number is 12 trillion or 20 trillion has significantly different policy implications.   Optimistic estimate Pessimistic estimate Central government debt 7.76 7.76 Local government debt 12.10 20.00 Policy banks bonds 7.86 7.86 Former Rail Ministry 2.79 2.79 Asset Management Cos. 1.39 1.39 Other 1.10 1.10 Total 32.9 40.9 % of 2012 GDP 63.4 78.8 Let's do a quick calculation on total government debt of China, which covers not only explicit debts of the central government and local governments, but also contingent liabilities including policy bank debts, former Ministry of Railway debts, and the debts of the four asset management companies. Total debts would equal to 32.9 trillion yuan or 40.9 trillion yuan, which was 63.4% or 78.8% of total GDP, depending on which local government debt number you want to believe. Of course our calculation might have missed items, such as pension fund liabilities, so the debt level could be even higher.   Figure 2 how fast is China's debt-to-GDP growing? What's more, if Xiang Huaicheng is right that total local government debt has mounted to 20 trillion yuan, it means that the debt-to-GDP ratio has been climbing and that China is wasting more resources to keep GDP growing. However, if local government debt was only 12 trillion, then the debt-to-GDP ratio has declined, which means that China has become more efficient. If we believe the first scenario, then China needs to reform as quickly as possible to adjust the situation. If we believe the second, China is already on the right track and the government can just let it go. In fact even if we believe in the second scenario, the situation does not look very good either. According to the last NAO report, 37.6 percent of LGFV assets, worth 900 billion yuan, were “illiquid or difficult to liquidate.” While it is not exactly clear what this means, it appears to suggest that the local governments would be unable to recover the full value of these assets should they be forced to liquidate them – and both the amount and the ratio look huge.  Figure 3 Total gov't debt (in billion yuan)  if we believe in Xiang Huaicheng Which number should we believe? We are in no position to judge that because Xiang Huaicheng did not offer any solid analysis while the NAO's number looks too small to be true. But we do not have to feel too frustrated, because the VIP in the State Council does not seem to know much more than we do (or maybe we should feel very frustrated since the top leaders know as little as we do...). He is as worried as we are, if not more, and that's why he asked for another round of research on a more thorough basis. It is hard to bet what number the third report will come out with, but I would say it is even likely to beat the upper limit of previous estimates, and that would be a real challenge for the new government.  ps: there are some updates on this audit on July 30th. According to Caixin, the audit will include not only provincial, city and county governments, but also central government and small township governments, which will be the most comprehensive audit ever done. Therefore it is more likely for us to see a gigantic number.  Central Banking Seminar Chen Long

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29 июля 2013, 13:07

Why will China start to audit local government debt again?

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Here is what the FT says:  China will conduct an urgent audit of all government debt, underlining concerns over rising financial risks in the world's second-biggest economy. The National Audit Office said in a one-line statement on Sunday that it had been instructed by the state council, China's cabinet, to come up with a tally of how much money is owed by all levels of government from villages up to central authorities. Why do we ask the question in the title? Because this would be the third audit report on local government debt, only one month after the last report was published, and it comes much earlier than everyone expected, including the National Audit Office (NAO) itself. Two audits have been done on this subject so far. The first audit covering more than 3000 local governments was conducted from March to May in 2011 and the report was published in June 2011. The second audit was in a much smaller scale as it only included 36 local governments. It was done during November 2012 to February 2013 and a report was published on June 10th, just a month ago. According to the information provided by the People's Daily (in Chinese, see FT report), the official newspaper of the Party, the third round of audit was required by the State Council and it will start immediately on August 1st. The NAO has called off other projects to focus on this one. This news has raised tremendous discussions in China and apparently a lot of people are very worried about the local government debt as Shanghai Composite Index fell 1.72% today.  Although the People's Daily tried to calm everyone down by saying “it was just routine work”, but clearly it was not routine as the last report was just published a month ago and the state auditors have other jobs to do if they did not get the call from the State Council. So why does the State Council want another audit only one month after the last audit report came out? My bold guess is that someone on top was not satisfied with the last report so this VIP wants another one to help him better understand the debt level. So here comes the next question, why wasn't this VIP satisfied with the last audit report? This table below can show you that the second audit was far less comprehensive than the first one and it is extremely doubtful whether the sample of 36 local governments can reflect the whole picture. In fact the last report could be misleading in many ways.   First audit Second audit Time End of 2010 End of 2012 Scale More than 3000 local gov'ts 36 local gov'ts Amount 10.7 trillion yuan 3.85 trillion yuan Growth rate on average 30% annually from 2000-2010 12% from 2010 to 2012 Why do I say this? The growth rate of debts in 36 local governments was 12% in the last 2 years, while it was on average 30% annually in the first decade of this century. If we believe the sample of 36 local governments is representative then we will see a very positive picture as local government debt growth has slowed down significantly in the past two years while GDP growth continued to be high. The first NAO report said that total local government debt was 10.7 trillion yuan and if we apply the 12% growth rate here, total local government debt would be 12 trillion yuan by the end of 2012, accounting for 23% of GDP, smaller than the ratio of 25% in 2010. Figure 1 Total local government debt (in billion RMB) if we believe in the last NAO report That local government debt totalled 12 trillion by 2012 simply looks too good to be true. Even the auditors themselves won't believe it. Dong Dasheng, deputy minister of the National Audit Office, said in May the latest debt scale for governments at all levels was between 15 to 18 trillion yuan, while Xiang Huaicheng, a former finance minister, said in April China's local governments might have already borrowed more than 20 trillion yuan. Three years after the government started the first audit, the total local government debt number still looks like a black box! However, that it is 12 trillion or 20 trillion has significantly different policy implications.     Optimistic estimate Pessimistic estimate Central government debt 7.76 7.76 Local government debt 12.10 20.00 Policy banks bonds 7.86 7.86 Former Rail Ministry 2.79 2.79 Asset Management Cos. 1.39 1.39 Other 1.10 1.10 Total 32.9 40.9 % of 2012 GDP 63.4 78.8 Let's do a quick calculation on total government debt of China, which covers not only explicit debts of the central government and local governments, but also contingent liabilities including policy bank debts, former Ministry of Railway debts and the debts of the four asset management companies. Total debts would equal to 32.9 trillion yuan or 40.9 trillion yuan, which was 63.4% or 78.8% of total GDP, depending on which local government debt number you want to believe. Of course our calculation might have missed items, such as pension fund liabilities, so the debt level could be even higher.   Figure 2 how fast is China's debt-to-GDP growing? What's more, if Xiang Huaicheng is right that total local government debt has mounted to 20 trillion yuan, it means that debt-to-GDP ratio has been climbing and China is wasting more resources to create GDP. However, if local government debt was only 12 trillion, then debt-to-GDP ratio has declined which means China has become more efficient.  If we believe in the first scenario, then China needs to reform as quickly as possible to adjust the situation. If we believe in the second, China is already on the right track and the government can just let it go. In fact even if we believe in the second scenario it does not look very beautiful either. According to the last NAO report, 37.6 percent of LGFV assets were “illiquid or difficult to liquidate”, which totalled 900 billion yuan. While it is not exactly clear what this means, it appears to say that the local governments would be unable to recover the full value of these assets should they be forced to liquidate them and both the amount and the ratio look huge.  Figure 3 Total gov't debt (in billion yuan)  if we believe in Xiang Huaicheng Which number should we believe? We are in no position to judge that because Xiang Huaicheng did not offer any solid analysis while the NAO's number looks too small to be true, but we do not have to feel too frustrated because the VIP in the State Council does not seem to know much more than we do (maybe we should feel very frustrated since the top leaders know as little as we do...). He is as worried as we are, if not more, and that's why he asked for another research on a more thorough basis. It is hard to bet what number the third report will come out, but I would say it is even likely to beat the upper limit and that would be the real challenge for the new government.    Central Banking Seminar Chen Long

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15 июля 2013, 13:00

China’s “right kind of growth” seems short-lived

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When the National Bureau of Statistic (NBS) said at a press conference (in Chinese, see FT report) last October that consumption contributed 55% of China's growth in the first three quarters of 2012, exceeding the contribution from investment, people were excited to announce that China finally started to follow “the right kind of growth” and many believed growth in the future would be consumption-led rather than investment-led. Since China was rebalancing, a moderate slowdown in GDP growth was not very worrying.  However, the excitement won’t last any longer as recent data suggest that China is again off the right track. At the press conference this morning ((in Chinese, see Reuters report), the spokesman of the NBS told reporters that overall consumption contributed 45.2% of GDP growth in the first six months of 2013 while investment’s contribution still stood well above half at 53.9%. Net exports contributed the rest at 0.9%. Consumption's 45.2% is the lowest proportion since 2010, as consumption contributed 55.5% and 51.8% of GDP growth in 2011 and 2012 respectively. First of all, I was not fully convinced that China followed the right rebalancing in 2011 and 2012 because the share of investment’s contribution was still more than half. Consumption (noted that it includes government consumption and household consumption)’s contribution increased at the expense of net exports rather than investment. The reason why investment-led growth worries people is that a lot of investments were not economically viable, so China has to slow down investment rapidly to adjust. But the adjustment we saw in the last two years had little to do with cutting investment, and bad debt risk was not reduced at all.  Second, the statistics released today suggest that while investment’s share of GDP continues to grow, consumption’s share of GDP is declining this year. We are not supposed to be too surprised because China usually becomes more reliant on investments when credit growth is very high, and it is very high this year. What worries us most is that it tells us consumption’s share of GDP can shrink when GDP growth slows down. In the past two years when GDP growth decelerated, analysts could comfort their clients and themselves by saying that it was the outcome of reform and adjustment which in the long run would benefit China, but that suggestion is no longer valid after today. What we are seeing now is lower growth accompanied with higher risk of bad investments, suggesting that we would have fewer buffers to deal with the potential bad investments, which is much worse than the situation seen last year or in 2011. I would make a bold guess that current economic policies will be significantly challenged since they failed to lift either overall growth or share of consumption.    Figure 1 Contribution to GDP growth since 2000 Year Final Consumption Expenditure Gross Capital Formation Net Exports of Goods and Services Contribution Share Contribution Contribution Share Contribution Contribution Share Contribution (%) (percentage points) (%) (percentage points) (%) (percentage points) 2000 65.1 5.5 22.4 1.9 12.5 1.0 2001 50.2 4.2 49.9 4.1 -0.1 0.0 2002 43.9 4.0 48.5 4.4 7.6 0.7 2003 35.8 3.6 63.2 6.3 1.0 0.1 2004 39.5 4.0 54.5 5.5 6.0 0.6 2005 38.7 4.4 38.5 4.3 22.8 2.6 2006 40.4 5.1 43.6 5.5 16.0 2.1 2007 39.6 5.6 42.5 6.0 17.9 2.6 2008 44.1 4.2 46.9 4.5 9.0 0.9 2009 49.8 4.6 87.6 8.1 -37.4 -3.5 2010 43.1 4.5 52.9 5.5 4.0 0.4 2011 55.5 5.2 48.8 4.5 -4.3 -0.4 2012 51.8 4.0 50.4 3.9 -2.2 -0.2 1H2013 45.2 3.4 53.9 4.1 0.9 0.1   Central Banking Seminar Chen Long

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10 июля 2013, 14:20

Unintended consequences made the PBOC’s strategy fail to work

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As overnight and 7-day repo rates fell back to the range of 3-4%, the so-called “interbank crunch” in China’s interbank market, which looked like a TV series to me, seems to be finally over, at least temporarily. The tide has gone out, but what are the lessons we learned from it?  There are lessons not only for the PBOC but also for commercial banks, big and small.   The PBOC’s hawkish stance in the first three weeks of June was quite a surprise to the market and some analysts argued that the PBOC proactively wanted a “stress test” in the banking system to teach the banks a lesson. I do not think the “stress test” was planned. Apparently the PBOC was way behind the market movement as it reacted to the massive speculative flows a couple of months after it started. What’s more, when Bernanke talked about the possibility of the QE exit, the global market was unprepared and astonished. Consequently, most Asian economies experienced outflows and tighter liquidity and China is one of them. The PBOC was not prepared for the sudden drop of inflows either as it just started to counter inflows by reissuing the PBOC bills which was halted for more than a year.  Therefore, it is not convincing to me that the interbank credit crunch was deliberately caused by the PBOC, but it is interesting to see that the PBOC reacted in a very hawkish way when interbank surged to over 10% before the Dragon Boat Festival and continued very hawkish in the next two weeks. It seems that the PBOC was quite comfortable to see the crunch happen as it did give the central bank an opportunity to punish banks who borrowed excessively in the interbank market to fund their lending with much longer tenures and the PBOC decided to take this chance to restrict shadow banking. However, there were a couple of unintended consequences of the PBOC’s hawkish action. First, more than 1 trillion wealth management products would mature in the end of June and the banks had to meet regulatory requirements at quarter end. As interbank rates soared, the banks had to issue more wealth management products at higher returns which would attract more money to the shadow banking sector and the banks would have to do more risky business because of higher funding cost. Therefore, the idea of cracking down shadow banking by lifting interbank rates failed to work. Second, the interbank crunch became so severe that it received a much bigger attention than the PBOC imagined. MNI’s report of Everbright bank failing to pay 6 bn first put it under the spotlight and it was on the top headline of global media from June 20 to June 25.  If the default rumors were still not shocking enough, when people started to question whether it was the Chinese version of “Lehman moment” and the mysterious payment accidents of ICBC and BOC took place, the panic rose to a higher level and it went beyond the central bank’s control.  In the end no bank was allowed to fail. Third, the PBOC’s communication with the public failed to work properly this time and it severely undermined the credibility of the central bank. The PBOC did not make any comment when the rates started to hike which made people very panic and on June 24th PBOC officials interviewed by Caixin said that overall liquidity was sufficient which implied that the policy would not ease because of the pressure. However, the PBOC failed to keep hawkish as it promised and an official announcement was released on the next day saying that the central bank had injected liquidity into the market. It also shows that either there is miscommunication inside the PBOC or someone else ordered the PBOC to do something it did not want. Otherwise I can hardly imagine why PBOC officials would send completely different messages in a day.  Last, when the PBOC finally injected liquidity to the market, as usual it was the big banks received the money. The cost of money was not disclosed but it is reasonable to guess that it must be much lower than market rate at that time and banks with better liquidity would likely to make profits from banks desperate for liquidity. Therefore, big banks again made money from the credit crunch. Given all these unintended consequences, I am very sceptical whether the PBOC’s strategy had worked at all. The scale of wealth management products did not fall; all banks learned that the PBOC had to save them in the end and big banks even made some money. The only hope is that banks, especially smaller banks, would cut their interbank leverage to some degree because they did lose a lot of money during the rate spike, but if the central bank has to inject liquidity in the end, why would any bank cut leverage? Moral hazard was clearly not reduced if not lifted.    Appendix: China “interbank crunch” episodes in media headline (mostly in Chinese, unfortunately) June 20th  Interbank rates broke historical records http://business.sohu.com/20130620/n379378120.shtml June 20th  Bank of China defaulted and the PBOC injected 400 bn to the market http://business.sohu.com/20130620/n379400451.shtml June 20th  Bank of China denied defaults http://finance.caixin.com/2013-06-21/100544069.html June 20th  ICBC denied 50 bn reverse-repo by the PBOC http://business.sohu.com/20130620/n379404948.shtml June 21st 21 century herald apologized for wrong report http://business.sohu.com/20130621/n379415491.shtml June 23rd ICBC depositors could not withdraw money from the ATMs http://money.163.com/13/0623/12/9227JCVS00252H36.html June 24th  transfer system of BoC failed to function http://news.qq.com/a/20130624/017964.htm June 24th PBOC officials say overall liquidity is sufficient http://finance.caixin.com/2013-06-24/100545330.html June 25th  the PBOC announced that liquidity had been injected http://www.pbc.gov.cn/publish/goutongjiaoliu/524/2013/20130625182009056961206/20130625182009056961206_.html June 26th  ICBC chairman criticized the central bank implicitly in Reuters interview http://cn.reuters.com/article/CNAnalysesNews/idCNCNE95P07K20130626?sp=true July 2nd China controls media reports on interbank crunch http://www.ft.com/intl/cms/s/0/b7d312f8-e2c5-11e2-87ec-00144feabdc0.html     Central Banking Seminar Chen Long

19 июня 2013, 07:54

One chart to show why China should worry about Fed tapering too

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Ok actually there are two charts. The first one is the USDCNY intraday-interday chart. For those who have followed our blog for more than a year, it would not look new. If it is the first time that you see this chart, you can find the background of this chart here. The second chart is the assets held by the Federal Reserve since the beginning of quantitative easing.  From the chart we can see that the onshore market's expectation of Renminbi appreciation since 4Q last year has been stronger than ever, after the depreciation expectation during 4Q2011 to 3Q2012. Coincidentally, the dramatic change of market's view on Renminbi was in line with the pace of quantitative easing in the US. It was during the interval between QE2 and QE3 when Renminbi was under depreciation pressure in the Chinese domestic market, and the depreciation expectation vanished very quickly after the launch of QE3 and we are seeing the strongest appreciation expectation ever since 4Q last year. Now everybody is talking about the Fed's tapering. The chart seems suggesting that the Renminbi would likely to face another round of depreciation pressure when tapering happens.  Why should China worry if Renminbi is under depreciation pressure again? FX inflow and outflow have tremendous impact on China's domestic monetary policy. When capital flows into China, in order to keep Renminbi exchange rate stable, the PBOC is forced to inject more liquidity into the banking system. Although someone may argue that the PBOC has issued bills and raised reserves to avoid excess liquidity injection, it does not seem to be the case. There are two problems here. First, the net bill issuance and reserve raising has never been enough to sterilize the capital inflow in recent years. Sun Guofeng, the deputy-head of PBOC's monetary policy department, said in his book that FX inflow can explain 25% of the deposit creation in China in the past decade. Second, PBOC bill itself is a quasi-money instrument as it is very liquid and people can use the bill as collateral to borrow so it is pretty hard to argue that issuing PBOC bills can effectively sterilize the excess liquidity.  When capital flows out of China, as we saw from 4Q2011 to 3Q2012, domestic liquidity creation and monetary expansion would be much slower. Of course the PBOC can inject liquidity by cutting reserve requirement ratio or doing reverse-repos, but the problem is that China has enjoyed excess liquidity for so long that even if liquidity situation goes back to normal China would feel thirsty. If the central bank failed to be proactive, liquidity situation could only go worse. Moreover, what we are seeing this year is that very fast credit expansion led to pretty low GDP growth (by China standard), so what would happen to economic growth if credit expansion slows down?  FX purchase has declined in May and the interbank rates in China have become unusually high since the beginning of this month, but it is just the beginning. The big story is yet to come.    Central Banking Seminar Chen Long