China's Revolutionary New Thinking On Private Capital

In a stunning series of announcements last week, Beijing opened the doors to private capital.  In the process, officials signaled a reversal of a half decade of anti-reform sentiment.

Play Video China has issued new measures on guiding non-governmental capital into the domestic banking sector.

The China Banking Regulatory Commission has stated that private investors will have equal rights with other state-owned banks. Private investors can bid for the establishment and capital increase of a rural bank.



They can now have a larger share of a rural bank, as state-owned financial institutions shareholding has been lowered to 15% from 20%.

In addition, the Chinese banking industry will strengthen its financial support for private investors.

Yesterday, for instance, the China Banking Regulatory Commission announced private capital will have the same entry standards as state capital when it comes to the country’s banks.  Specifically, private companies will be able to buy into banks through private stock placements, new share subscriptions, equity transfers, and mergers and acquisitions.  Moreover, the government will liberalize investment into the rural banks and as well as the trust, financial leasing, and auto financing sectors.

And on the day before, Beijing gave the “all-clear” for the break up of state monopolies.  The State-Owned Assets Supervision and Administration Commission issued guidelines that, among other things, permit private investors to contribute cash or assets like intellectual property to state enterprises in return for equity and discourage these enterprises from placing additional restrictions on private parties when the enterprises sell their stakes in listed companies.  As SASAC noted, “The guideline reflects equal treatment of various kinds of investors and it helps ensure fairness in economic development.”

These two major developments followed a series of other recent indications of liberalization.  The China Securities Regulatory Commission announced it would allow private companies to list on domestic and foreign stock markets and to issue bonds; the National Development and Reform Commission said it is drafting rules to open the electricity, oil, and natural gas sectors to private capital; and the Ministry of Railways talked about opening railroads to private capital.  The State Council itself announced it is looking for private investment in the energy, telecom, education, and health care industries.

China, in short, is open for business, and there is no mystery surrounding the sudden change of attitude.  First, many cite the eroding profitability of state enterprises for these announcements.  In fact, official figures show that their profits fell 8.6% year-on-year in the January-April 2012 period.

Second, other factors include the decline of foreign direct investment—FDI fell for the sixth consecutive month in April—and a dramatic slowdown in economic activity—the economy showed signs of either zero growth or contraction last month.  Initial indications for this month, such as the sinking HSBC Flash PMI, are mostly bearish.

Third, Beijing technocrats realize they will fall far short of reaching their target of 36 trillion yuan of fixed asset investment because the central government can only “channel” 402 billion yuan and state enterprises are sitting on their hands.  The inescapable conclusion is that the only way to make up the difference is private capital.

Despite the country’s economic distress, it’s not clear when we will actually see implementation of the dramatic announcements.  For one thing, it is not an encouraging sign that Beijing issued precious few details.  At the moment, this looks like another instance of Chinese vaporware.

Why?  In the last few years state enterprises have become entrenched and extremely powerful in Chinese political circles.  And provincial and local governments are even more hostile to non-state capital because of the perceived divergence of interests between private investors and Party officials.

Moreover, it’s unlikely that much, if anything, will get done this year as top leaders are now embroiled in disruptive political struggles.  In fact, part of the reason for the accelerating economic slide is that for months they have been distracted by the worsening turmoil in the top reaches of the Party.  Moreover, not much may get done next year either.  Xi Jinping is slated to take over this fall, and new supremos usually take a couple years before they are able to effectively exercise power.

In any event, central government ministries, if they were truly serious about liberalization, would just implement structural changes as opposed to talking about them.  Until there is a sign he is serious this time, many will think Premier Wen Jiabao is borrowing from his 2010 playbook when he had his State Council grandly announced similar reforms that were not put into effect with real rules.

And there is one more factor suggesting private capital will not rescue the Chinese economy this time.  As domestic and foreign investors learn more about both the fundamental and cyclical problems in China, it will be increasingly unlikely that anyone will commit substantial sums to the country.

After all, you don’t see private investors heading for Greece at the moment, and in some important ways China is in far worse shape.  The internal and global narratives on the Chinese economy and political system are changing, and those changes are bound to have a negative effect on investment sentiment.

In short, Beijing’s announcements this month may evidence a welcome change of heart, but they could end up being both too little and too late to stop the country’s accelerating slide.

Gordon G. Chang, Forbes Contributor

I write primarily on China, Asia, and nuclear proliferation.

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China FDI at record pace: overseas uptick, policy steady

Q1 inflow leaves country on course to surpass 2011 record of US$116bil

* FDI momentum is slowing though and trade outlook difficult

* Suggests policy will be biased towards supporting economy

BEIJING  - Reuters:  China bagged foreign direct investment (FDI) at a record-setting pace in the first three months of 2012 but an easing in its monthly momentum and a difficult trade outlook will keep monetary policy poised to compensate for any dip in capital inflows.

The first quarter inflow of US$29.8bil leaves China on course to surpass 2011's US$116bil record, even though inflows compared with a year earlier have fallen for five successive months, Commerce Ministry data showed.

A 53% leap in inflows to US$11.8bil in March from February typical after the Lunar New Year was a fresh sign that capital flow is firming enough to underpin money supply growth, following a US$124bil first-quarter jump in foreign exchange reserves, providing policy stays on its current pro-growth bias.

“I don't think this changes anything for monetary policy,” Alistair Thornton, economist at IHS Global Insight in Beijing, told Reuters.

Steady growth: Workers assemble automobile parts at Changan Ford Mazda Automobile plant in Chongqing. A 53% leap in inflows to US$ 11.8bil in March from February is a fresh sign that China’s capital flow is firming enough to underpin money supply growth— AP

 

China's government has been fine-tuning economic policy settings since the autumn of last year as the outlook for the global economy darkened, export growth sank and capital inflows a core component of money supply stalled.

The People's Bank of China (PBOC) has cut by 100 basis points (bps) the ratio of deposits banks are required to keep as reserves (RRR) to keep credit and money supply growth steady. The two moves added an estimated 800 billion yuan (US$127bil) of lending capacity to the economy.

The PBOC said last week that broad money supply rose 13.4% in March from a year earlier, stronger than market expectations for 12.9% and ahead of the previous month's 13% pace.

Economists forecast another 150 bps, or 1.2 trillion yuan in RRR cuts, for the rest of 2012 to help cushion China's worst slowdown since the global financial crisis of 2008-09.

“There are signs that the economy has reached a bottom, but there's nothing to suggest in recent data that equity investors should be positioning for a strong rebound or anything like a V-shaped recovery,” Thornton said.

EXTERNAL DEMAND

China's economic growth has slowed for five straight quarters. The annual growth rate in the first quarter eased to 8.1% from 8.9% in the previous three months, below an 8.3% consensus forecast in a Reuters poll.

Reasonably strong FDI and a return to an overall trade surplus of US$5.35bil in March heralds the prospect that a revival in global growth is lifting overseas demand just in time to compensate for a slowdown in the pace of domestic activity.

FDI is an important gauge of the health of the external economy, to which China's vast factory sector is orientated, but is a small contributor to overall capital flows compared to exports, which were worth about US$1.9 trillion in 2011.

Ministry of Commerce spokesman, Shen Danyang, told a news conference on the FDI data that the government was confident of achieving its target for trade growth in 2012 despite a difficult international economic backdrop.


China targets 10 percent growth for exports and imports in 2012, but both goals were missed in March when imports rose 5.3 percent and exports increased 8.9 percent over a year earlier.

Beijing has pledged to bring its current account into balance as it refocuses the economy more towards domestic consumption and away from volatile foreign demand for manufactured goods.

China's two biggest export markets faltered through 2011. Demand from the European Union was dogged by the sovereign debt crisis, while a U.S. recovery was slow to take hold, especially among consumers.

For the first quarter as a whole, Customs Administration data from China shows the value of total exports was $430.02 billion, while imports were $429.35 billion - bringing the trade account roughly into the balance targeted by the government.

"If we want export growth to be stable, we must ensure that policies are stable," Shen said. "If there are any policy adjustments, these adjustments will be more towards pro-exports rather than limiting exports."

CURRENCY RISKS

But he said some exporters were nervous about the outlook for their business, particularly after China loosened its tightly controlled currency regime by doubling to 1 percent the daily trading band for the yuan against the dollar.

"Some exporters are a little bit worried, so they are not so sure about taking long-term orders, but only took short-term orders, mainly because they are not confident in managing exchange rate fluctuations," Shen said.

The change, a crucial one as China further liberalises its nascent financial markets, underlines Beijing's belief that the yuan is near its equilibrium level, and that China's economy is sturdy enough to handle important, long-promised, structural reforms despite its cooling growth trajectory.

Slower growth is cautiously welcomed by China's leadership as it allows them to make reforms, particularly to prices the government sets, with a reduced risk of igniting inflation that the ruling Communist Party fears could trigger social unrest.

The widening of the yuan's trading band is the most significant adjustment made to China's currency regime since a landmark decision in 2005 to de-peg the yuan from the dollar, which set the Chinese unit on an appreciating path that has seen it gain about 30 percent against the dollar.

In tandem, China has encouraged direct settlement of international trade in yuan, amounting to 2.08 trillion yuan ($333 billion) in 2011, more than triple that in 2010, central bank data shows.

Dariusz Kowalczyk, senior economist and strategist at Credit Agricole CIB in Hong Kong, said 11.7 percent of March FDI flows were settled in yuan, up from 9.5 percent in February, 8.5 percent in January and 3.2 percent for all of 2011.

"Direct investment has become a new frontier for Chinese yuan internationalisation," he wrote in a note to clients.

Beijing targets $120 billion in FDI inflows for each of the next four years, drawing up new rules to encourage foreign investment in strategic emerging industries, particularly those that bring new technology and know-how to China.

The Q1 numbers are on course to achieve that.

"For foreign investors, China remains attractive compared to other countries," Zhao Hao, economist at ANZ Bank in Shanghai, said.

China's efforts to expand its own direct investments in foreign countries are surging. Outbound FDI rose 94.5 percent in the first quarter versus a year earlier to $16.55 billion.

"In the future, the trend is that FDI inflows will pick up while outbound FDI will rise even faster, so the net inflows will fall," Zhao said.

By Zhou Xin and Nick Edwards

China to Become the World's Largest Importer by 2014

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Helen H. Wang, Contributor Author, consultant and expert on China's middle class >

We have heard a lot about China becoming the world’s largest this and that. In 2009, when the world was in recession, China leapfrogged the U.S. to become the world’s largest auto market. In 2010, China overtook Germany as the world’s largest exporter. This year, China is likely to surpass Japan to become the world’s largest luxury goods market.

So, it shouldn’t be a surprise when The Economist predicts that China will become the world’s largest importer by 2014. Yet, many skeptics still doubt China’s potential to be a stronghold of the world economy.

Last month, I was on BBC World News to discuss the eurozone debt crisis and whether Chinese consumers can make a difference in the world economy.  My discussion partner Johathon Holslag from the Brussels Institute of Contemporary China Studies argued that Chinese consumption is still far below its production, and people should not be over optimistic about China rescuing the world economy. See the discussion video below:



Yes, official statistics show that consumption is only 34 percent of China’s GDP (compared to 70 percent in the U.S.). While the West’s economy is imbalanced with over-spending, the Chinese economy is imbalanced with under-consumption. However, this dynamic is changing. When I travel in China, I can clearly see the consumption boom in China’s large and small cities. Retail has been growing like a wildfire in recent years.



While it is not China’s role to save the world economy, it is in China’s best interest to balance its own economy toward domestic consumption. In so doing, China serves as a counter-balance of over-spending Western economies.  China may not want to bail out Italy or Greece, but China can provide opportunities for these troubled economies to get their own house in order.

As matter of fact, China has already helped. The Chinese middle class is creating enormous opportunities for Western companies selling into China. Europe’s exports to China have been growing steadily. Many Western brands are doing extremely well in China.

For example, Chinese consumers prefer to pay a premium price for furniture that is made in Italy. The UK-listed retailer Burberry has opened 60 stores in China and plans to have 100 stores in the near future. Western automakers, from Volkswagen to Bentley to General Motors, are enjoying huge success in China.

In the coming years, China’s economy may slow down a little, but will still grow at least at 7 or 8 percent. There are plenty of opportunities for Western companies to take advantage of China’s growing middle class. For companies that want to export to China, here are a few useful tips:

• Check out your local Chamber of Commerce or Export Assistance Center and familiarize yourselves with legal and regulatory issues in China. These facilities also have a lot of resources and services that can help you develop China market entry strategies and find the right business partners.
• Consider rebranding or repositioning your products in China. Remember, what works in your native country may not work in China. You really need to learn about Chinese culture, understand Chinese consumers, and adapt your products and services to the China market.
• For smaller brands, e-commerce is a great way to break into the China market without significant upfront cost. China’s ecommerce has been growing at 60 percent each year in recent years. More than 100 million Chinese shopped online last year. And China’s Internet users are expected to reach 750 million in 2015.

According to Credit Suisse, China will become the largest consumer market in the world by 2020. In the past, all the predictions about China have proved to be on the conservative side. With all its problems and potential crises, China somehow has managed to astonish the world again and again.

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Investing during turbulent times

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Tips on how to invest during turbulent times

STOCK markets around the world lately gave investors that sinking feeling again, weighed down by deepening woes of Europe's sovereign debts, an anemic US economy and new fears of a sharp economic slowdown in China.

Many investors sold shares to hold more cash, despite cash earning very little interest. In Singapore for example, six months USD fixed deposits of less than US$1mil earns zero interest in some banks.

In the United States, 10-year Treasury bonds are yielding 2.1% per annum; despite misery returns, many investors prefer the safety of US Treasuries during crisis times, while waiting for policymakers to act boldly and markets to stabilise.

At the same time, we see many economists and other pundits offer a whole host of predictions about today's global financial predicaments. The many predictions range from the slightly hopeful to the pessimistic, right down to the disastrous and absurd.

Does it sound familiar? Did we not hear many such predictions during the 2008/2009 global financial crisis? Who should we listen to? What should one do?

No doubt in hindsight, a few forecasts will be correct; and as the dust settles, many extreme predictions will also likely be forgotten. Yet for investors today, separating much of the “noise” from facts is one of the more tricky parts of steering through these very challenging times.



Fundamentals and valuation takes a back seat during a crisis

Volatile stock markets today are driven by latest positive or negative news flow affecting sentiment. Uncertainties during a crisis causes investment risks to spike, stock investors tend to sell first and ask questions later; fundamentals and stock valuation typically takes a back seat in the short term.

No doubt many investors worry about negative impact to a company's fundamentals in difficult times. For example, a manufacturing company's stock with a present price earning (PE) multiple of six times can change drastically to 60 times PE if earnings were to collapse 90% because of a global financial crisis.

Similarly, a property company's price to book value discount of 60% can easily drop to 30% if asset value is marked down by half in troubled times. Monitoring, reassessments and analysis of a company's financial progress is obviously important during tumultuous times.

Share prices of companies (even those with good fundamentals) may continue to fall indiscriminately, due to many reasons such as panic selling, fund redemption and repatriation. Investors should tread cautiously, even if stock prices may appear to be at very attractive levels.

I relate a challenging experience from the last global stock market plunge. In 2008, I invested in the largest luxury watch distributor and retailer in China (at that time 210 stores and sales amounting to 5.5 billion yuan a year or about 30% market share).

This Hong Kong listed Chinese company sells luxury watches (such as Omega, Longines, Bvlgari) from global brand owners Swatch group of Switzerland and LVMH of France (both by the way are also 9.1% and 6.3% shareholders of this Chinese company respectively).

As the US sub-prime mortgage crisis deepens by end-July 2008, many stocks around the world plunged. This company's shares similarly dropped from HK$2 to HK$1.50 in a matter of weeks.

We vigorously reassessed the company's fundamentals, including visits to retail outlets in China and Hong Kong. The result was an affirmation of our conviction to invest in the company for the long-term, despite short-term price weakness.

By late September 2008, we decided to purchase more shares when valuation proved so attractive at HK$1.15 per share (at a PE multiple of eight times).

Unfortunately, as the global financial crisis worsened, the company's shares continued to plunge and bottomed to a low of HK$0.51 by Nov 26, 2008.

This stock eventually recovered back to HK$2 per share (by June 1, 2009) and went on to exceed HK$5 per share by late 2010. The company's share prices recovered partly because Asian equities rebounded quickly in 2009, but also reached new highs because the company's fundamentals continue to improve with strong sales (+49%), profitability (+26%) and expansions (+140 stores to 350 stores) from 2008 to 2010.

A lesson if you will that during a crisis, one should be prepared for short-term (weeks and months) stock market volatility.

It is essential for bargain hunters to have long-term holding power, good understanding of company fundamentals and strong conviction on a company's prospect. In the long-term, we know fundamentals and valuation does matter.

How does one invest during a time of crisis?

My approaches to investing in turbulent times are:

• Search for and invest (when valuations are attractive) in well managed companies that will not only survive but emerge stronger from crisis times;

• Be prepared to stomach stock market volatility in the months ahead;

• Have a longer term investment horizon (perhaps two to three years); once this crisis dissipates, reap the rewards as stock markets recover.

In Asia, macroeconomic fundamentals likely will remain resilient as many Asian economies have strong foreign currency reserves, coupled with more fiscal and monetary policy options to support growth.

China is also likely to withstand any fallout from Europe better than most would think. China's economy is still growing at a strong 9.1% gross domestic product growth for the third quarter of 2011; speculations about China's economy crashing may be somewhat premature at this stage.

Similarly, I think many established Asian companies have sufficient resources be it cash, borrowing powers or human capital, to emerge out of these turbulent times faster and stronger than before.

I believe with increasingly attractive valuation, the investing risk-reward equation (potential downside risk versus long term return prospects) favors Asian equities in the long run. I have confidence investing in Asia's fundamentals and Asian companies for many more years ahead.

Teoh Kok Lin is the founder and chief investment officer of Singular Asset Management Sdn Bhd

China’s US$3.2 trillion headache

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ENTER THE DRAGON By YAO YANG

WHILE the downgrade of US government debt by Standard & Poor's shocked global financial markets, China has more reason to worry than most: the bulk of its US$3.2 trillion in official foreign reserves more than 60% is denominated in dollars, including US$1.1 trillion in US Treasury bonds.

So long as the US government does not default, whatever losses China may experience from the downgrade will be small. To be sure, the dollar's value will fall, imposing a balance sheet loss on the People's Bank of China (PBC, the central bank). But a falling dollar would make it cheaper for Chinese consumers and companies to buy American goods.

If prices are stable in the United States, as is the case now, the gains from buying American goods should exactly offset the PBC's balance sheet losses.

The downgrade could, moreover, force the US Treasury to raise the interest rate on new bonds, in which case China would stand to gain. But S&P's downgrade was a poor decision, taken at the wrong time. If America's debts had truly become less trustworthy, they would have been even more dubious before the agreement reached on Aug 2 by Congress and President Barack Obama to raise the government's debt ceiling.

That agreement allowed the world to hope that the US economy would embark on a more predictable path to recovery. The downgrade has undermined that hope. Some people even predict a double-dip recession. If that happens, the chance of an actual US default would be much higher than it is today.

Reason to worry: China’s US$3.2 trillion problem will become a 20-trillion-renminbi problem if China cannot reduce its current account surplus and fence off capital inflows. — AP

These new worries are raising alarm bells in China. Diversification away from dollar assets is the advice of the day. But this is no easy task, particularly in the short term. If the PBC started to buy non-dollar assets in large quantities, it would invariably need to convert some current dollar assets into another currency, which would inevitably drive up that currency's value, thus increasing the PBC's costs.

Another idea being discussed in Chinese policy circles is to allow the renminbi to appreciate against the dollar. Much of China's official foreign reserves have accumulated because the PBC seeks to control the renminbi's exchange rate, keeping its upward movement within a reasonable range and at a measured pace.

If it allowed the renminbi to appreciate faster, the PBC would not need to buy large quantities of foreign currencies.



International experience

But whether renminbi appreciation will work depends on reducing China's net capital inflows and current account surplus. International experience suggests that, in the short run, more capital flows into a country when its currency appreciates, and most empirical studies have shown that gradual appreciation has only a limited effect on countries' current account positions.

If appreciation does not reduce the current account surplus and capital inflows, then the renminbi's exchange rate is bound to face further upward pressure. That is why some people are advocating that China undertake a one-shot, big-bang appreciation large enough to defuse expectations of further strengthening and deter inflows of speculative “hot” money. Such a revaluation would also discourage exports and encourage imports, thereby reducing China's chronic trade surplus.

But such a move would be almost suicidal for China's economy. Between 2001 and 2008, export growth accounted for more than 40% of China's overall economic growth. That is, China's annual gross domestic product (GDP) growth rate would drop by four percentage points if its exports did not grow at all. In addition, a study by the China Centre for Economic Research has found that a 20% appreciation against the dollar would entail a 3% drop in employment more than 20 million jobs.

There is no short-term cure for China's US$3.2 trillion problem. The government must rely on longer-term measures to mitigate the problem, including internationalisation of the renminbi. Using the renminbi to settle China's international trade accounts would help China escape America's beggar-thy-neighbour policy of allowing the dollar's value to fall dramatically against trade rivals.

But China's US$3.2 trillion problem will become a 20-trillion-renminbi problem if China cannot reduce its current account surplus and fence off capital inflows. There is no escape from the need for domestic structural adjustment.

To achieve this, China must increase domestic consumption's share of GDP. This has already been written into the government's 12th Five-Year Plan. Unfortunately, given high inflation, structural adjustment has been postponed, with efforts to control credit expansion becoming the government's first priority. This enforced investment slowdown is itself increasing China's net savings, i.e., the current account surplus, while constraining the expansion of domestic consumption.

Real appreciation of the renminbi is inevitable so long as Chinese living standards are catching up with US levels. Indeed, the Chinese government cannot hold down inflation while maintaining a stable value for the renminbi. The PBC should target the renminbi's rate of real appreciation, rather than the inflation rate under a stable renminbi. And then the government needs to focus more attention on structural adjustment the only effective cure for China's US$3.2 trillion headache. - Project Syndicate

● Yao Yang is Director of the China Center for Economic Research at Peking University.