Briefing: financial scams in China, why so many?

Scams in China’s finance industry is a trend I think will continue for a long time. Quartz has done this great compilation of financial scandals in China:

Here are a few highlights:

E Zubao and other P2P financing platforms—at least $11 billion

Fanya Metal Exchange—about $6 billion

MMM social financial network—beyond calculation

Zhuoda Group—about $1.6 billion

GSM Financial Group—about %6.2 billion

And it also discusses why these schemes succeed, or why investors keep falling for them:

First off, opportunities in real estate and of course the stock market seem dubious, and new financial companies, especially peer-2-peer lending firms present an attractive alternative.

But of course, while rule of law has much to catch up on this new and upcoming industry, presenting a great opportunity for crooks with a bit of brains to come in and attract innocent investors looking for swift gains.

Indeed, many of these firms lie beyond the scope of supervision. P2P lending platforms often go beyond their normal role as sole information brokers and provide services and products that only licensed banks or lending companies offer. Many of them are not even registered with the State Administration for Industry and Commerce.

And investors will just go for these seemingly shady companies for really quite simple reasons: i)friends recommended it,

ii)just believed in their marketing campaign promising incredibly high returns (in some cases, people know it’s a ponzi scheme but still go for it confident they can get out with some gains before it all collapses),

iii)some famous investor spoke well of it (eg.,

iv) some local government has backed them like in the case of Fanya. People just expect the government will have their back once things go south. Nothing more than the trusting soul of man under authoritarianism.

v)And another unique feature on mainland:


Put these all together: it’s a lack of experience in investments. Mainland has arrived to capitalism late and so investing habits are also in its teenage years. So all of this will take time to develop, but it will also require reform on all fronts, law, regulation, supervision, general education, and availability of information etc. But most importantly, my view is that it is the enforcement of law, as always, they can make most difference in the short-term.


深夜的经济学|Late night economics: what did the People’s Bank of China do to the offshore RMB market?

The background:

China has two currency rates. One is onshore, which trades within a narrow band dictated by a central bank daily rate (the yuan is allowed to rise and fall by 2% of this fixed rate). The other is offshore, where the yuan floats freely and serves as an indicator of what markets think about the Chinese economy.

Since last August, when the PBoC declared a change to how it fixes daily yuan rates, which they say reflects market value, the yuan was expectedly devalued. But it was depreciating at much quicker pace than people had anticipated.

Caixin’s details on the change:
The new method, which officials said better reflects market value, links the daily rate to the currency’s closing price for the previous trading session. The fixing is a reference the central bank provides to interbank forex market traders based on the perceived value of the yuan. It is a mid-point from which daily spot trading prices for the yuan are allowed to deviate by 2 percent in either direction.

Dreading further depreciation of the yuan, those with offshore yuan holdings started selling. Then you had speculators who sought profit from the weakening yuan by short-selling their yuan holdings, and the gap between onshore and offshore yuan widened to a record. (Besides the fact that offshore is free floated and onshore isn’t, the fact that capital can’t come out freely from mainland once in, has contributed to the widening gap).

Details on short-selling CNH (offshore RMB in Hong Kong):
Known as “carry trading,” it has become popular practice for speculators to swap borrowed offshore yuan for dollars, then rebuy RMB when it has depreciated, pay off the loan and keep the remainder. Only made possible since August when the RMB started depreciating.

All this had led offshore RMB to become significantly more devalued than onshore RMB, with the gap widening to over 1,300 basis points (in November it was about 300).

What the PBoC has done is to stop short-sellers by raising the interest rate at which they can borrow CNH. It has done so by selling its massive foreign exchange reserves and buying up offshore RMB through state-owned banks in Hong Kong. Hibor (Hong Kong Inter-bank Offered Rate) went to record highs of 66.8% on January 12.

The RMB has now stabilized at 6.58 against the dollar.

But the move has not been without costs. Countering short-selling in such a manner reduced FOREX reserves, which last year shrank for the first time by 500 billion USD to 3.3 trillion. At a time when, Chinese companies are still saddled with 1.53 trillion dollars in foreign debt, most of which are also short-term.

But as China’s economic transition continues (as well as the ups&downs of the stock market), the expectation is further depreciation, and that means more intervention of that nature is likely.

Briefing: 旧的不去,新的不来 how to reform the state-owned enterprises? Look to Korea.

If the old doesn’t go, the new won’t come.

As discussed in the last post, central to solving China’s debt problem is the reform of a system that keeps state-owned zombie enterprises on life support, while new, innovative companies are denied the privilege.

Here’s a nice idea by Michael Schuman, a Bloomberg view columnist, and one that I always thought of writing, but he did it better than I previously conceived in my mind.

Look at what Korea did with its Chaebols, copy/adopt it. I say this, not just because, or maybe partially because I’m from South Korea.

1. Break the tripartite relationship between Government-Corporations-Banks

South Korea has followed state capitalism model for development, starting from rule of the military dictator Park Jung-hee (father of the current president) whereby policymakers directed credit to strategic industries, and ordered major business leaders to focus on them. The result was dramatic growth.

But by the ‘90s, these chaebols, so central to the growth miracle, had become just like what China’s SOEs look like: bloated, inefficient, hoarding resources that can go to those with better business plans.

Notably though, it did take a crisis for this status-quo system to unravel. The ’97 Asian Financial Crisis. Massive restructuring took place.

Banks were freed from state reins, became well more efficient and held to more stringent standards. Everything from the way window customer services were conducted to loan decisions were revamped to distribute resources more efficiently and as quick as possible.

And chaebol affiliates won’t be able to make loans to each other to survive. Off the dole they were, as Schuman puts, and once on their own, they began to, well, behave more like corporations in a normal capitalist economy. For them, it meant “streamlining their business by cutting staff and selling assets”. This happened to a lot of other firms too, if they weren’t forced to go bankrupt or go through mergers. There were many suicides.

Can we call it necessary evil?

Now, Samsung is just second to Apple in smartphone productions, although not the most well-known, Hyundai cars are being sold the world over, etc. It’s a miracle to see corporations from a nation of 50 million that has risen from the ashes of war just 50 odd years ago to be shouldering with the world’s top corporations. Did I say I was South Korean?

As a caveat, I have to mention that it took a financial crisis to urge Korean corporations transform themselves into what they are now. Debates are still ongoing as to possibilities of a hard-landing, but China has a stunningly solid macroeconomic environment, as the World Economic Forum report has pointed out, making a crisis very unlikely. Lest, the government deliberately lets one happen. But that’s highly unlikely, for the ruling Communist party will surely lose all credibility.

Where has China got too? As Schuman points out, China is nowhere near doing this.

About 80% of all loan so to state-owned companies whose returns are only a third of private firms. Beijing has shown balls of steel in radically restructuring state-owned firms back in 1990s. But as of now, I’m not sure what’s holding them back, but local governments for sure are continuing to funnel subsidies to these state-owned zombies. Why? They used to be biggest tax contributors. Their local growth may depend on these firms, which often are the biggest employers especially in heavy industry regions like the Northeastern provinces, Shanxi, and Inner Mongolia. And also they fear social unrest if mass layoffs happen all too quickly. According to China Labour Bulletin’s monitor, number of labour related protests have perceptibly gone up since 2013.

But Caixin has argued that there is a new economy up and coming to absorb the pain from scalping away the old. Just need to give more gas to the younglings? However, I do think that especially in areas like Manchuria where there is little sign of the new economy, things are looking quite bleak. More on that later.

Briefing: China’s debt problem

Here is what’s wrong with debt in China: too huge, built-up too fast, and hard to count.

Huge compared to produced goods:

Although economy has grown at 6.9% in Q3 y-o-y, yet bank loans increased by 15.4% in Q3 compared with the same period in 2014.  China’s overall debt-to-GDP ratio is continuing its steady upward march.

Growth in credit did slow down. Measured by total social financing (TSF) growth (bank loans + corporate bonds + shadow lending) soared to 35% in 2009, but rose by 13% this quarter from a year earlier. But what is important is to see how much debt is rising vis-à-vis GDP, to truly measure indebtedness.

Fast Buildup:

In 2007, debt was 160% of GDP. Now the ratio stands at more than 240%, 161 trillion yuan ($25 trilliion). That’s almost double the buildup in debt in the US and UK in the run-up-to the financial crisis.

Here is the graph that Bloomberg produced based on McKinsey numbers:


Hard to count:

The sheer pace of new lending, regulatory loopholes, shadow banking practices, and a murky system of implicit guarantees (not clear whether debt is backed by the government or who would be allowed to go bust)

A crisis?

Since most of the debtors are state-owned companies and creditors, state-owned banks, the Chinese government can still control the situation. It has done so by simply rolling over non-performing loans when they are due, or extend the deadline.

SOE and finance reform central to reducing debt:

However, that only spares the economy of an eventual reckoning in the short-run. And in addition, when there is a need for loans to be distributed to soft-land growth, a lot of it is still being funneled to zombie corporations rather than the enterprising private sectors.

This situation has got worse. 6 years before the crisis, one yuan of credit brough 5 yuan of national output. Now that ratio has come down to 1/3.

Indeed, central to reducing debt is restructuring old and unproductive SOEs as well as overhauling a financial system which continues to favour these at the cost of new, full-of-potential companies that will precisely be the new drivers of growth.

What has the government done so far?

The government should bravely have pulled the plug on these old SOEs continuing to extend loans and not letting them go bust (the power equipment maker Baoding Tianwei, and Kaisa Group which has failed to pay overseas bonds) apart from but it hasn’t done so because it fears of social unrest and the toll it might take on.

It has so far tried to get a clearer picture of liabilities:

  • – require local government to compile and display better data on debt.
    – force banks to bring more of their shadow loans onto balance sheets (they have made more official loans to substitute shadow loans)

    It has also used monetary easing and low cost bonds (longer payback periods)-swap program (2 trillion yuan worth of high-interest debt) for local governments to reduce cost serving debt.

One problem is the last solution. People think this is just brushing the problem else where. Net bond issuance in first nine months of 2015 was 8.7 trillion yuan, up 67% y-o-y. More on bonds later. 

Optimism and Pessimism:

Optimists say companies and local governments will simply grow their way out of the problem with an expanding economy. As China continues to grow (still at 6 something %, it will need additional projects; one road one belt, though by itself will not be enough). And the Chinese government has plenty of money to cover bad debt.

They also pluck on specific types of debt. The ratio of debt to equity for listed companies, for instance has peaked at 159 % in the middle of 2012, aand has started to edge down. It’s some distance away from the 234% in the US just before the Lehman collapse. Additionally, while those in the old economy do indeed have excess credit, with close-to zero return on assets, those in the new economy like e-commerce Alibaba are more innovative, cater to consumers, post much less debt to equity ratios and more impressive return on assets. The private sector is outpacing state sector in output, profits, and employment. Service sector’s contribution to GDP has been bigger than manufacturing since 2013.

But pessimists say risks are mounting as China’s economy cools and slower inflation threatens to make debts harder to repay. The Chinese government does have an unusually strong fiscal firepower and can bailout everyone. But high debt can drag on growth, like it did on Japan and Europe. IMF puts the drag-on-growth threshold at 96% of GDP. 

The Beijing Mayor’s head is safe

-“The Beijing mayor has vowed on his own head to control the smog, but we still have to rely on the wind to control it,”…
-“Hi Mayor, I’m here, waiting for your head,” a person using the Internet handle “I Love Rao Zizhao” wrote
-People’s Daily editorial said, “It is the determination and active actions that will lead to the most-wanted clean air, not the promised ‘head.’”

Chinese Gov’t ‘Causes an Investment Gap with U.S.’

(Beijing) – There is a widening gap between Chinese investments in the U.S. financial sector and those heading the other direction, mainly caused by the Chinese government’s restrictions on market access against foreign investors, an expert from the U.S. research firm Rhodium Group says.

Chinese merger and acquisition deals in the U.S. financial services this year are expected to break a record, reaching more than US$ 2.8 billion, up from last year’s US$ 100 million, data from Rhodium show.

Deals that are expected to be completed next year totaled nearly US$ 1.6 billion.

Meanwhile, U.S. investments in the Chinese financial sector are expected to reach only US$ 115 million, down from the US$ 163 million last year, the data show.

An important factor behind the decline is restrictions on investment imposed by the Chinese government, said Thilo Hanemann, research director at Rhodium. He said the limitations amounted to a protectionist barrier that does not affect Chinese investors in the U.S. financial sector as much.

The major restriction on U.S. companies is a limit on the equity stakes they can hold, he said.

Chinese investors are far more likely to be allowed to hold majority ownership in companies they invested in the U.S. financial sector than U.S. firms seeking partners in China, and this was caused primarily by Chinese government restrictions, Hanemann said.

Investments worth US$ 4.4 billion from China to the U.S. financial sector, where Chinese investors hold bigger stakes than their U.S. partners in a co-founded venture, have been made or are expected to be completed from 2000 to the end of next year, Hanemann said.

Meanwhile, only US$ 731 million worth of investments heading the other direction have majority U.S. ownership, he said. In deals worth US$ 3.2 billion, U.S. investors’ ownership fell in the range of 10 to 50 percent.

Chinese government restrictions on market access are “particularly acute in the most attractive sectors under the new growth model, including high-tech manufacturing and modern services,” Hanemann said.

In sectors like communications and financial services, China scored 0.75 on the OECD FDI Regulatory Restrictiveness Index. The United States scored 0.11 and 0.042, respectively. Lower figures signify fewer restrictions.

The U.S. business community has been one of the most important drivers of an American policy of engagement with China, Hanemann said. If it is being excluded from attractive sectors of the Chinese economy, he warned, that could “tip the scale in favor of less engaging” policy toward China.

China’s stock market crash and its links to the global economy: not all that bad.

Despite the Chinese economy’s deep integration with that of the world (slowdown in China’s growth rate has been a major factor in the globe’s commodities slump), its stock markets are still relatively insulated.

First, the direct links: foreign investors only hold 2% of all Chinese equities, the rest is all dominated by retail investors. Chinese investors, who may have lost a fortune in recent, and ongoing crash, also have very limited holding of global financial assets, apart form of course the official foreign reserve.

Secondly, and you must be aching to ask, the knock-on effect: if the stock market crash impacts consumer and business spending, or worse yet, says something about the health of the economy, surely it will diminish Chinese demand for world goods (and that’s serious because not only is China the second largest economy, but it is also the top trading partner of more than 100 countries).

1. Remember the bull run since January occurred in the midst of a comprehensive slowdown; skyrocketing equities had little to do with actual economic activity, but more driven by retail punters
buoyed by the crowd enthusiasm, and funded my margin financing. And as Chen Long points out, “the economy is actually showing signs of stabilisation as industrial value-added business and property sales are rebounding.”

2. Surely it would significantly reduce consumer and business spending, the former having lost wealth, and latter losing one of its capital-raising channels? First, only stocks held is worth about RMB 13 trillion, less than 5% of Chinese household assets—RMB 50 trillion are bank deposits and property assets are more than RMB 150 trillion. Out of total financing in China, equities only represent 5%. So again, though a channel may have been lost, the more important source of capital, in China that’s loans from banks and bonds, are still very much on a green light.

Taken together, the impact on the economy, as it stands, is relatively minimal. So, we may shift all our energies and attention unto the situation in Europe, and hope that the people of Greece make the right choice.