Can China's Demand Strength Stir Global Demand?

# Signs that extensive government investment and credit extension are contributing to a soft landing for China are giving rise to hopes that Chinese demand might support other emerging economies. Chinese commodity imports, which have surged in volume terms, may be supporting commodity exporters in Latin America and Asia in particular, yet other imports continue to be weak.

What Countries Might Benefit From Chinese Demand?

# Singapore, Taiwan and South Korea have been more dependent on exports to China, while several South East Asian economies like Indonesia, Malaysia, the Philippines and Thailand have lower dependency.
# The composition of Chinese imports has also shifted. Fewer intermediate goods are being sourced for the processing trade given weak demand in the G3, the ultimate recipient of such goods. This shift, if persistent, could hurt traditional exporters in East Asia like South Korea, Taiwan, Singapore and Japan which have tended to be reliant on Chinese demand.
# China’s imports of commodities such as iron ore, coal and crude oil have been extraordinarily strong, increasing speculation that China is building strategic inventories of the most important commodities - boosting Latin America (especially Brazil and Chile) the ASEAN countries and Australia.
# With Latin American trade with China having increased, a Chinese slowdown would have a more significant role than one in the U.S. or the EU.
# While strong US retail sales previously pushed up exports from China, in turn boosting China’s imports, the engine for China’s economic recovery is now likely to be public works spending. Thus, China's imports from Japan may be lower than expected.

Will Chinese Recovery Lead to Import Growth?

# China seems to be sourcing an increased share of parts and intermediate goods domestically. Despite an increase in car sales, auto parts imports and autos have not increased. China has been implementing a Buy China policy for its stimulus projects which might continue to hold down China's goods and services imports.
# Over time, as China's growth shifts to more domestic sources, its demand will boost the rest of Asia. In the short-term, however, a sustainable recovery in developing Asia depends on positive developments in advanced economies. While Chinese government investment has boosted its outlook in the short-term, such efforts may provide little support in 2010 if global demand continues to be weak. A reduction in Chinese exports and export related capex could lead to weaker potential GDP over the next three to five years.
# Overall, Chinese imports continue to seem weaker than would be anticipated during an investment boom. Land purchases may account for a significant share of the reported Fixed asset increase.
# There is a risk that Chinese investment might be contributing to further overcapacities and domestic imbalances. If China (and other export economies) continue to export capacity rather than boost consumption in the face of global demand, it could weaken the prospects of global economic recovery.
# The rebound in China’s exports since early in 2009 has been weaker than in most other Asian countries, suggesting that China has been a major driver in Asian countries’ export recovery.
# China can lead but that will not be enough to save the world or the other Asian economies.
# China generates only 7% of global output, at market prices; moreover, real imports are likely to fall 5% in 2009 . China's net stimulus to the rest of the world will only be around 0.1% of global output.
# A slowdown to 6% or less in China’s growth rate would have significant impact on the already weak global economy.
# Even if it escapes a hard landing and achieves 7-8% growth, subpar GDP growth in China over the next two years at least will weigh on global growth.
# Income increases in East Asian countries and currency appreciation would cause large increases in consumption imports (those that are consumed at home). In 2006, in addition, U.S. consumption goods imports in 2006 equaled $430 billion while East Asian consumption goods imports equaled $220 billion.


p/s photos: Zhang Xin Yu

China's Lending Explosion

Is there anything wrong with China's lending spree. The central bank basically "advised" banks to ratchet up their lending, and the banks followed dutifully for the past couple of quarters with amazing results.

First of all, you cannot suddenly find so many attractive "borrowers" to lend aggressively to. Secondly, not many will say no when you offer to lend them money.

To be fair, this strategy pulled the domestic economy from falling further along with the ill effects of a global economy in crisis, but at what price. As I have mentioned before, this has to play itself out, and will not result in a sudden correction in property or stock prices in China. The liquidity rush will soon find its way into higher equity prices in China (hence bullish for the rest of the year for Chinese equity), and some may trickle back into Chinese property mart as well. Brace for high default rates when the music stops, probably after Chinese New Year in 2010.

China’s new lending more than doubled in June from a month earlier, increasing concerns bad loans and asset bubbles will emerge amid a credit boom.

New lending was 1.53 trillion yuan ($224 billion), the central bank said on its Web site today, bringing total lending this year to 7.4 trillion yuan. The calculation for new loans is preliminary, the central bank added.

The government is countering an export collapse by flooding the economy with money to fuel domestic demand. Rapid credit growth poses a risk to the nation’s lenders and a concentration of credit in some industries and businesses may damage the stability of the financial system, the banking regulator said yesterday.

Excess liquidity is fueling speculation and that means asset bubbles and wasteful investment. Already China recently failed to complete a $4.1bn auction of one-year government bonds, which suggested that investors are positioning for higher inflation caused by the credit surge.

Just something more to chew on, in 2005 Ernst & Young published a survey estimating that the bad loans in the Chinese banking system equaled close to $900 billion. Since then there has been enormous speculation in both the stock and real estate market. The average urban residential property prices fell by 15 to 30 per cent over the next two years from their levels at the end of 2008. Of course, by the end of 2008 they had already fallen from there 2007 highs. You cannot have real estate fall that much without having bad loans. Here is the juicy part, according to the prospectus for the Commercial Bank of China, it is illegal in China to foreclose on residential property.So what are bad loans? Bad loans = immediate write downs? No, they are then carried as what??? ... long term assets??? The reality is that no one knows exactly how bad the situation is in any bank. Information has value and is not disclosed unless required by law or for consideration. Since the banks in China are owned by the state, there is no legal requirement.


Something's gotta give ... but let's have a bull run first...

p/s photos: Elanne Kong Yuk Lam

China's Liquidity Traps & Benefits

China has been ramping up lending over the last 7 months. Yes, it was with good intentions. Yes, it was actual lending not just for show. Yes, banks in China were "asked" to do their bit to lend aggressively. While there is a lot of good to have money circulating around, it will also weigh down on those borrowing on the "unqualified" end of the spectrum, people who willing take on more debt than they should. Its a mini time bomb. No, it will not implode yet. What the figures below shows to me is that China's equity markets will have a major run up right through the end of 2009. When you pump in so much liquidity, there are very few places for it to surface. We may see a combustion effect only maybe in the second half of 2010.

China's credit card debt that was at least six months overdue rose 133.1 percent year on year in the first quarter to 4.97 billion yuan (727.67 million U.S. dollars), the People's Bank of China, or the central bank. Debt overdue by six months or more accounted for 3 percent of the total outstanding credit card debt at the end of March, or 0.6percentage point more than in the same period last year, the report said.

It warned of potential risks of the increasing overdue credit card debt as financial institutions expanded their credit card business. As of March 31, Chinese banks had issued more than 150 million credit cards, or 0.11 card per person, up 42.9 percent year on year. But Chinese consumers still have relatively few credit cards, compared with 4.39 per person in the United States and 0.95 in Brazil. Outstanding credit card loans rose 87.6 percent year-on-year to165.86 billion yuan at the end of March.

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New bank loans in China will exceed 1 trillion yuan (US$146 billion) and may top 1.2 trillion yuan this month as the regulator expressed its concern over irresponsible lending, according to a newspaper report.

This month's figure may be the third-highest this year after March's and January's, the China Securities Journal reported yesterday, citing people it didn't identify. That would also represent a sharp jump from May's 664.5 billion yuan.

The news, coming in the wake of the central bank's remark on Thursday that it will stick to an appropriately loose monetary policy to support economic growth, sent bank shares higher yesterday on expectations of better profit.

Shanghai Pudong Development Bank gained 3.79 percent to 22.98 yuan while the Industrial and Commercial Bank of China, the country's biggest lender, rose 2.02 percent to 5.55 yuan, easily outperforming the key Shanghai Composite Index.

Earlier this week, the China Banking Regulatory Commission demanded that lenders avoid a sudden jump in loans at the end of each month and each quarter, a move used by domestic banks to meet internal targets.

The regulator told lenders to ensure the money is channeled to the right sectors such as small businesses to help stimulate the economy, and to monitor capital flow into the stock and property markets.

This month's lending surge was mainly fueled by mortgage loans and funding of government projects, the Journal said.

The new bank loans in the first five months of the year have reached 5.84 trillion yuan, more than last year's total and exceeding the government's target of 5 trillion yuan for this year.


p/s photos: Zhou Weitong

China's Scare Tactics & Longer Term Vision

Over the last few months China has been more vocal in asserting its voice in the economic wilderness. Beijing has openly blamed the excesses by the Americans as being hugely responsible in bringing about the current global financial calamity. Next Beijing further warned the US not to assume that China will always buy US Treasuries. As if that wasn't enough, Beijing went further to suggest that the US dollar has to be replaced as the reserve currency of choice. They cited the IMF's Special Drawing Rights as an option. Are these genuine concerns?

To me, its a lot like a mother nagging his son to get married. Its not like the mum is going to disown the son if he fails to get married. Its mainly nagging voices from Beijing. Why? The IMF Special Drawing Rights is a pie in the sky idea (please read my previous posting on the subject). Next, China will never be able to stop buying US Treasuries completely - the two nations are too interdependent on each other's economy to risk obliterating that relationship. If Beijing stops altogether, US interest rates will balloon, can you imagine what will happen if US interest rates rises from 3% to say 12% - US rates will rise sharply to continue to attract other funds to buy US Treasuries. That will stop borrowing and lending dead in the tracks, that will cause the stock markets to hit new lows because how are you going to find stocks that can better the risk free rate of say 12%. The move will cause other central banks to be filled with fear and start dumping US Treasuries before the currency collapses further. So, the USD may fall to 60 yen to the dollar and imagine the 1 USD buying only 2.4 ringgit. Which might not be a bad idea at all because that will make US exports a lot more competitive and thus helping to address its trade deficit.

But all that is hype and snarls... what is really happening is that Beijing has shifted the bulk of their holdings and new purchases to just the short term Treasuries. They are staying away from the long term Treasuries because they probably forsee a sustained long term weakness of the USD judging from the quite massive printing of new money by the Americans.

Beijing knows it cannot stop buying Treasuries, so it is thinking outside the box by reducing the risk strategically by other means. There is a clear sign that China, as the largest holder of US dollar financial assets, is concerned about the potential inflationary risk of the US Federal Reserve printing money. Hence the first priority is to GUARD AGAINST THE inflationary consequences of the US printing press - buy real assets, preferably denominated in a currency other than USD.

Chinese companies thirst for Rio Tinto, Fortescue Metals, ... is just the beginning ... they will buy and keep buying any and every kind of commodity producers.

The second strategy is to be nicer to countries other than the US so that they will be more open to Chinese companies expansion and acquisition strategy. Its more pragmatic but will strengthen China's economic hand at being able to dictate global economic direction, rather than being dictated now by the G-7. The one big issue which many have not brought up has to be the "currency swap lines". China has been very open and friendly to arranging these swap lines with many countries trying to defend their currencies during this financial crisis.
China has just signed its sixth bilateral currency swap arrangement with Argentina for CNY70bn ($10bn) . This follows five other earlier bilateral currency swap deals with:
Korea (CNY180bn last December)
HK (CNY200bn in January)
Malaysia (CNY80bn in February)
Belarus (CNY20bn in March)
Indonesia (CNY100bn March).

The CNY vs. local currency swaps, which total CNY650bn (US$95bn), will be valid for three years. More agreements with other emerging market countries are expected in the pipeline. The bilateral swaps with China do not require an IMF program to access more than 20% of the swaps. In the short term, China’s bilateral swaps promote bilateral trade and investment (especially trade finance), helping Chinese slumping exports by making access to finance easier. In the longer term, it is China’s strategic economic and political interest to promote internationalisation of CNY. But that will require full convertibility of the CNY.

The most recent deal with Argentina has swamped the media in Latam. More importantly is what this could mean for other Latin American countries should China extend this further across the region. Bilateral trade with the region adds up to USD112bn for which the top three are Brazil, Mexico and Chile. These swaps can help internationalise the Chinese yuan, if there is to be a new reserve currency in 30 years, why can't it be the Chinese yuan, or so Beijing seems to be thinking. The swaps will increase trade financing and engineer a closer economic relationship between the said countries.

Looking at it from a geopolitical point of view, Beijing has been quick to help Asian countries to stabilise their currencies. Like it or not, Beijing knows that for China to lead the rest of Asia into the next 50 years to be The Decade Of Asia Rising, China will not be able to it alone, and will need all the Asian tigers and lions to prosper and be economic successes as well. Hence Beijing would be more than happy to extend economic help to the rest of Asia if it can.

p/s photo: Jojo Stryus

Views On Chinese Equities

• Feb 24: After rising by 1/3 in early 2009, Shanghai Composite equities pared their gains to 20% as global and Chinese outlook worsened.
• Many of the new loans extended in December and January may have found their way into the equity market as investors seek better return on assets, this could imply that the lending surge is not being invested in sectors that will boost growth- and that stock market gains are vulnerable especially given that chinese equity returns have become more correlated with global trends
• Shenzhen equities rose 38% (Feb 16). The CSI fell 65% in 2008 as worsening global outlook, higher costs squeezing corporate profits, falling bank profits and government intervention are weighing on equities.
• Shanghai Composite Index, rose 9.3% in January, including three weekly gains before closing for the new year holiday. The Chinese equity market has rebounded since fiscal stimulus was announced in November 2008.
• Index may head towards the 200-day moving average at 2578 before a pullback. After the completion of a pullback, the index is expected to approach 2850 or 0.236x retracement level of the decline from the peak of 6429 (UOBKH)
• Citi: telecom and energy sectors may underperform, while highly geared companies, like financials, are likely to outperform Yet margin contraction, rising credit costs and decelerating fee income momentum will create downside risks for banks
Policy responses
• The government will ban cross-border fund flows, push publicly-traded companies to return more money to investors and toughen rules to punish insider trading
• China's cabinet approved a trial program for margin trading and short-selling even as other countries have imposed curbs on short selling. Shorting stocks could allow investors to hedge exposures but could be more destabilizing in the short-term
• China may allow investors to sell bonds that can be swapped for shares and may use brokerages as intermediaries to sell their shares rather than secondary market to ease pressure on share prices
• The Chinese equity market continues to be speculative because hedging tools are limited (deterring institutional investors) information on the companies is limited (Pettis) Level of government meddling in the market makes true transparency difficult (Hewitt) Many retail investors (who led the boom in 2007) have retreated to demand deposits
• Volume: Shares worth an average 118 billion yuan ($17 billion) changed hands every day on the Shanghai and Shenzhen stock exchanges early in 2008, 38% less than in 2007 (Bloomberg)
• Credit Suisse: the four most undervalued sectors are energy, materials, real estate. Consumer staples are relatively overbought
• Chinese equities may now be more susceptible to global outlook good or bad despite limited foreign investment in mainland equities. But it has also been driven by factors particular to China including previously high valuations, worries that anti-inflation measures would crimp growth
• Anderson: A-share capitalization now equals 40% of Chinese financial assets, a similar ratio to other markets
• In 2007. China's market capitalization $4.48 trillion or 140% of GDP. Average trading volume $26b. Chinese companies raised $62b in domestic market IPOs (WB) Shanghai index rose over 80% in 2007, smaller Shenzhen rose 120% in 2007 as limited investments, tax policies, RMB appreciation, negative deposit rates fueled share price boom

p/s photo: Natalie Tong Sze Wing

China Stimulus - Sector By Sector

• In addition to stimulus plans announced in November, State Council has announced additional sector specific ones relating to auto, steel, textile, machinery manufacturing, shipbuilding, light industries, electronics, petrochemical industry, logistics, and non-ferrous metal sectors. General focus is to try to reduce overcapacities and foster encourage consolidation (long term goals), though doing so may be difficult, particularly as some of the funds may just add to overcapacities. Additional real estate and energy focused support has not been included (federal and regional govt already rolled out real estate supportive policies in late 2008) but are being discussed at the party conferences.
  
• Auto and Steel: lower purchase tax on certain cars, especially fuel efficient; $730m in one-off allowances to farmers to upgrade vehicles; encourage industry consolidation;and establish a 10b-yuan government fund in steel. However it may be more difficult to phase out surplus and consolidate than expected - China currently has a steel glut as producers reversed production cuts too soon
• Non-ferrous metal: increase tax rebates; support high-value added exports of non-ferrous metal products; create and expedite national reserves; give credit to upgrade the technology. total capacity of nonferrous metal producers will be controlled
  
• Textile: increase tax rebate; phase out obsolete capacity; eliminate energy-intensive equipment and technology; and encourage relocation to central and western areas (these plans have been under way for some time but may not be key priority)
• Shipbuilding: increase credit extend the financial support for oceangoing vessels until 2012; suspend construction of new docks and the expansion of slipways
• Electronics: promoting the 3G mobile services and digital TVs; develop national science and technology projects and improve public technological service platforms; and promote outsourcing and increase tax rebates
• Light industries: subsidize farmers' purchase of TVs, refrigerators, washing machines and mobile phones, microwave ovens; increase export tax rebates; and remove restrictions on some labor-intensive and hi-tech processing trade
• Petrochemical: speed up of oil refining and ethylene projects construction; limit development of the coal-to-chemical industry and stop approvals for production expansion
• Logistics: develop transport and transshipment facilities; build logistics parks esp in rural areas,; encourage the development of logistics for major industries such as energy, minerals, automobile, agriculture and pharmaceuticals.

p/s Elanne Kong Yuk Lam

China Markets Extending Gains

China markets continued its strong showing after Chinese New Year holidays. The GDP growth rate was respectable at 6.8% in the fourth quarter and the expected government stimulus that should ensure a growth rate of 8% in 2009. Moreover, the Shanghai Composite Index was up an impressive 9.3% in January. That is impressive in comparison to the nearly identical 8.8% change in the Dow, though for the Dow it was in the other direction.

China's official purchasing managers' index (PMI) for January rose to 45.3 from 41.2 in December and a record low of 38.8 plumbed in November, the China Federation of Logistics and Purchasing (CFLP) said on Wednesday. A reading over 50 indicates an expansion of activity in the manufacturing sector while one below 50 suggests contraction. New orders, including those for exports, and production rose strongly. The only two sub-indexes to decrease were stockpiles of finished products and employment.

The January PMI indicates that China's economy is gradually bottoming out. The government's 4 trillion yuan ($915 billion) stimulus plan had started to have a positive impact on business, which was booking more orders for capital goods. Moreover, banks extended about 1.2 trillion yuan in new loans in January, a monthly record, in response to government calls to lend more to halt the economy's decline.

The stimulus plan is just as big as Obama's stimulus plan. One big difference, the China plan has a huge slant towards infrastructure. While Obama's plan is dissected into hundreds of pieces to satisfy various interest groups and to create a strong safety net for the poor. It is easier to marshal resources and get all provinces to work in tandem with government policies in China - and that is a huge advantage.

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previous posting on China in mid-January 2009:

1. The “smart money” is buying, not selling. Many foreign banks (including Li Ka Shing) have been selling down their Chinese banking shares in droves - the activity has been substantive over the last few weeks. We have to recognise that the foreign banks are selling because they are in trouble, not because the Chinese banks are in trouble. Secondly, the Chinese banks are the only kind of assets that can still get a decent price nowadays. Thirdly, the Chinese banks are the only kind of assets that there are plenty of willing money to buy them even now. Funds investing in emerging-market stocks raised their Chinese holdings to the highest level since 1995.
   
2. Chinese shares are very reasonably valued. If legendary investors like Warren Buffett really like US stocks trading at 12 times earnings, they should be rabid over Chinese stocks. Based on the MSCI China Index, the average Chinese stock trades for less than eight times earnings, and they do not have to contend with the massive de-leveraging.
3. Oil is much cheaper. One of China’s biggest challenges was to keep a lid on inflation, while still maintaining its breakneck pace of economic growth. That was no easy task with oil at $150 as the cost of shipping, food and fuel were increasing rapidly. Keep in mind, China imports a net 3.3 million barrels of oil a day. Now that oil prices are down considerably, the recently announced stimulus would see a more effective trickle through effect and multiplier effect, and not being "wasted" on oil prices. The risk of inflation in injecting the huge stimulus is muted as well.
   
4. The economy is NOT in a recession. Sure, it’s slowing down, but China is still on track for a solid 5%-6% expansion based on analysts’ estimates. And 8% if you believe the government statistics. Regardless of who ends up being right, compared to the contraction in most other economies, such a rate is downright explosive.
5. The last time Chinese stocks were this cheap was during the Asian financial crisis. Back then, most Asian countries were running huge deficits. But this time the roles are reversed. As of December, China boasts $1.95 trillion in foreign reserves. And counting. If necessary, the government can deploy these surpluses to keep economic growth humming along.
6. The consumer is just getting started. The country’s burgeoning middle class, now the size of the entire United States, is just getting started. The McKinsey Quarterly estimates that it will take two decades before these nouveau riche reach their full spending potential. As we know from our own experience and prosperity - 70% of GDP in the United States is attributed to consumer spending - the consumer is an engine of economic growth. In other words, the global recessionary headwinds are no match for the Chinese consumer. Like it or not, the global economy has grown by 70% in trade terms since 2000 till mid 2008. Much of that growth was due to globalisation and a huge new middle class of consumers being created in China, India and Latam - that middle class, while affected by the current crisis, will still be a force to be reckon with.
   
7. Locals are optimistic. We know consumer confidence plays a big role in the success of our own economy. It flat out stinks right now in the United States, And the economic conditions reflect it. But in China, it’s an entirely different situation. A recent survey from the Pew Research Center shows that most Chinese (86%) feel positive about where their country is headed. And that’s up from 25% just six years ago.
   
8. The “mother of all stimulus plans.” While the Obama stimulus has yet to take hold in the United States, rest assured it will. Same goes for the $584 billion the Chinese government is pumping into its economy. China’s “got the mother of all stimulus plans” when you factor in the government spending, savings rates and the rapid decline in commodities prices.

p/s photos: KC Concepcion