Tag: China

With the AIIB the world gets a new banker

From The Conversation.

Beijing was in full party mode this week as delegates from 50 countries gathered to sign the articles of incorporation for the Asian Infrastructure Investment Bank (AIIB). Seven more countries are due to sign by the end of the year when the bank is expected to formally open its door for business.

This marks yet another milestone in the establishment of a China-led development lender that, according to its charter, aims to finance investments in infrastructure and other “productive” activities in Asia.

The mean and the lean

The share and governance structures of the bank have been under the radar. On one hand, China has vowed to bring something new to the table with a “new type” of multilateral development bank. On the other hand, western countries, whether those that have jumped aboard the bandwagon or those remaining on the sideline (particularly the US and Japan), have been wary. They are concerned the AIIB is part of Chinese plans to expand its geopolitical and economic interests at the expense of “international best practice”.

The proposed structure of the bank has been a compromise between China’s ambition and western concerns. Contributing almost US$30 billion of the institution’s US$100 billion capital base, China collects 30.34% of stake and 26.06% of voting rights within the multilateral institution. This makes China the largest shareholder in the bank, followed by India, Russia and Germany, with Australia and South Korea being equally fifth in shares.

What is notable is that China offered to forgo outright veto power in the bank’s routine operations, which helped win over some key founding members. However, a 26% voting right will give China veto power over “important” decisions that require a “super majority” of at least 75% of votes and approval of two-thirds of all member countries.

According to a report by the Wall Street Journal, the new lender will be overseen by a lean staff, in the form of an unpaid, non-resident board of directors. Established development banks (such as the World Bank) have been accused of being over-staffed, costly, and bureaucratic. But the AIIB approach tilts the power balance to the bank executives who will be based in Beijing and led by a Chinese-appointed governor. More institutional details must be worked out to strike a better balance between transparency, accountability, and efficiency.

Be in it to win it

The fact that a host of its allies have flocked to join China’s AIIB despite a campaign of dissuasion from Washington has sparked some serious soul searching in the power circle of the United States. Ben Bernanke, former chairman of the Federal Reserve, blamed the US Congress for the impasse in approving reforms to the IMF in granting emerging powers, particularly China, greater clout in the institution. Lawrence Summers, former US Treasury secretary, wrote recently that America’s blunder on the AIIB may be remembered as the moment it “lost its role as the underwriter of the global economic system”.

Indeed, Washington could have kicked the ball back to Beijing if it had taken a more participatory approach. The articles of association prove external concerns can be addressed through negotiation and compromise, but one needs to be at the table rather than pointing fingers from outside the room.

The current institutional framework suggests that previous fears of an unfettered Chinese influence within the bank were overblown. Yes, China could exert its veto power on important decisions, but conversations with Chinese bureaucrats suggest China is very unlikely to invoke it. After all, hijacking the agenda with its veto power has been the very way the US governs the institutions under its control, from which China is trying to distance itself.

In addition, it is less noted that the voting rights of the “Western” block, in its widest terms, (including South Korea and Singapore), are more than 30% in total. This means a mutual veto between China and western interests. In practice, this delicate balance tends to lead to negotiated consensus rather than open confrontation.

Engaging the new banker

For a long time, China has been urged to be a “responsible stakeholder” for the international community. The AIIB could well be a touchstone for China to demonstrate its ideas and ways of leadership. As Lou Jiwei, Chinese finance minister, said:

“This is China assuming more international responsibility for the development of the Asian and global economies.”

It is time to turn the table around. Instead of an endless debate on China’s strategic intentions as an emerging power, what we should do is explore ways to shape China’s behaviour to be more aligned with international expectations.

The new development bank presents a rare opportunity to achieve this in a multilateral context. So far China has largely acted on the sidelines in major international institutions, such as the World Trade Organisation and the G20 (before the Brisbane summit), and had leadership experiences in mostly regional settings, such as the Shanghai Cooperation Organisation.

The world has a new banker. However, it lacks expertise in international development finance; it lacks international governance experiences; and its ideas are untested.

These are not reasons for pessimism about the bank’s future. On the contrary, these are the very reasons we should join the initiative. By doing so, we could more effectively shape China’s view of the world and its role in the world when it is in need of ideas, expertise, and most importantly, support.

Whether China will be a friend or foe largely depends on whether we treat it as a friend or foe. After all, as Hillary Clinton once said of the US relationship with China: “How do you deal toughly with your banker?”

Author: Hui Feng, Research Fellow, Griffith Asia Institute and Centre for Governance and Public Policy at Griffith University

China’s Growth: Can Goldilocks Outgrow Bears? – IMF Paper

The latest IMF working paper analyses the recent growth dynamics in China, evaluating both cyclical positions and long-term growth prospects. The analysis shows that financial cycles play a more important role than traditional inflation-based cycles in shaping the dynamics of growth.

China’s impressive growth record speaks for itself, and the country’s policymakers have won additional accolades for the timely response to the Global Financial Crisis. The Chinese GDP has been growing at the average rate of nearly 10 percent per year in the past four decades. The well-timed policy relaxation supported growth in the immediate aftermath of the crisis. Several analysts pronounced the arrival of a goldilocks economy in China—not too hot to fuel inflation and not too cold to slip into recession —and some see a continuation of the stable economic growth as the most likely scenario for China.

A key question is how much of China’s slowdown is temporary (cyclical) versus long lasting (structural). Growth fluctuations in developing and emerging markets often follow a pattern of spans of impressive growth followed by long periods of stagnation. The concern is therefore not only about a cyclical growth slowdown typically experienced by mature economies, but a prolonged slump so often experienced in emerging markets. These fears are also fed by the observation that structural ‘imbalances’ in the Chinese economy—exceptionally high investment rates associated by some with ‘forced savings’ —have further grown since the GFC, reducing investment efficiency and total factor productivity (TFP) growth.

Headline growth in China has slowed from the pre-GFC peak of 14 percent to less than 8 percent in 2013. China benefitted from the pre-crisis global expansion, but its export-based model suffered a blow when global demand collapsed. At the same time, the authorities embarked on a massive credit-cum-investment stimulus, which cushioned the impact of the global slowdown.

China-GrowthThe paper simulates theoretical convergence growth paths by substituting China’s data to two versions of the estimated model. The actual growth path for China is significantly above the convergence path simulated from the full model (‘low convergence path’) and is oscillating around the Asian Tigers’ path (‘high-convergence path’) since the dismantling of the strict central-planning system in 1979.

In summary, the paper contributes to the ongoing growth debate by identifying the cyclical position and assessing the degree of potential output slowdown in China. The main results are:

  1. Expect growth to slow down in the near-term. Financial cycles in China play a significant role in shaping growth dynamics, and the economy is now likely near the peak of a powerful cycle propelling the economy since the GFC. An adjustment is therefore both likely and needed to bring the economy closer to equilibrium.
  2. Potential growth is slowing. This is expected as China makes progress on the long journey of converging to advanced economy income levels. As it moves closer to this technology frontier, growth will continue to slow. However, the pace of convergence, and thus China’s medium-term growth rate, will depend on structural reforms. With success in implementing reforms, China can follow the historical experience of other fast-growing Asian economies.

Currently, the ‘finance-neutral’ gap—a measure of the financial cycle—is large and positive, reflecting imbalances accumulated in the economy since the Global Financial Crisis. A period of slower growth is therefore both likely and needed in the near term to restore the economy to equilibrium. In the medium term, growth will slow as China moves closer to the technology frontier, but a steadfast implementation of reforms can ensure that China follows the path of the “Asia Tigers” and achieves successful convergence to high-income status.

Note The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.

China Policy Shift Prioritises Growth Over Debt Problem – Fitch

Fitch Ratings says the Chinese government directives last week concerning local government debt signal a potentially significant policy shift to prioritise growth over managing the country’s debt problem. Uncertainty over the scale and strategy to resolve high local government debt remains a key issue for China’s sovereign credit profile, and the latest directives could reflect a continuation of an “extend and pretend” approach to the issue. The directives should be credit positive for local governments, while broadly neutral for banks.

A joint directive from the Chinese finance ministry, central bank and financial regulator on 15 May, instructed the banks to continue extending loans to local government financing vehicles (LGFV)s for existing projects that had commenced prior to end-2014, and to renegotiate debt where necessary to ensure project completion. This is an explicit form of regulatory forbearance, and serves to delay plans to wind down the role of LGFVs. More broadly, it also suggests that propping up growth in the short term has temporarily taken priority over efforts to resolve solvency problems at the local government level.

Fitch estimates local government debt to have reached 32% of GDP at end-2014, up from 18% at end-2008. The CNY14.9trn increase accounts for 18% of the rise in total debt.

The authorities’ efforts to rein in indebtedness have led to a squeeze on monetary conditions and credit that has dampened growth. GDP expanded 1.3% qoq in 1Q15, and April activity data indicated the slowdown has persisted into the second quarter with weak demand across the board. Fixed-asset investment growth slowed to 12% yoy for the first four months of 2015, a 14-year low. Property investment growth fell to 6% from 8.5% in March as China’s 2009-2014 real estate boom continues to unwind.. This poses downside risk to Fitch’s projection of 6.8% growth for 2015.

Earlier, on 13 May, the central government also announced a USD160bn debt swap plan by which local governments would be allowed to convert LGFV debt for municipal bonds and where the bond yields would be capped.

For local governments, the swap will ease the interest burden at a time when a slowing economy and a significant reduction in land sales are weighing on revenue growth. Local government debt often carries interest rates in excess of 7%, whereas the local bonds that will be converted from debt under this programme will be restricted to yields not in excess of 30% above central government bonds with similar tenors.

Fitch views the development of a local bond market as credit positive in itself for local governments. They will benefit from an extended maturity profile on the bonds compared with LGFV instruments. This will significantly reduce liquidity risks, and ensure a better asset/liability match. It also widens local governments’ funding channels and builds a more transparent fiscal reporting system.

More broadly, Fitch expects the resolution of China’s debt problem will ultimately involve sovereign resources, and that debt will migrate on to the sovereign balance sheet. The agency views the debt-swap plan as part of this process, even though the new local government debt is not expected to carry an explicit sovereign guarantee – as the debt is likely to be perceived as having a strong implicit guarantee. Nonetheless, the expectation of substantial contingent liabilities is factored into China’s ‘A+’/Stable sovereign IDR, affirmed in April 2015.

For Chinese banks, the shift from debt to bonds will affect profitability, especially as the rates on the swapped bonds are being capped. Banks will receive lower yields on the same exposure at a time when net interest margins are coming under pressure owing to the macroeconomic slowdown. Furthermore, the government directive to continue extending loans to LGFVs on certain projects will have a negative effect on banks’ liquidity and leverage. More broadly, the directive highlights that banks remain subject to direct influence from the authorities, which could have an impact on management governance and standards.

However, it also reinforces the role that state banks play in economic stability, and therefore the high likelihood that they will benefit from state support. Furthermore, the impact on liquidity will be offset somewhat by the fact that banks will be able to use municipal and provincial bonds as collateral to access key lending facilities. This will enable them to boost lending to higher-margin business. Notably, too, the conversions should have some positive impact on banks’ reported capital ratios as municipal bonds have lower risk weights than local government loans.

Chinese Banks’ Earnings Unlikely to Improve in 2015 – Fitch

Fitch Ratings says Chinese banks’ 2014 results indicate their earnings remain under pressure and the agency does not expect meaningful improvement in the current year. The banks’ earnings will be challenged by deteriorating asset quality and net interest margins (NIM) that in 2015 will further feel the effects of stiff competition for deposits and on-going deregulation of deposit rates – the latter being especially true for mid-tier banks.

For Fitch-rated Chinese banks that have reported results for 2014, their revenue grew by 13.1%, but net profit only rose by 7.2% due to higher loan provisioning. State banks reported stable, if not slightly higher, NIMs, reflecting efforts to shift towards loans with higher yield, such as micro and small-business loans, and lower-cost funding sources like core deposits. In contrast, the mid-tier banks’ NIMs were under pressure, which they tried to offset by expanding non-interest income.

Fitch estimates the rated banks’ new NPL formation rate accelerated to 0.85% in 2014 from 0.42% a year earlier, as they continued to expand loans and assets. In 2014, loans increased 11.4% and assets expanded 10.6% on average across Fitch’s rated portfolio, with mid-tier banks speeding ahead with asset growth of 16.6%, compared with the state banks’ 9.0%. Fitch views the system’s pace of credit growth as unsustainable, with the banks already being highly leveraged by emerging market standards.

With slower economic growth, all Chinese banks reported further increases in NPLs, special mention loans and overdue loans in 2014, even as more bad loans were written off and/or disposed. The reported system NPL ratio was 1.25% at end-2014 (up from 1.0% at end-2013) while the provision coverage ratio was 232%. However, most mid-tier banks reported NPL ratios of 1.02%-1.3% and provision coverage ratios around 180%-200%. The Viability Ratings on Chinese banks range between ‘bb’ and ‘b’, reflecting, among other things, Fitch’s expectation that slower economic growth could weaken borrowers’ repayment ability and drive further deterioration in asset quality, the pressure on banks from high leverage, and their potential exposure to liquidity events.

Fitch believes the health of credit quality remains overstated across the banking system. Banks with lower provision coverage will face greater pressure to dispose their NPLs in 2015 in order to meet the requirement to maintain a minimum 150% provision coverage ratio.

Although banks have been shoring up capital, their capital positions are unlikely to improve meaningfully as long as their loans and assets keep expanding at the current pace. Banks that adopted revised capital calculations raised their core tier 1 capital ratios by 92-154bps, except Agricultural Bank of China, whose core tier 1 capital ratio fell by 16bp. The mid-tier banks’ core tier 1 remained largely unchanged. The banks’ tier 1 and total capital ratios were also lifted by the issuance of Basel III-compliant securities during 2014, while the state banks reduced their dividend payout ratios and China CITIC Bank suspended the distribution of final dividends to replenish capital.

For the banks that disclosed information on wealth management products (WMPs), outstanding WMPs at the end-2014 increased by 41% on average, with the amount of WMPs issued during 2014 up 35%. The majority of the WMPs have tenors shorter than one year. While most WMPs are non-principal guaranteed by the banks, Fitch believes banks may assume some losses in the event a WMP defaults or provide funding to the entities that bail out the WMPs that are in danger of default.