Transcript Notes
The year is 2031, and China’s economy is defined by a wave of new medium and large sized firms that have replaced the old, inefficient State Owned Enterprises. This led to… middle class. How did they get here?
The private sector in China
Inefficient; half of private firms. More debt than private firms: 2005, both had DER of 1.3; 2013 0.8 for P, 1.6 for SOE. Debt:GDP 260%, 115% of which is SOEs. However, in 2012 was only 100%. From 2006-2016, share of profits by SOEs has halved. Response: lighter touch model (like Singapore) in 2015; encouraged growth of new private firms to take over SOEs.
A new reserve currency?
Renminbi to be a WRC, indicated by 1) Petrodollar demand drops as Reuters, Deloitte and BP predict US becomes oil self-sufficient by 2035; FT ran 2015 piece on how China overtook US importing oil, trend continues in future. China deliberately securing use of renminbi in trading oil: 2012 – Iranian diplomats confirm China buying crude oil in Yuan. PBOC and UAE Central Bank perform $5.5bn currency swap, setting stage for Abu Dhabi settling oil sales to China in yuan.
2) China taking advantage of IMF’s Special Drawing Rights. August 2015, World Bank issued 500 million 3-year SDR bonds to selection of 50 banks, brokerages and insurers in China; director general of PBOC Zhu Jun says bonds will attract official investors and then private sector. China Construction Bank Corp. predicted that in the years following, SDR bonds would swell to $7bn across nation. Renminbi included in SDR basket as of October 2016: central banks holding SDRs all over the world exposed to renminbi overnight, gains official reserve currency status quickly
Why advantageous to the Chinese private sector? Reduction in regulations surrounding capital flows + SDR bonds = businesses can venture outside China more easily Better capital account convertibility + more open capital market = financing needs met easily (according to Holdings Plc chief China economist Qu Hongbin.
But might a stronger currency threaten low-value added Chinese exports? Not an issue, as changes to the manufacturing sector are forcing China to switch to high value-added.
China reaches a Lewis Turning Point
Lewis turning point (IMF forecast this by early 2020s). Cost of labour rising since 2000 by 20% per year. Cost of capital rising 4.3% per year between 2000-2010. Between 1990-2005 China needed $3.4 capital for $1 GDP – by 2005-2015, this was $5.4 – by 2025 (IGM predicted the figure would be) $7.6. Trend was already evident in 2016: some heavily capital-reliant industries required .96c in China for every dollar in US. Therefore cost advantages of producing in China disappeared.
Solution is innovation: new business models (such as Xiaomi increasing the lifespan of phones to 24 months to benefit from greater economies of scale and reduce cost of researching new components), higher quality products that fit into different market tier. Already in 2016: R&D jumped from 43% of US’ R&D in 2012 to nearly 60 in 2016.
This growth of the private sector responsible for other changes: fuels ballooning middle class, higher incomes and also attracts FDI to China alongside educated foreign workers to meet the demand created by Chinese firms (15 years not enough time to re-educate entire generation of Chinese students).
FINANCIAL INSTABILITY
China also had to tackle financial instability in the peer-to-peer lending sector before 2031. The industry started around 2013 and grew tenfold in the next couple of years to account for 0.5% of Chinese lending, though it was rife with fraud, scams and malpractice circa 2014-16. The best example of this was Ezubao, the largest peer-to-peer lending group in 2015 which turned out to be a Ponzi scheme, costing 900,000 investors the equivalent of US$7.2 billion.
What did the government do to stop this issue?
What happened was that stricter Chinese regulation of the sector from around 2017 onwards, which included the setting up of a regulatory authority for peer-to-peer lenders and increased penalties for those engaging in malpractice, not only helped to rid the sector of most issues but also aided China’s growth as small firms and individuals were more able to gain financing as a result of Chinese lenders increased trust in the system. Because of this, the value of the shadow banking industry (which was estimated at 45 trillion yuan in 2016) has grown at a far slower rate than the Chinese banking industry as a whole, though estimates of its true size are likely to be unreliable.
China also had to cope with financial instability caused by the prevalence of non-performing loans, or NPLs. In 2016 the proportion of NPLs as a total of all Chinese loans was very hard to establish; back in the days before Chinese figures were reliable, official statistics stated that NPLs formed 2.15% of Chinese commercial bank loans, although most independent estimates placed them at around 10% and Kenneth Rogoff famously said that ‘no serious person thinks it’s below 7-8%’. These statistics were even harder to estimate given the fact that the definitions of NPLs varied widely between China and the West, the fact many bad loans that would be NPLs elsewhere were classed as being in ‘special measures’ under the Chinese system, and the fact that Chinese NPL prevalence only included the banking system and not those loans held by Asset Management Companies or other trusts. In 2022, after the proportion of non-performing loans to total Chinese loans increased to a widespread belief of around 20%, stock markets in China became increasingly volatile, eventually encouraging the Communist Party to ditch its strategy of doing nothing and letting all the bad debt roll over, and solve the issue.
What was the solution to this?
This took the form of a debt resolution act in the early 2020s, which relaxed Chinese restrictions on debt/equity swaps and encouraged banks to make use of them to regain capital due on any outstanding non-performing loans (given the valuation of the companies as valued by the newly-created Debt Management Agency). The resolution also gave banks greater power to seize assets to repay NPLs and reduced the time required to solve NPL disputes in the Chinese court system; the former increased inequality and poverty slightly in the short-term but eventually led to far higher levels of investment in Chinese businesses and subsequently lowered unemployment. China’s making the renminbi a world reserve currency also led to major increases in Chinese capital markets and foreign investment, and increased the proportion of Chinese debt held abroad from 5% to 35%, although (as in the past) there remain some complaints from foreigners of courts being biased in favour of domestic firms in loan disputes. Nonetheless increased foreign investment led to the spreading of NPL ownership around the world, reducing the impacts of default on the Chinese economy whenever defaults did occur (though NPLs currently stand at around merely 3% of Chinese loans).
In the news
The story of China different to story you will see in the news. If our predictions on China are right, expect these stories to develop as they are the steps China will take to protect and nurture its new private sector and world reserve currency status.
Corruption rid of to 1) aid credit flows to Chinese businesses 2) encourage investment in such firms by making them more reliable. Example of Xi Jingping.
Petroyuan recycling: cities in Nigeria, Iran like Dubai (especially given China’s fondness of designing and building entire cities from scratch). Benefits of such recycling: petrodollar used to purchase dollar-denominated assets such as treasury bills which ensure financial liquidity, keep interest rates low and promote non-inflationary growth – expect China to be afforded the same luxury.
No comments:
Post a Comment