One chart to show why China should worry about Fed tapering too

Ok actually there are two charts. The first one is the USDCNY intraday-interday chart. For those who have followed our blog for more than a year, it would not look new. If it is the first time that you see this chart, you can find the background of this chart here. 

From the chart we can see that the onshore market's expectation of Renminbi appreciation since 4Q last year has been stronger than ever, after the depreciation expectation during 4Q2011 to 3Q2012. Coincidentally, the dramatic change of market's view on Renminbi was in line with the pace of quantitative easing in the US. It was during the interval between QE2 and QE3 when Renminbi was under depreciation pressure in the Chinese domestic market, and the depreciation expectation vanished very quickly after the launch of QE3 and we are seeing the strongest appreciation expectation ever since 4Q last year. Now everybody is talking about the Fed's tapering. The chart seems suggesting that the Renminbi would likely to face another round of depreciation pressure when tapering happens. 

Why should China worry if Renminbi is under depreciation pressure again?

FX inflow and outflow have tremendous impact on China's domestic monetary policy. When capital flows into China, in order to keep Renminbi exchange rate stable, the PBOC is forced to inject more liquidity into the banking system. Although someone may argue that the PBOC has issued bills and raised reserves to avoid excess liquidity injection, it does not seem to be the case. There are two problems here. First, the net bill issuance and reserve raising has never been enough to sterilize the capital inflow in recent years. Sun Guofeng, the deputy-head of PBOC's monetary policy department, said in his book that FX inflow can explain 25% of the deposit creation in China in the past decade. Second, PBOC bill itself is a quasi-money instrument as it is very liquid and people can use the bill as collateral to borrow so it is pretty hard to argue that issuing PBOC bills can effectively sterilize the excess liquidity. 

When capital flows out of China, as we saw from 4Q2011 to 3Q2012, domestic liquidity creation and monetary expansion would be much slower. Of course the PBOC can inject liquidity by cutting reserve requirement ratio or doing reverse-repos, but the problem is that China has enjoyed excess liquidity for so long that even if liquidity situation goes back to normal China would feel thirsty. If the central bank failed to be proactive, liquidity situation could only go worse. Moreover, what we are seeing this year is that very fast credit expansion led to pretty low GDP growth (by China standard), so what would happen to economic growth if credit expansion slows down? 

FX purchase has declined in May and the interbank rates in China have become unusually high since the beginning of this month, but it is just the beginning. The big story is yet to come. 

 

Central Banking Seminar

Chen Long

 

Posted by China Seminar at 11:54 pm

Import from Taiwan and USA overstated as well?

That's what the charts are suggesting.

Many argue that China's export data is overstated because China's export to HK is way higher than HK's import from China, but in fact you have to examine China's export to other major trading counterparties (US, Japan, Germany, Korea, Taiwan) and their import from China before making the conclusion.

In history, China's export to HK is always much higher than HK's import from China and China's export to US and Japan is always much lower than US and Japan's import from China. Why? Because the final destinations of a lot of China's export to HK are actually US and Japan. HK is just used as a re-export harbour. 

This year, when we see a widening gap between China's export to HK and HK's import from China, we do not see a equally widening gap between China's export to other major trading counterparites and their import from China, which suggests that there are a lot of exports that can hardly be explained as normal trades. Many argue that there are a lot of fake trades between China's Guangdong province and HK just in order to bring money in and arbitrage on the HK-China interest rate spread and Renminbi appreciation.

The Chinese Customs also acknowledged this fact. Together with the State Administration of Foreign Exchange (SAFE), they tried to eliminate the fake trades and it seems to have worked. 

 

 

Here is what Xinhua, the official newswire said about China's foreign trade data of May: 

"Total foreign trade volume grew 0.4 percent year on year last month to 345.1 billion U.S. dollars, a significant pullback from the 15.7-percent gain in April, the General Administration of Customs said on Saturday.

Exports inched up merely one percent year on year to 182.77 billion U.S. dollars, while imports declined 0.3 percent to 162.34 billion U.S. dollars, leaving China with a surplus of 20.43 billion U.S. dollars.

The export data came in much lower than market expectations, even considering the effect of the government rules to curb hot money.

Rising momentum in China's foreign trade in recent months has raised suspicions that companies may have misreported exports to obtain tax rebates or to bypass the country's capital controls to move money into the mainland, prompting authorities to release new rules to check the flows.

"The May data reflected China's recent crackdown on hot money inflow", noted Chang Jian, China economist with Barclays Capital."

Ok, the gap of China's export to HK and HK's import from China in the first four months widened. After the Customs and SAFE take measures to crack down hot money inflows, we saw a lower-than-expected export growth in May. Actually, China's export to HK only increased by 8% from the same period of last year and the growth was 93% and 57% in March and April. All of these seems to prove that a lot of China's export to HK are fake trades and spelative capital flows. 

But why did import growth drop significantly as well? We used the same methodology to look at China's import from major trading counterparties and their export to China, and we find some strange pattern in China's import from Taiwan and US. 

As we can see from the charts below, China's import from Taiwan has been higher than Taiwan's export to China and this is because a lot of trades go through HK. However, this year we see the same widening gap. If you believe China's export to HK includes many fake trades, you probably have to also believe that a lot of China's import from Taiwan and US are not true, because when the authority started to crack down fake trades, China's import growth from Taiwan dropped to 14% in May from 56% in April and China's import growth from US dropped to -2% in May from 20% in April. Taiwan and US are China's second and third largest import counterparty. 

Official explanation of the import decline is "deteriorating trade environment" and "weaker domestic demand", but we did not see new trade dispute between Chinese mainland and Taiwan, and China's import from Australia did not slow down as much as from Taiwan. Australia is supposed to be more sensitive to Chinese domestic demand, especially investments. 

Do we have an answer? I tend to believe China's "overstated" imports from Taiwan and US includes fake trades. When you bring money in and arbitrage on interest rate spread, you have to take profits and bring money out, so import is overstated together with export. But why Taiwan and US? I do not know this part. I hope smarter people can help me figure it out. 

 

Posted by China Seminar at 10:59 pm

Why did Chinese shadow banking surge after 2009?

Chinese shadow banking has become a well-noted subject in the discussion on Chinese financial system. Joe Zhang, a former research analyst and investment banker at UBS, recently published a book Inside China's Shadow Banking: The Next Subprime Crisis which fueled the already heated discussion on this topic.  Similar to other analysis, Joe attributes the origin of China's shadow banking to financial repression, which includes the artificially low interest rate in China. 

I agree. Deposit rates in China have been artificially low and real deposit rate was negative in half of the last decade (see the first chart). On the contrary, annual GDP growth was above 10% on average since 2000. This makes depositors, including household depositors, corporate depositors and government depositors seek higher return from somewhere else. At the same time, lending rates were too low as well and it boosted endless credit demand together with other pro-investment institutions. To avoid inflation and credit bubbles, the banking regulators set loan quota every year for the banking system (but it failed several times in controlling inflation and it never succeeded in curbing property prices). Since 2010, property developers were specially restricted to get access to bank loans as a measure to curb the property market. However, the property prices only dipped for a short while. Loan quota and specific restriction on property loans makes some borrowers, especially property developers, seek financing from non-bank channel. Consequently, from both the borrowers' and the depositors' sides, there is tremendous need for a "banking system" that is not as strictly regulated as the formal banks. Therefore, not only the non-bank financial institutions started to fill in the gap (trust company products, security company products, etc), but the formal banks tried to facilitate those demands in a way that regulators can hardly control (bank wealth management products).

 

Chart 1 Real 1-year deposit rate and real 1-year lending rate (benchmark interest rate - CPI)

However, there is a key question that Zhang and many other analysts failed to answer. Why did Chinese shadow banking surge only after the global financial crisis? Negative real interest rates and lending quota have existed in China for many years before 2009, but the "shadow banking" people referred to during that time was largely lending of pawn houses or lending between individuals. Large financial institutions were not involved that much. It was only after 2009 when trust companies and banks' WMP (wealth management product) business surged that people started to talk about Chinese shadow banking. I am afraid we may miss some important points if we simply blame interest rate controls for the emergence of shadow banking because negative real interest rate was much more severe in 2004 than in 2010. Why didn’t the Chinese shadow banking surge in 2004?

Part of the answer lies in the credit boom in 2009. As we can see in the second chart, while actual credit growth went beyond the target in most of years after 2000, it was usually within an acceptable range. But it more than doubled the target in 2009, which was unprecedented. In order to boost economic growth, the banking watchdogs tolerated a much higher credit growth than they planned in late 2008 and it almost went out of control in the beginning of 2009. New credit was as much as 4.58 trillion in the first quarter of 2009, almost equal to the total new loans in 2008. 

 

Chart 2 Actual new lending every year and the lending target (in billion Renminbi)

Of course, the stimulus package successfully helped China avoid an economic crisis, but unfortunately the bullets were not free. The banking regulators realized that credit growth in 2009 was too exceptional and it would create problems. It did and it led to severe inflation and asset price bubble in 2010 and 2011. To counter inflation, the People’s Bank of China (PBOC) reiterated the importance of credit target and urged the commercial banks to lend within the limit in 2010. However, as the old Chinese proverb says, it is easy to go from frugality to extravagance, but difficult to go from extravagance to frugality. Borrower became much more addicted to credits and many investment projects simply needed more credits to sustain. Facing obstacles getting official bank loans, they went to seek credits from other channels and non-bank financial institutions led by trust companies were well prepared to welcome their new customers.

Compared with 2004, 2009 was the perfect timing for non-bank financial institutions to grow their business. Why? Except that credit demand was much stronger in 2009, there is another reason. It was only until September 2004 that the CBRC started to allow banks to do Renminbi-denominated wealth management business. In other words WMPs did not even exist before 2004. The first Renminbi-denominate wealth management product was launched by the Everbright Bank in July 2004, two months before the official permission, and the expected annual return was 2.18%. In late 2005, the CBRC officially issued the guidelines for the wealth management business of commercial banks.

The first surge of the WMPs was in 2006 when Chinese stock market was roaring. Thanks to the bull market, share prices usually went up by more than 50% on their IPO debut which created huge demand for subscribing IPO stocks. To seize the opportunity, the banks cooperated with trust companies to set up liquidity pools to subscribe IPO stocks (banks cannot subscribe stocks themselves due to the requirement of separate operation). The business proved to be successful before the stock market collapse and the scale of WMPs and trust assets both surged. The cooperation of commercial banks and trust companies in 2006 laid the foundation for the joint business after 2009, which provided credits to borrowers who could not get access to formal bank loans either because they were restricted to borrow or because banks were restricted to lend.

Astonished by the growth of bank-trust cooperation business, the CBRC stopped it in July 2010 and asked the banks to move off-balance-sheet products back to the balance sheet in order to control the growth. However it did not mean financial deregulation came to an end. Trust companies were still growing at a ferocious speed. Trust assets reached almost 9 trillion Renminbi by March 2013, from 3 trillion by 2010 and 900 billion by 2007. While trust companies are still expanding their business, security companies started to work with commercial banks to issue wealth management products, thanks to the deregulation by China Security Regulation Committee (CSRC) in October 2012. The wealth management assets of security companies skyrocketed to 1.89 trillion Renminbi by the end of 2012, from a mere 281.8 billion by the end of 2011, and it has reached 3 trillion by the end of March this year. To follow, China Insurance Regulation Committee also relaxed restrictions on insurance companies as well. Sometimes the Chinese financial regulators (PBOC, CBRC, CSRC and CIRC) look more like competitors rather than allies. When the PBOC started to release Total Social Financing numbers in April 2011, some researchers said privately that the central bank wanted people to blame other parties for the rising CPI, because the TSF showed that loan growth was much lower than non-loan credit growth.

 

Chart 3 Trust assets growth (in billion Renminbi)

 

We cannot simply attribute the creation of Chinese shadow banking to financial regulations like interest rate control. The emergence of Chinese shadow banking was the outcome of strict regulations on traditional banking business and deregulations on non-traditional banking business and non-bank financial business. Real deposit rates were negative in half of the years after 2000 so there was always a demand from depositors looking for higher return, but in 2004 the demand from borrowers was not that strong and financial institutions were not able to facilitate. Financial deregulations after 2004 and the stimulus package in 2009 made it possible. 

 

Chen Long

Central banking seminar

Posted by China Seminar at 5:13 am

Is anti-corruption slowing down overall retail sales in China?

Last week I did a small research about the impact of the anti-corruption campaign on China's retail sales growth. While some analysts argue that the anti-corruption campaign by top party leaders has dragged down overall retail sales growth, my findings do not suport this argument.  My study suggests that the slowdown of retail sales is a multi-year trend and it has been in line with the slowdown of GDP growth. While anti-corruption does affect luxury goods sales, overall retail sales may not be affected as many think.

Since some readers may not be very familiar with the anti-corruption campaign, I would like to make a brief on the background. Shortly after the 18th National Congress of the Communist Party of China which was held last November, the new party leaders started a new round of move against corruption within the bureaucracy. Technically, the anti-corruption campaign was initiated during a meeting of the Chinese politburo on December 4th last year. The party leaders laid down eight rules asking government officials to maintain a frugal and low-key lifestyle .Several government officials were put under investigation because of corruption issues and the latest one was Liu Tienan, a vice-director of the National Development and Reform Commission, the most powerful state planning agency. What's more, in response to this campaign, it is reported that many state-owned enterprises and even private-owned companies cut expense budgets even for their annual conferences. Coincidentally, retail sales growth continued to slip this year and it has been below analysts' expectations. There are also several anecdote stories saying that luxury goods sales growth decelerated substantially in China this year. Therefore, some analysts argue that the anti-corruption campaign is causing the decline of overall retail sales growth. 

However, if we look at the medium-term trend of retail sales growth we will find that the slowdown of retail sales growth has been in line with the cool-off in overall economic activity since 2010. As the economic growth continues to decelerate this year, it seems that retail sales growth would keep slowing down anyway, regardless of the anti-corruption campaign. 

Retail sales growth and GDP growth

Moreover, the campaign can only affect a small portion of consumption rather than overall retail sales. Within the components of China's retail sales indicator, catering services and retail goods are the two big groups by consumption pattern, with the former making up slightly more than 10% of the total and retail goods accounting for almost 90%. Within the retail goods component, half of total sales come from small and medium-sized enterprises whose annual revenues are below CNY20 million and revenues from retail sales are below CNY5 million. Further available breakdown by sector is only available from large enterprises whose annual wholesale revenues are above CNY20 million and retail revenues are above CNY5 million.These sales account for another half of retail goods sales and 43% of total retail sales.

Breakdown of retail sales

 

If we assume that the anti-corruption campaign has had a negative impact on retail sales, it would be the large enterprises that suffer the most because those are the manufacturers of the premium goods, but sales by large enterprises have been slowing since 2010, suggesting that it has limited to do with anti-corruption. In fact, the growth of retail goods sales from small and medium enterprises has picked up at the expense of large competitors.

Retail sales growth by group

 

If we look further into the components of retail sales of large enterprises, the top four are automobile, petroleum, food and beverage and clothing, which account for 31% of overall retail sales. Others items include home appliance (2.7%), medicine (2.3%), jewellery(1.4%) and small categories accounting for less than 1% of total retail sales individually. Of these categories, petroleum sales are highly correlated with transportation and machinery and the volume of transport is related to overall activity, as machinery is to investment. None are likely to be much affected by an anti-corruption campaign. Home appliance is highly correlated with property market so it is not very related to anti-corruption. Neither is medicine sales. Therefore  it only leaves automobile, food and beverage, clothing and jewellery, but the latter has seen an acceleration in sales this year. 

So here comes the victim of the anti-corruption campaign: auto, food&beverage and clothing. 

One of the latest WSJ article talked about the slowdown of luxury car sales in China: 

The maker of Bentley luxury cars is the latest high-end auto maker to warn that ebbing confidence among Chinese consumers and a government-led drive against conspicuous consumption has hurt demand for its expensive rides.

..."Currently the luxury or premium market in China is getting lower growth rates," Mr. Lafrentz said. "Maybe it has to do with people just seeing how the country develops with the new government, how the economy and political scene develop."

 BMW AG sold 86,224 cars in China in the first quarter, up 7.5% from a year earlier, compared with a 37% jump in the year earlier period. Sales of Volkswagen's Audi rose 14% to 102,810 cars in China versus a 41% gain in the year-earlier period.

We do acknowledge that luxury goods sales have been affected quite severely by the austerity compaign. For instance, prada sales in Greater China slowed down since October last year and Swiss watch exports to Hong Kong and China fell 9.1% and 25.6% respectively in the first quarter of this year. 

Prada sales in Greater China 

Prada sales in Greater China

 

But Decline sales of luxury items may help lower-priced goods sales because of the supplementing effect. This is seen in autos, which is the single largest component in the retail goods breakdown (11.2% of total retail sales). 

The China Association of Automobile Manufacturers said that premium car sales only increased by 4% y/y in the first quarter of 2013, with the sales growth of both BMW and Audi, two of the most popular premium marques, slowing substantially. But overall passenger car sales in China rose by 17% y/y in the first quarter of 2013, up from +7% in 2012, and the fastest pace since 2010 when the market was boosted by a subsidy program.

Auto sales growth in China

 

Finally, food and beverages and catering are most likely to be affected by the anti-corruption campaign owing to popularity of wining and dining as well as the gifting of expensive liquor and cigarettes. Food, beverage, liquor and tobacco account for 6.6% of retail sales while catering services account for another 10.6%.

Controls on department budgets have significantly affected the restaurant trade, particularly for places favoured by officials. In the first quarter of 2013, catering service revenues increased by just 8.5% y/y while those of larger restaurants actually fell by 2.6%. 

Chinese baijiu, the indispensable component in Chinese banquets, has seen sales decline as well. It's widely believed that the government and military are the biggest customers of China's leading baijiu producers, suggesting sales are acutely sensitive to official expenditure. Sales of Guizhou Maotai rose 26.3% y/y in the first quarter, down from +48.3% and +40.5% in the previous two years. Wuliangye sales grew by just 6.7% in the first quarter, compared with +32.9%, +39.8% and +31.2% the previous three years. The empirical evidences indicate that they have been affected. However, it is worth pointing out that baijiu sales started to drop when toxic chemical was found in a few kinds of liquors in last November which hurt baijiu sales as well. 

Baijiu sales growth in China

So the conclusion is that anti-corruption did little to the retail sales slow down. Is it a happy ending? Not really. If I am correct and the slowdown of retail sales is not because of anti-corruption but the slowdown of overall economic activity, we should be more worried from a rebalancing perspective. Some economists argued that it is possible to have consumption grow at 8-9% annually when GDP growth slows to 6-7% so it is possible to rebalance at a fast level of GDP growth. This argument is undermined at least from the retail sales figures. Although we acknowledge that retail sales number is not a perfect proxy of Chinese consumption, especialy household consumption, it still seems that when GDP growth slows down, it is very difficult to maintain high consumption growth. In order to achieve it, we need a bigger transfer of wealth from the state sector to the household sector. 

 

Chen Long

Posted by China Seminar at 1:51 pm

China's rebalancing, shadow banking and RMB internationalization in INET Hong Kong

Last week, Yang Le and I were fortunate to attend the INET annual planery conference in Hong Kong as a part of the young scholar group. As it did in Berlin, INET again invited many speakers who are among the wisest minds in the world and they shared with us a lot of insights. The difference of the HK conference and the Berlin one is that we had much more discussions on a variety aspects of China. Among the most concerned issues are China's growth under rebalancing, the shadow banking system and the future of Renminbi internationalization. I saw several shifts of those viewpoints in the HK conference and this is what I would like to write briefly about today. Read more

Posted by China Seminar at 6:26 am

Is Capital Flight Taking Place in China?

From the balance of payment perspective

Despite a larger-than-expected amount of net exports this year, China’s capital accounts have printed negative numbers for several months, while in the past China always reported surpluses in both current account and capital account. Some analysts start arguing that China is facing tremendous amount of capital outflow implying that many people are losing confidence on China’s economy. Moreover, they say, Renminbi depreciation in the first three quarters support the view that capital is flowing out of China. Acknowledging capital flight a very important issue, we at the central banking seminar made an effort to find out the reasons for the Renminbi depreciation and the capital account deficit. Read more

Posted by China Seminar at 2:59 am

How does China’s Monetary Policy Committee influence monetary policies? - A brief history (2)

In April 2003, the State Council decided to restructure the Monetary Policy Committee and the new committee was composed of 13 people: the PBC's Governor and two Deputy Governors, a Deputy Secretary-General of the State Council, a Vice Minister of the NDRC, a Vice Finance Minister, the Administrator of the SAFE, the Chairman of China Banking Regulatory Commission (CBRC), the Chairman of China Securities Regulatory Commission, the Chairman of China Insurance Regulatory Commission (CIRC), the Commissioner of National Bureau of Statistics (NBS), the President of the China Banking Association (CBA) and an expert from the academia. Read more

Posted by China Seminar at 4:24 am

What caused the fall of discounting bills in September?

Yesterday the FT Alphaville had an interesting blog post on China’s banking system. Among the major financial media it was probably the first who noticed the very detailed changes in China’s loan structure. If we look at the year-to-date number, the outstanding amount of discounted bills, short-term loans and medium &long term loans rose by RMB 831.3B, 3.33T and 2.36T, respectively. However, in September, the outstanding amount of discounted bills dropped by more than 200B while short-term loans and medium and long-term loans continued to rise from the previous month.

  Read more

Posted by China Seminar at 8:04 am

How does China’s Monetary Policy Committee influence monetary policies? - A brief history (1)

Nowadays we see overwhelming comments on China’s monetary policy in the local press every day. These comments could be from the government officials, college professors or research analysts, but one specific group of people have been paid particular attentions to – the monetary policy committee members of the People’s Bank of China.   Inspired by similar studies focused on the Fed’s Open Market Committee, we try to analyze the public remarks of the monetary policy committee members to gain some insights. Read more

Posted by China Seminar at 5:29 am

Is it possible or even necessary for the Renminbi to become a dominant international currency ?

Since 2009, we have seen a rapid rise of Renminbi in the international trade settlements. China’s exports and imports settled in Renminbi have increased 48 times from January 2010 to December 2011. The Renminbi has also become the third-largest currency for LCs, with 4% market share after the US dollar and the Euro, according to the SWIFT. Many analysts believe these are perfect evidences that the Renminbi internationalization has been successful and it will continue to be very successful in the future. Some even argue that Renminbi will replace the US dollar as the dominant international currency in two decades, because China will become the world's largest economy very soon as what they believe. Read more

Posted by China Seminar at 6:33 am

Debunking misconceptions on China?

Recently the research house CLSA issued an in-depth special report on Chinese economy called Misunderstanding China, trying to debunk certain so-called western illusions about China’s economy. Some of its points, such as the party’s influences on domestic financial institutions, the absence of a mature legal system and etc., are fairly reasonable. However, we believe that this report still illustrates a typical optimists’ view on China’s economy that we do not agree with. Therefore, we find it very necessary to clarify our standpoints of the Chinese Economy by raising our counter-arguments to some of CLSA’s assertions, with which we disagree most.

  Read more

Posted by China Seminar at 12:24 pm

Why FX deposits surge in China

China’s monetary statistics for April 2012 showed weakness in both loan and deposit growth. In particular, Renminbi deposits fell by 465.6bn yuan, compared to a 342.4bn increase in April 2011. However, bank deposits denominated in foreign currencies (FX deposits) in China have been surging since the beginning of this year. FX deposits increased by 32.5% in the first 4 months of 2012, compared with 6% growth in the first 4 months of 2011. Every month there is about 20bn USD added into the banks’ deposit accounts.

Read more

Posted by China Seminar at 11:40 am

PBoC against the market on USDCNY

We update our USDCNY interday-intraday framework, which was first proposed here. The advantage of this framework is that it decomposes USDCNY movements into two parts and thus distinguishes market view from PBoC’s view on USDCNY, which are often in opposite positions.

  Read more

Posted by China Seminar at 11:27 am

China’s FX Flow Framework

During the “Two Sessions”, China’s Premier Wen Jiabao and the State Administrator of Foreign Exchange Yi Gang both said that the Renminbi might be close to the “equilibrium” level. This top-level comment could probably mark a much lower Renminbi appreciation this year and the advent of RMB’s two-way floating process. Last September, the long-standing consensus of one-way Renminbi appreciation was challenged for the first time since 2005 when the PBoC allowed Renminbi to appreciate against USD. Afterwards, in the onshore market, USDCNY hit lower trading bound set by the PBoC for 12 consecutive days in December; FX purchase by the banks dropped for three straight months in Q4. Read more

Posted by China Seminar at 10:05 am