Tuesday, November 12, 2013

601 China-Pakistan freight & pipeline corridor will link Xinjiang to the Persian Gulf

China-Pakistan freight & pipeline corridor will link Xinjiang to the
Persian Gulf

Newsletter published 18 July 2013

(1) Chinese property price surge fuels rate rise fears
(2) Fitch says China credit bubble unprecedented
(3) Auditor warns China debt crisis could dwarf GFC
(4) Behind China's liquidity crisis - John Ross
(5) China's Premier endorses Rebalancing (higher wages, shift from
exports to internal consumption)
(6) City complains because China will not let its banks fail. They are
state-owned; it will print money & prop them up
(7) Barry Eichengreen: Fed causes panic with talk of ending QE; PBOC
over-reacts to credit bubble
(8) Red Capitalism: The Fragile Financial Foundation of China's
Extraordinary Rise
(9) China banks abandon Western accounting firms, auditors
(10) China-Pakistan economic corridor connects Kashgar (Xinjiang) to
Gwadar (Arabian Sea)

(1) Chinese property price surge fuels rate rise fears


By online business reporter Michael Janda

Analysts say a surge in Chinese home prices are a cause for concern, but
the government has made moves to take some heat out of the market.

Property prices in China's 70 major cities rose an average of 3.6 per
cent over the year to March, but analysts were more concerned by a 1.2
per cent jump last month.

There were also concerns about the more rapid price increases in some of
the so-called tier one cities, with Beijing prices up 8.6 over the past
year and 3.1 in March, and Shanghai up 6.4 per cent over the last 12
months and 2.6 per cent last month alone.

TD Securities head of Asia-Pacific research Annette Beacher says she is
concerned by the sudden, sharp acceleration in prices, but believes a
change in government policy may have been partly to blame.

"We're trying to figure out if there's some degree of front-running
ahead of what are pretty widely documented changes in loan restrictions
and property price controls [that take effect in April]," she told ABC
News Online.

"Certainly a report like this tells us that the heat has to come out of
the property market."

However, Ms Beacher is hopeful that the government measures, which
focused on making it harder to buy multiple properties in the nation's
most expensive cities, will now start taking a little bit of heat out of
those sections of the property market that are surging, without crashing
the whole real estate sector. ...

The concerns about surging property prices come hot on the heels of a
warning by a leading Chinese auditor that the nation's local authorities
have dangerous levels of debt that could trigger a financial meltdown.

(2) Fitch says China credit bubble unprecedented


Fitch says China credit bubble unprecedented in modern world history

China's shadow banking system is out of control and under mounting
stress as borrowers struggle to roll over short-term debts, Fitch
Ratings has warned.

By Ambrose Evans-Pritchard, International Business Editor4:12PM BST 16
Jun 2013

The agency said the scale of credit was so extreme that the country
would find it very hard to grow its way out of the excesses as in past
episodes, implying tougher times ahead.

"The credit-driven growth model is clearly falling apart. This could
feed into a massive over-capacity problem, and potentially into a
Japanese-style deflation," said Charlene Chu, the agency's senior
director in Beijing.

"There is no transparency in the shadow banking system, and systemic
risk is rising. We have no idea who the borrowers are, who the lenders
are, and what the quality of assets is, and this undermines signalling,"
she told The Daily Telegraph.

While the non-performing loan rate of the banks may look benign at just
1pc, this has become irrelevant as trusts, wealth-management funds,
offshore vehicles and other forms of irregular lending make up over half
of all new credit. "It means nothing if you can off-load any bad asset
you want. A lot of the banking exposure to property is not booked as
property," she said.

Concerns are rising after a string of upsets in Quingdao, Ordos, Jilin
and elsewhere, in so-called trust products, a $1.4 trillion (£0.9
trillion) segment of the shadow banking system.

Bank Everbright defaulted on an interbank loan 10 days ago amid wild
spikes in short-term "Shibor" borrowing rates, a sign that liquidity has
suddenly dried up. "Typically stress starts in the periphery and moves
to the core, and that is what we are already seeing with defaults in
trust products," she said.

Fitch warned that wealth products worth $2 trillion of lending are in
reality a "hidden second balance sheet" for banks, allowing them to
circumvent loan curbs and dodge efforts by regulators to halt the excesses.

This niche is the epicentre of risk. Half the loans must be rolled over
every three months, and another 25pc in less than six months. This has
echoes of Northern Rock, Lehman Brothers and others that came to grief
in the West on short-term liabilities when the wholesale capital markets

Mrs Chu said the banks had been forced to park over $3 trillion in
reserves at the central bank, giving them a "massive savings account
that can be drawn down" in a crisis, but this may not be enough to avert
trouble given the sheer scale of the lending boom.

Overall credit has jumped from $9 trillion to $23 trillion since the
Lehman crisis. "They have replicated the entire US commercial banking
system in five years," she said.

The ratio of credit to GDP has jumped by 75 percentage points to 200pc
of GDP, compared to roughly 40 points in the US over five years leading
up to the subprime bubble, or in Japan before the Nikkei bubble burst in
1990. "This is beyond anything we have ever seen before in a large
economy. We don't know how this will play out. The next six months will
be crucial," she said.

The agency downgraded China's long-term currency rating to AA- debt in
April but still thinks the government can handle any banking crisis,
however bad. "The Chinese state has a lot of firepower. It is very able
and very willing to support the banking sector. The real question is
what this means for growth, and therefore for social and political
risk," said Mrs Chu.

"There is no way they can grow out of their asset problems as they did
in the past. We think this will be very different from the banking
crisis in the late 1990s. With credit at 200pc of GDP, the numerator is
growing twice as fast as the denominator. You can't grow out of that."

The authorities have been trying to manage a soft-landing, deploying
loan curbs and a high reserve ratio requirement (RRR) for banks to halt
property speculation. The home price to income ratio has reached 16 to
18 in many cities, shutting workers out of the market. Shadow banking
has plugged the gap for much of the last two years.

However, a new problem has emerged as the economic efficiency of credit
collapses. The extra GDP growth generated by each extra yuan of loans
has dropped from 0.85 to 0.15 over the last four years, a sign of

Wei Yao from Societe Generale says the debt service ratio of Chinese
companies has reached 30pc of GDP – the typical threshold for financial
crises -- and many will not be able to pay interest or repay principal.
She warned that the country could be on the verge of a "Minsky Moment",
when the debt pyramid collapses under its own weight. "The debt snowball
is getting bigger and bigger, without contributing to real activity,"
she said.

The latest twist is sudden stress in the overnight lending markets. "We
believe the series of policy tightening measures in the past three
months have reached critical mass, such that deleveraging in the banking
sector is happening. Liquidity tightening can be very damaging to a
highly leveraged economy," said Zhiwei Zhang from Nomura.

"There is room to cut interest rates and the reserve ratio in the second
half," wrote a front-page editorial today in China Securities Journal on
Friday. The article is the first sign that the authorities are preparing
to change tack, shifting to a looser stance after a drizzle of bad data
over recent weeks.

The journal said total credit in China's financial system may be as high
as 221pc of GDP, jumping almost eightfold over the last decade, and
warned that companies will have to fork out $1 trillion in interest
payments alone this year. "Chinese corporate debt burdens are much
higher than those of other economies. Much of the liquidity is being
used to repay debt and not to finance output," it said.

It also flagged worries over an exodus of hot money once the US Federal
Reserve starts tightening. "China will face large-scale capital outflows
if there is an exit from quantitative easing and the dollar
strengthens," it wrote.

The journal said foreign withdrawals from Chinese equity funds were the
highest since early 2008 in the week up to June 5, and withdrawals from
Hong Kong funds were the most in a decade.

(3) Auditor warns China debt crisis could dwarf GFC


By business editor Peter Ryan and staff

There are warnings that China could face a financial crisis bigger than
the United States or Europe unless it gets its debt under control.

One of China's top auditors has revealed his accounting firm has stopped
approving requests from local governments to increase their debt exposures.

Concerns about a potential meltdown come as China's stellar economic
growth begins to slow.

{inset} We're in the position, and have been for many years, where debt
is rising more quickly than the ability to service that debt.
Michael Pettis, professor of finance at Peking University
{end inset}

It is pretty hard to get an accurate reading on China's total debt
levels, much of which is held by local authorities, but estimates are
that China's provinces, cities, regions and villages owe a collective
$US3 trillion.

All of this stems back to 2008, when the collapse of Lehman Brothers
triggered the global financial crisis and China needed to protect its
growth and status and, as a result, pumped more than $US500 billion of
stimulus into its economy and created a massive credit boom.

Now a senior Chinese auditor who is the head of China's accounting
association, Zhang Kew Hoc, has told the Financial Times of London that
he has stopped signing off on risky bond sales by local governments.

Debt party ending

Michael Pettis, a professor of finance at Peking University, says the
ramped up caution shows China's debt party might soon be over.

"The problem is that so much of this investment is going into empty real
estate, empty highways, empty airports, unnecessary manufacturing
capacity, etc, that we're in the position, and have been for many years,
where debt is rising more quickly than the ability to service that
debt," he warned.

"So that's the conundrum they face - if you want to bring that problem
under control, you have to bring investment down, and if you bring
investment down growth rates will slow very, very sharply."

It is not just a few accountants and academics warning about Chinese debt.

The International Monetary Fund has also been warning about China's debt
levels, and investment banks and ratings agencies have been on the front
foot after failing to read the initial signs leading up to the GFC.

There is a very big focus on China's real estate sector, which accounts
for 13 per cent of the country's GDP.

There has already there has been a sharp decline in values but, unless
Chinese authorities intervene to stop a real estate bubble, some
economists are quite worried that there could be much more than a
correction but a crash that could rival the US one, which of course
almost brought down the US economy back in 2008.

You can follow Peter Ryan on Twitter @Peter_F_Ryan or on his blog.

(4) Behind China's liquidity crisis - John Ross

Behind China's liquidity crisis


John Ross

07 July 2013

In June, China suffered its worst liquidity crisis in over a decade.
Some sections of the U.K. and U.S. media exploded with wild comparisons
to the US financial crisis in 2008.

Such comparisons were nonsense, however, based on an elementary economic
mistake. The U.S. did not suffer a liquidity crisis in 2008. It faced an
insolvency crisis. The former is a shortage of means to meet immediate
payments; the latter occurs when banks' liabilities exceed their
capital. In 2013, Chinese financial institutions faced liquidity
problems, but not a single major institution failed. Numerous U.S.
financial institutions collapsed in 2008. Comparing the two events is
rather like claiming that the flu and the bubonic plague are equally
serious, since both are illnesses!

But not being the bubonic plague doesn't mean that in its own terms flu
is not unpleasant, or that it doesn't have side effects that last for
some time. Therefore, it is important to analyze the crisis' causes in
order to determine whether similar events will recur. While the exact
form of crisis was not predictable - it never is - both Chinese
economists and the present author predicted why there would be problems
for the Chinese economy. Now that June's symptoms have been somewhat
ameliorated, whether a similar crisis emerges in the future depends on
whether the key mistake that led to the present one is resolved.

The key symptom of June's crisis was a spike in interbank lending rates
to a 13 percent peak. Willingness to pay this indicated that financial
institutions urgently needed cash. Analyzing the links between the
underlying disease and the symptoms shows why.

The core problem that led to the liquidity crisis was advocacy that
China abandon the policies which for 35 years have made it the world's
most rapidly growing economy, in favor of something termed "consumer led
growth," a theory that boosting consumer demand will lead companies to a
more rapid increase in production of consumer goods and a more rapid
rise in living standards. Unfortunately, this theory factually doesn't
take into account that investment is the main source of economic growth,
and conceptually it doesn't understand what a market economy actually is.

A market economy necessarily can only be "profit led growth." Output
does not increase due to "demand," but only because of profit. Failure
to understand this pushed the economy towards the liquidity crisis via
its key policy proposal that the percentage of consumption in China's
GDP be increased, and to pay for these purchases the percentage of wages
in GDP should increase.

Increasing the percentage of wages in the GDP necessarily means reducing
the percentage of profits. Therefore the theory of "consumer led growth"
in reality advocated that a profits squeeze should be applied to
companies via wages growing more rapidly than GDP. Regrettably, in the
first part of 2013, this policy was pursued, with China's consumption
rising significantly more rapidly than its investment, an indication
wages were rising more rapidly than GDP. This produced the only possible
consequence in a market economy: a chain reaction leading to crisis,
which duly broke out in June in credit markets

Wages rising more rapidly than GDP squeezed company profits. By May
2013, the overall profit increase by companies listed on China's A-share
market was zero percent - they were falling in inflation-adjusted terms.
Consequently, both private and state-owned companies starting reining in
investments. In the first five months of 2013, growth in fixed assets
investment was 0.2 percent lower than growth in the first four months,
and private investment growth was 0.1 percent less than it had been a
year before.

This, in turn, led to economic slowdown. GDP growth fell from 7.9
percent in the last quarter of 2012 to 7.7 percent in the first quarter
of 2013, placing greater pressure on profits. Profits were then squeezed
further by the rise in the RMB exchange rate, which created difficulties
for China's exporters.

This inevitably affected credit markets. With profit growth slowing, and
in some cases, becoming negative, companies needed credits to plug holes
in cash flows. Simultaneously, as companies were using cash to plug
payment holes and not to invest, credit became less effective at
stimulating growth. Given that profits were squeezed in most sectors,
companies diverted what resources they could into markets which were
more profitable - most notably, real estate, fuelling price increases in
this sector. The pressure on company profitability therefore expressed
itself via ballooning demand for credit, ineffectualness of credit in
accelerating growth and excess upward pressure on real estate prices.

To attempt to stop ballooning credit, the Central Bank tightened
liquidity. But this tackled symptoms, not the disease - rather like
treating chicken pox by pressing on the spots. The disease was therefore
not cured. Indeed the situation worsened as companies' cash flows were
now squeezed from two directions - from the fundamental processes
described above and by the Central Bank's liquidity tightening. If this
dual pressure had continued, there would have been a financial collapse.
Therefore, the Central Bank had to alter course and inject credits.

By supplying liquidity, the Central Bank took pressure off companies
from one side, thereby overcoming the immediate crisis. But the
underlying cause of the problem will not be overcome until the company
profits squeeze is fully reversed.

Finally, while a crisis would have occurred anyway, it was worsened by
the incomplete structure of China's banking system. China, like every
country, must possess a core of system making banks that are "too big to
fail." Such huge banks will never be adequately responsive to small
companies' needs, however. In the U.K., which has a private dominated
banking system, there are endless complaints by smaller companies about
large banks! China has not yet created an adequate system of "small
enough to fail" banks, which are responsive to smaller companies, around
its large core lenders. Instead, an insufficiently regulated shadow
banking system developed.

But the same fundamental factors that made it possible to accurately
predict rapid growth of China's economy for 35 years show it is
relatively easy for China to overcome these problems, as they are
self-inflicted policy problems, not objective constraints.

In 2012, under the influence of the World Bank report on China, similar
policies were pursued in the first half of the year. They also led to a
growth slowdown. When this policy was reversed in mid-2012, with an
investment stimulus, growth accelerated from 7.4 percent to 7.9 percent.
In 2013, unfortunately, the wrong policy was pursued for longer and
therefore led to June's crisis.

Lin Yifu, former senior vice president of the World Bank, recently
stated: "Those who advocate that China's economy should rely on
consumption are, in fact, pushing the country into a crisis."
Regrettably, June's events confirmed these words.

Large forces in China are working against the errors that led to the
June crisis. Companies do not want profits pressured. Slower economic
growth will lead to less rapid increase in living standards, creating
dissatisfaction among consumers. As June's events in China's financial
market were a liquidity crisis, not one of solvency, and China's banks
remain highly profitable with assets far outweighing liabilities, no
systemic damage has been done to China's banking system. June's events
simply demonstrated that even in a country with China's very strong
macroeconomic fundamentals, an incoherent theory can wreak havoc. A
non-sequitur like "consumer led growth," which necessarily applies a
profit squeeze to companies, inevitably leads to economic crisis.

June's credit market explosions were simply the market economy reminding
everyone that, within it, there can never be "consumer led growth." Only
"profit led growth" is possible.

Hopefully the appropriate lessons have been drawn. *   *   *

An earlier version of this article appeared at China.org.cn.

(5) China's Premier endorses Rebalancing (higher wages, shift from
exports to internal consumption)


Chinese premier highlights economic restructuring

Ding Qingfen

China Daily

Publication Date : 17-07-2013

Chinese Premier Li Keqiang pledged on Tuesday to push ahead with
economic restructuring while maintaining stable growth.

"We should not shift our policy orientation just because of temporary
changes in economic indicators," he said at a meeting with economists
and corporate leaders.

He made the remarks as figures show the economy is growing at its
slowest pace in a decade.

Economic restructuring is aimed at turning export- and investment-led
growth into growth driven by domestic consumption.

The National Bureau of Statistics said on Monday the economy expanded by
only 7.5 per cent in the second quarter, down from 7.7 per cent in the
first - a far cry from nearly double-digit growth two years ago.

Li said the economy has entered a new stage of development that
prioritises restructuring and technological upgrading.

The focus of macroeconomic control is to avoid big swings in the economy
and to keep growth within a reasonable range through stable growth,
adequate employment and low inflation, he said.

Li said China is capable of achieving its growth target of 7.5 per cent
this year without a massive stimulus program similar to the one launched
during the 2008-09 global financial crisis.

The Central Economic Work Conference late last year set a goal for
inflation this year of 3.5 per cent, with a registered urban
unemployment rate of below 4.6 per cent.

"We are confident and capable of accomplishing the tasks given the
current conditions," Li said, adding that it will require painstaking

Small policy adjustments can be made if growth is considered too slow or
sliding toward the government's acceptable limit, the premier said,
adding there are plenty of options.

In view of slowing economic growth, economists at home and abroad have
been speculating on whether China will take immediate measures to
stimulate the economy.

But Li said the nation can tolerate the current economic growth rate and
should improve the quality of growth.

He has been pushing for economic restructuring since taking office,
which some economists say suggests the government is not in a hurry to
launch fresh stimulus measures to revive an economy in a protracted

Li said the economy is facing unprecedented complications, with the
global economic recovery "twisted".

China should rely more on a structural transformation and technology
upgrade, allowing the market to play a full role, focusing on innovation
and improving people's livelihoods in an attempt to sustain stable and
healthy economic growth in the long term, he said.

During the meeting, Li also called for high vigilance against the
economy deteriorating beyond the acceptable limit.

According to the General Administration of Customs, China's exports fell
3.1 per cent in June, the most since October 2009, while imports dipped
0.7 per cent.

The agency predicts grim prospects for the third quarter.

Long Guoqiang, director of foreign economic relations at the State
Council Development Research Center, said, "There will be negative
growth in exports in the second half of this year", because of slackened
global demand, increased costs and a rising yuan.

Zhang Yuyan, a senior researcher with the Chinese Academy of Social
Sciences, said economic growth is slowing but still remains at a
reasonable level.

"A 7 per cent growth rate is acceptable," Zhang said.

(6) City complains because China will not let its banks fail. They are
state-owned; it will print money & prop them up


Chinese banking: a Wild West in the Far East?

China’s banks are now the biggest in the world but fears are growing
they are very unstable, writes Harry Wilson.

By Harry Wilson 8:00PM BST 06 Jul 2013

As Government ministers ponder whether to split Royal Bank of Scotland
into a “good bank” and a “bad bank”, it is worth remembering that China
did something similar with not one big lender, but four at the turn of
the millennium.

In October 1999, a month before Fred Goodwin began his ill-fated reign
as chief executive of RBS, the Chinese government created four massive
“asset management companies” that would eventually take on toxic loans
valued at $480bn (£320bn).

Thirteen years on, these bad banks still exist, operating out of office
blocks dotted around Beijing and Hong Kong, and continue to hold
non-performing loans worth Rmb1.7 trillion (£180bn), according to credit
rating agency Moody’s.

Largely unknown to the outside world, they are a reminder that China’s
banking system remains as prone to boom and bust as any Western economy
and perhaps more so.

As the rescue showed, the “Big Four” banks were, and are, not just “too
big to fail”, but the beating heart of the entire Chinese economic
system, controlling nearly half the country’s $19 trillion of financial

Taken together, the four largest lenders, Industrial and Commercial Bank
of China (ICBC), China Construction Bank, Agricultural Bank of China and
Bank of China have a combined market capitalisation of £470bn, about
£200bn more than the total value of Britain’s five largest lenders.

ICBC alone has 393m individual customers, the equivalent of a single
bank managing the bank accounts of every man, woman and child in western
Europe, and this year became the first Chinese lender to top The Banker
magazine’s annual table of the world’s biggest banks by market value,
with a total capitalisation of $236bn. Ranking the world’s banks by
profits made, the top four positions are now taken by China’s behemoths.
Hold on everyone, the Chinese are not coming, they have arrived.

Despite paying negative savings rates — the 3.5pc base rate interest on
Chinese deposit accounts is generally believed to be well below the real
rate of inflation — 70pc of Chinese household wealth is held in cash and
bank deposits. Just over a third of India’s private wealth is kept in
its banking system.

With this largely captive market, citizens’ savings have been used to
fund an infrastructure and property boom on an unprecedented scale and
led to warnings of an asset bubble.

While official figures show a 113pc increase in property prices in the
past eight years, research by Tsinghua University and the National
University of Singapore found prices actually rose by 250pc between 2004
and 2009, a faster increase than was experienced by the US in the lead
to the sub-prime crisis.

Carson Block, of Muddy Waters Research, which has laid bare several
accounting scandals in Chinese companies, thinks the problems in China’s
banking system are more severe than those which kick-started the global
crash in 2008. “We believe that the domestic Chinese banking system is a
mess, with an enormous amount of bad loans, or loans waiting to go bad.
The problems of China’s lenders are greater than those of Western banks
on the eve of the financial crisis,” he says.

So, as Chinese lenders take their place at the pinnacle of the world’s
banking system, the warning appears to be that things could be about to
go very wrong, very quickly.

The risks to the banks come largely from three areas: loans to local
governments, loans to property developers, and the shadow banking system.

As of last September, about 14pc of all Chinese bank loans, or Rmb9.3
trillion of debt, was accounted for by local governments. In large part,
this money has been used to finance a vast infrastructure spending
spree. While detailed information on local government finances is not
available, analysts at Nomura believe that much of this investment is
unprofitable and is only being financed through land sales, which have
stalled in the past two years, and the sale of new debt to repay
existing loans.

This process is reaching its limit and local government financing
vehicles will need to find Rmb1.8 trillion (£197 billion) this year just
to repay their existing debt, according to Nomura — an amount greater
than the total amount of urban construction bonds sold in 2012.

Banks also have a direct exposure to property developer loans of Rmb3.9
  trillion (£426 bn), giving rise to fears of new non-performing loans
as developers struggle to find buyers for their latest projects amid a
downturn in demand.#

Most worrying of all is the shadow banking sector. This amorphous
network of trust companies, credit guarantee companies and “wealth
management products” has ballooned in the past five years as the central
government has sought to limit the major banks’ lending at the same time
as it has attempted to sustain economic growth with a series of stimulus

Back in 2008, the assets managed by trust companies stood at just Rmb1.2
  trillion (£130 bn). However, by the end of last year this had grown to
Rmb7  trillion, with trusts overtaking the Chinese insurance and mutual
fund sectors in terms of the total funds placed with them.

Though Chinese savers might be wary of the trusts, the attraction of a
higher interest rate and the perceived backing of the state has helped
put the sector in a position to fill the space left by banks. Last year,
50pc of all new credit in China was provided by these shadow banks,
according to Bestinvest.

“The authorities have placed increasing restrictions on the mainstream
lenders in order to improve capital ratios and stave off further debt
delinquency. Despite this, the central government continues to target a
long-term growth rate of 7.5pc, effectively driving local governments
and private companies alike into the hands of the shadow banking system
to provide the necessary funding,” said the fund manager in a recent
letter to clients.

One of the greatest problems created by the increased reliance on shadow
banks is the maturity mismatch. While most infrastructure and property
investments are financed over three to five years, products sold by the
shadow banks generally have a maturity of less than one year and often
as little as three months. This has effectively created what Bestinvest
describes as a nationwide “Ponzi scheme”, whereby existing investors’
returns are paid for from the influx of money gathered from new depositors.

The funding mismatch has echoes of the problems which brought down
British lenders, such as Northern Rock and HBOS, where short-term
wholesale funding was used to finance an aggressive expansion in lending
that led to disaster as lending markets shut in the wake of the credit
crunch and the collapse of Lehman Brothers.

Charlene Chu, a credit analyst at Moody’s in Singapore, has been one of
the most vociferous critics of this system, and last year the credit
agency cut China’s rating from AA- to A-, largely on fears about the
potential cost of bailing out trust company depositors if the market

Chu pointed out that in the last 10 days of June alone Rmb1.5 trillion
(£164  bn) of wealth management products were due to mature,
highlighting the scale of the “maturity wall” faced by the shadow banks.

“It is a Wild West atmosphere in many respects and that is one of the
reasons why we are so worried,” Chu said of China’s shadow banking
sector at a conference in Frankfurt last month.

Trusts have frequently failed in the past and the size of the industry
today is several orders of magnitude larger. The risks are clear.

Among the largest sellers of these products have been mid-tier Chinese
lenders. The aptly-named Evergrowing Bank had nearly 350 separate wealth
management products outstanding as of the end of June and the 15 largest
non-rated sellers of the schemes accounted for about half the 3,500
products in existence.

Another potentially worrying sign for the banks has been the increase in
pay. Though still well below the amounts paid out on Wall Street or in
the City, Chinese financial services sector employees are better paid
than workers in any other profession or industry.

Over the past nine years, banking and insurance industry wages have
grown by a compound annual average of 17.7pc, according to Credit
Suisse. At the Big Four banks, the rise has been even more pronounced
with average salaries increasing by 70pc in the past five years to
Rmb156,000 (£17,000).

As the banking industry’s problems have become clearer, the banks
themselves are on the cusp of becoming less transparent. After opening
up about the state of their finances over the past decade, rule changes
are likely to make the Chinese banks more opaque again.

Carl Walter and Fraser Howie, the co-authors of Red Capitalism and both
financiers with decades of experience in China, pointed out in the Wall
Street Journal last week that from 2017 onwards no Chinese bank will be
audited by an international accountancy firm. “The fact is that no
purely local firm has the experience required to audit some of the
largest and most important banks in the world,” they wrote.

The bankers pointed out that the first-ever professional audit of China
Construction Bank, the country’s second largest lender, took more than
1.2m man-hours.

The fear is that with non-performing loans at risk of imploding, the
rule changes will not just make it easier for lenders to hide their
problems, but also it is effectively an officially-sanctioned accounting

“The accounting rules will send China’s financial reform process back to
the 1980s — all in the name of creating Ministry of Finance-sponsored
'national champion’ auditors. This is not a sound financial policy,”
Walter and Howie said.

With little external investment in China’s banking system, its problems
may seem of minimal interest to the global economy. However, any
bail-out of a major Chinese lender will be bad news for the rest of the

It is true that unlike their Western rivals, Chinese banks have lower
global salience, given their size, in the global capital markets. This
is in part down to the fact that on average 86pc of the shares in the
big four Chinese banks are held by the state, and also a reflection of
their infrequent use of the international debt markets where total sales
of debt by Chinese lenders since 2007 totalled under $8bn (£5.4bn) — one
tenth the amount sold by Russian banks.

However, if the banks and the wider financial system were to require a
rescue package it could set in train a process that would cause chaos
around the world.

“Because they are state-owned, the government will most likely print
money and prop them up. This will of course have dire consequences for
China’s economy,” says Block.

“Everyone goes on about the size of China’s reserves, but this will
count for very little if they have to mount a rescue of their domestic
banking system as most of these assets are denominated in dollars. What
people don’t seem to realise is that funds are pretty much useless for
this job,” says one senior portfolio manager at a major international bank.

This is not the only problem China will face. Compared with 2000 — the
time of the last bank bail-out — the economic and demographic backdrop
in 2013 is less forgiving. Thirteen years ago a series of aggressive
reforms, combined with entry to the World Trade Organisation and the
mass migration of hundreds of millions of people from the country’s
interior to booming coastal regions, helped the Chinese economy recover.
Today, such routes to growth are no longer open to China, while its
working age population has begun to shrink for the first time in two
decades. This has heralded the end of the huge pool of cheap labour.

How to deal with the banking sector’s problem is likely to create a
civil war among the Chinese financial establishment, with the Ministry
of Finance and the China Investment Corporation, the national sovereign
wealth fund, expected to push for increased support for lenders, against
the more hawkish People’s Bank of China (PBoC), the country’s central
bank, and the China Banking Regulatory Commission.

“The PBoC will want commercial banks to recognise non-performing loans
on their balance sheets in order to inject more transparency into the
financial system and assuage the perception of widening risk. But
commercial banks and their owners will push back against such efforts
citing the risk of capital flight and weaker assets bases,” says
Nicholas Consonery, a senior Asian analyst at Eurasia Group.

Problems in the Chinese banking industry could put it into competition
with Asian rivals. The Bank of China is already preparing plans to
hoover up more offshore deposits and is expected to increase interest
rates on its Taiwanese savings accounts.

This mirrors the short-lived war between banks in Britain and Ireland in
2008, following the Irish government’s offer of a full guarantee on all
bank deposits.

Given regional tensions, any suggestion that Chinese banks were
attempting to grab more foreign deposits to shore up their domestic
financial system would be inflammatory.

The hope remains that the Chinese authorities have spotted the dangers
early and will be able to manage the slowdown of the economy without
precipitating a crisis. However, given the repeated boom and busts of
the past 30 years, it seems likely that today’s highpoint will be seen
in hindsight as the ultimate warning signal of a coming crash.

(7) Barry Eichengreen: Fed causes panic with talk of ending QE; PBOC
over-reacts to credit bubble


A Tale Of Two Tapers


Barry Eichengreen

The United States Federal Reserve and the People’s Bank of China are not
typically seen as two peas in a pod. But they have had similar
experiences in recent weeks – and neither has been a pleasant one.

The Fed’s bout of indigestion started with Chairman Ben Bernanke’s June
19 press conference, where he warned that the Fed’s purchases of
long-term securities might start to taper off if the economy continued
to perform well – specifically, if unemployment fell to 7%. Stock prices
swooned. Yields on US Treasuries spiked. Emerging-market currencies
weakened on fears that capital flows from the US would reverse direction.

Indeed, the reaction was so extreme and alarming that a parade of Fed
officials felt compelled to clarify. To say that the Fed’s policy of
“quantitative easing” might taper off, they explained, was different
from saying that it would be halted. When and how purchases of long-term
securities were reduced would depend on incoming data. In particular,
there was no guarantee that 7% unemployment would be reached before the
end of the year.

By coincidence, June 19 was the same day that the People’s Bank of China
decided not to provide additional liquidity to the country’s strained
credit markets. The interest rate that Chinese banks charge one another
for short-term loans had begun rising two weeks earlier on rumors that
two medium-size banks had defaulted on their debts. The interbank rate
went from 5% to nearly 7%. Investors expected that the PBOC would step
in, as always, to prevent rates from rising further and slowing the
economy’s growth.

Instead, the PBOC stood pat. Officials worried that banks had been
lending too freely to property developers and large state-owned
enterprises (which in many cases are one and the same). They were
concerned that the banks, through their wealth-management arms, were
borrowing excessively on the overnight market to finance high-risk

In China, too, market reaction was violent. The Shanghai Composite, the
country’s main stock index, tanked. Interbank rates shot up to 25%,
raising deep concern about the stability of the financial system.

This was not what Chinese officials expected. Like their Fed colleagues,
they found it necessary to clarify and backtrack. They reassured
investors that they would “guide market interest rates into a reasonable
range,” and backed their statements with credit injections.

Neither experience enhanced the reputation of the central bank in
question. Though June 19 may not “be a date which will live in infamy,”
few central bankers will remember it fondly.

But central bankers, like the rest of us, should learn from their
mistakes. What are the lessons of this one?

First, the June 19 episode reminds us that central banks’ communications
strategies remain works in progress. The Fed has repeatedly sought to
explain its policies better. But, if a few relatively anodyne words can
spark such a powerful reaction, then investors evidently remain
uncertain, if not confused, about the Fed’s intentions.

The PBOC performed even worse, having done nothing to prepare the
markets for its new anti-speculation strategy. The Chinese authorities
are seeking to develop the renminbi into a first-class international
currency. But China’s June 19 episode is a reminder that the PBOC in
particular and Chinese policy-making institutions in general have a long
way to go before they succeed in instilling the necessary confidence in
both the renminbi and themselves.

A second lesson is that central banks are wise not to overreact to the
latest bit of news. The Fed’s statements suggesting an end to
quantitative easing appear to have been grounded in very recent evidence
that the economy was improving. Now that the markets have reacted
adversely, some investors have begun to worry that, as a result, the
economy is doing worse. The Fed should wait for more – much more – data
to come in before adjusting either its policy or its rhetoric.

The PBOC, similarly, seems to have overreacted to data indicating a bank
credit boom. In fact, some of this supposed evidence was misleading,
because it reflected nothing more than a change in regulatory standards
that had brought hidden loans to the surface. The PBOC would have been
wise to wait for more data, so that it could distinguish the trend from
the accounting glitch.

A final lesson is that monetary policy is a blunt instrument for
addressing asset-market problems. In the absence of inflation, it was
mainly warnings about new asset bubbles that pressured the Fed to
curtail its purchases of long-term securities. Similarly, worries about
property prices drove the PBOC’s abrupt change of course.

Bubbles should be a concern, but the June 19 episode in the US and China
reminds us that addressing them is first and foremost the responsibility
of regulators. Central bankers cannot afford to ignore them, but they
should be wary of reacting too soon. In the meantime, they have bigger
fish to fry.

© Project Syndicate

(8) Red Capitalism: The Fragile Financial Foundation of China's
Extraordinary Rise


by Carl E. Walter  (Author) , Fraser J. T. Howie (Author)

In Red Capitalism, Carl Walter and Fraser Howie detail how the Chinese
government reformed and modeled its financial system in the 30 years
since it began its policy of engagement with the west. Instead of a
stable series of policies producing steady growth, China's financial
sector has boomed and gone bust with regularity in each decade. The
latest decade is little different. Chinese banks have become objects of
political struggle while they totter under balance sheets bloated by the
excessive state-directed lending and bond issuance of 2009.

Looking forward, the government's response to the global financial
crisis has created a banking system the stability of which can be
maintained only behind the walls of a non-convertible currency, a myriad
of off-balance sheet arrangements with non-public state entities and the
strong support of its best borrowers--the politically potent National
Champions--who are the greatest beneficiaries of the financial status quo.

China's financial system is not a model for the west and, indeed, is not
a sustainable arrangement for China itself as it seeks increasingly to
assert its influence internationally. This is not a story of impending
collapse, but of frustrated reforms that suggests that any full opening
and meaningful reform of the financial sector is not, indeed cannot be,
on the government's agenda anytime soon.

(9) China banks abandon Western accounting firms, auditors


July 1, 2013, 1:01 p.m. ET

Beijing's Financial 'Reform' that Wasn't

New rules that help Chinese accounting firms win state bank contracts
have made corporate law meaningless.


Chinese central bankers' slow response to the recent interbank credit
crunch struck many as a change of course after five years of
freewheeling lending. Here too, perhaps, was a preview of new Premier Li
Keqiang's plans for financial reform: less tolerance for bad loans and
bailouts, and more emphasis on economic fundamentals and accountability.

Nice as that would be, optimists should temper their expectations.
Rather than speculate too wildly about future policies, they should
consider one so-called "financial reform" already underway—the Chinese
government's dangerous meddling with its bank auditing system.

China's major state banks are currently audited by joint partnerships
between the Big Four Western international accounting firms and local
Chinese firms. Since 1998 these partnerships have enabled the
restructuring and public offerings of banks once regarded by the Chinese
government as nearly unfixable. This has not been an easy task. The
first-ever professional audit of China Construction Bank, for instance,
required more than 1.2 million man-hours.

For all the help they have given China—and despite their state-mandated
conversion in 2017 to majority local ownership—the Big Four partnerships
nevertheless appear to be on the outs with Beijing's financial stewards.
That's bad news for those who believe that independent, responsible
auditing based on global standards of banks' books is a first step to
better Chinese corporate governance.

In 2010, China's Ministry of Finance issued bank auditing regulations
that are seemingly designed to unfairly promote the interests of
less-experienced—and more easily influenced—local accounting firms. At
almost the same time, the Stock Exchange of Hong Kong amended its rules
to allow purely Chinese auditors, as selected by China's Ministry of
Finance and Securities Regulatory Commission, to audit listed Chinese

One effect of the 2010 rule change is that many Chinese banks will soon
need to choose a new auditor. The banking measures specify that
consecutive engagements between accounting firms and Chinese banks shall
not exceed five years. Three out of China's four major state banks will
need a new auditor next year.

Although not explicitly stated by law, it is also understood (in an
informal understanding between banks and audit firms and perhaps the
Ministry of Finance itself) that the major banks each require a
dedicated auditor. In other words, a single firm can audit only one of
China's four major banks.

When these banks select a new auditor in the coming years, it is
entirely possible that a purely Chinese accounting firm will win. That's
because the 2010 rules don't simply prod Chinese banks to start shopping
for a new auditor. They also give banks regulatory cover to hire
less-reputable accounting firms willing to overlook bad balance sheets.

For one thing, the task of selecting the best three bids for a bank's
auditing business now falls to a panel including unspecified outside
"experts" appointed by each bank. What's more, these panels are directed
by law to choose final bids according to selection criteria that
prioritize bid price and auditing staff size over professional ethics,
quality control and qualifications. By overweighting cost, these
criteria falsely equate local accounting firms with the "Big Four" joint

The fact is that no purely local firm has the experience required to
audit some of the largest and most important banks in the world.
Similarly unprepared are local firms who have partnered with obscure
international auditors in order to acquire a veneer of respectability.

Together, the Chinese government's regulatory changes represent the end
of its 15-year efforts to raise the standards of Chinese banks to
international levels. Nothing good can come from having banks' boards of
directors relinquish authority over auditors to an unaccountable bidding

In the future, bank management will not only face interference from
their bank's internal communist party committees. The Chinese Ministry
of Finance bureaucracy will also get a chance to assert its will. By
creating the outside bidding committees and marginalizing banks' boards,
the ministry has rendered Chinese corporate law and corporate governance
meaningless. This is purely a power play by the ministry to sponsor
home-grown, favored accounting forms.

The accounting rules will send China's financial reform process back to
the 1980s—all in the name of creating Ministry of Finance-sponsored
"national champion" auditors. This is not sound financial policy. It's a
bid for political achievement by bureaucrats who think that if China's
banks can be seen as global winners, so too should China's nascent audit

The question before Li Keqiang is whether he wants to know the true
extent of the difficulties facing China's state banks, or whether he
believes that their political power should trump financial
accountability. Though positioned as reforms, the Finance Ministry's
auditing rules provide banks with the means to obscure balance sheets
from the prying eyes of Chinese and foreigners alike. They must be reversed.

Messrs. Walter and Howie are the authors of "Red Capitalism: The Fragile
Financial Foundation of China's Extraordinary Rise" (Wiley).

(10) China-Pakistan economic corridor connects Kashgar (Xinjiang) to
Gwadar (Arabian Sea)


China, Pakistan ink transport pact

Li Xiaokun and Zhang Yunbi

China Daily

Publication Date : 06-07-2013

China and Pakistan signed an agreement on Friday on the blueprint for a
huge transport project linking northwestern China to the Arabian Sea.

Observers said the project, named the "China-Pakistan economic
corridor", will open a new route for China's goods and energy.

It will also give a strong boost to Pakistan's economy and help maintain
security there, they said.

The broad agreement was among eight pacts signed after a meeting at the
Great Hall of the People between Premier Li Keqiang and Pakistani Prime
Minister Nawaz Sharif.

The cost of the economic corridor project is not known at this stage.

"Our two countries can closely link China's Western Development Strategy
with Pakistan's development strategy of reviving its economy," Li told
Sharif at their meeting.

"This will also deepen regional cooperation in South Asia and benefit
people of the two countries and the region."

The transport link is described as a "long-term plan" to connect Kashgar
in the Xinjiang Uygur autonomous region to the southwestern Pakistani
port of Gwadar, more than 2,000 km away across a mountainous area.

Sharif said before the visit that he would focus on economic topics
during his trip, with the corridor topping the agenda. He told Chinese
reporters the corridor will "change the fate" of the region.

"Now that the management of Gwadar (port operations) has been handed
over to China, we expect that Gwadar is ready to become a very important
economic hub and an important Arabian Sea port," he said.

China Overseas Holding Ltd took over operational control of Pakistan's
important Gwadar deep-water port from Singapore's PSA International
earlier this year. Gwadar is close to the Pakistan-Iran border and the
Strait of Hormuz, through which much of the Gulf region's oil exports
are bound by ship for overseas markets.

Sharif said the economic corridor will boost bilateral trade
considerably and offer opportunities for businesses in both countries.

In talks with Sharif on Thursday, President Xi Jinping referred to his
guest as "an old friend and a good brother". He said strengthening
strategic cooperation with Islamabad is a priority for Beijing's foreign

Wen Fude, vice president of the Chinese Association for South Asian
Studies, said the corridor will provide another strategic choice for
China's transport sector.

It will also stimulate infrastructure construction in Pakistan, Wen
said, adding that increased bilateral trade brought by the corridor will
help Islamabad to cut its huge trade deficit with Beijing.

"Beijing is helping Pakistan to produce blood by itself, instead of
donating blood through assistance," Wen said.

Another agreement signed on Friday covers the laying of a fibre optic
cable from the Chinese border into Pakistan that will boost Pakistan's
access to international communications networks.

Sharif, previously elected prime minister in 1990 and 1997, has been a
frequent visitor to China and believes China is Pakistan's "most
reliable friend".

He is making the first stop on his first foreign trip since being
elected in May. Sharif met Li during Li's visit to Pakistan in late May,
before Sharif was formally sworn in.

At the start of his meeting with Li on Friday, Sharif said the warm
welcome he received reminded him of the saying "Our friendship is higher
than the Himalayas and deeper than the deepest sea in the world, and
sweeter than honey."

Li and Sharif agreed to upgrade the China-Pakistan free trade area and
deepen anti-terror cooperation.

Sharif promised that Pakistan will do its best to protect Chinese
citizens in the country. Two Chinese were killed in
Pakistan-administered Kashmir by Taliban terrorists on June 23.

The prime minister enjoyed a subway trip in Beijing on Thursday
afternoon and he planned to take a bullet train to Shanghai on Friday.

He told China Daily that he is "very much looking forward to"
introducing Chinese trains to his country.

The main objective of the ride is to explore the possibility of having
similar high-speed trains in Pakistan, he said.

"It is going to be a tremendous experience," he said.

He is also scheduled to meet the leaders of many major Chinese
enterprises, especially in the infrastructure construction and energy

Hu Shisheng, a researcher on South Asian studies at the China Institutes
of Contemporary International Relations, said infrastructure
construction and energy scarcity are the two biggest problems for
Pakistan's economy.

"China and Pakistan have enjoyed very strong political and military
ties. Now they are building up in the economic field," Hu said, adding
that economic issues are the theme of Sharif's political agenda.

AP and Pakistan Press International contributed to this story.

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