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China industrial growth fastest in almost two years.

China industrial growth fastest in almost two years.

China has reported the fastest monthly expansion of industrial output in almost two years of 6.6% in November, while retail sales grew 10.1%, as the world’s second-largest economy looks to continue its patchy recovery from the pandemic.


The People's Bank of China (PBoC) also announced no change to rates, in line with market expectations, while injecting RMB 1.45 trillion of funds, which was well ahead of market expectations.


According to the latest figures released by the National Bureau of Statistics, November's industrial output surpassed the 5.6% consensus forecast and was up from October's 4.6% rise.



On the retail front, November sales growth was up from October's 7.6% rise and the quickest pace since May but short of an anticipated 12.5% surge.


Analysts had projected a more significant increase, given the low base effect from 2022 when China grappled with stringent zero-Covid policies.


A year ago, China was still being ravaged by the effects of its zero-Covid exit strategy, which provides a low base for comparison. 


"China’s economy remains at a low ebb, despite headline improvement in industrial output," said Duncan Wrigley, chief China economist at Pantheon Macroeconomics.  


He said the headline rise in industrial output growth was due to base effects and utilities output, with manufacturing output pretty steady.


Retail sales growth was disappointing, he said, indicating fading consumption demand as winter approaches.


Fixed asset investment data was "steady", though, he said, "buttressed by policy-supported manufacturing and infrastructure investment, though dire residential construction figures showed a tiny improvement, thanks to rising completions". 


New home price declines were also steady, he noted, but existing home price falls are steepening, in a sign of market adjustment.  


On the PBoC, he said it "probably means the Bank has decided to provide funding to accommodate rapid government bond issuance via MLF [medium-term lending facility] rather than an RRR [reserve requirement ratio] cut", providing a "somewhat lesser signalling effect to the market".  


He added: "Falling global yields mean China theoretically has more room to ease monetary policy, but the impact of rate cuts would be limited given the troubled property sector. The CEWC [Central Economic Work Conference] confirms that policymakers have prioritised restructuring the economy towards high-end manufacturing and innovation, and away from debt-heavy sectors like property. The property sector is showing marginal improvement and indications are that policy will continue to be be stepped up only incrementally, notably on the developer funding side. This means private consumption is likely to remain fairly sluggish in H1, and China will continue to issue dollops of fiscal support to prop up activity."


Source: Oliver Haill, Proactive Investors


China Monetary Policy: support for a...

China Monetary Policy: support for a slowing economy.

China's top parliament body has approved a 1 trillion yuan ($137 billion) sovereign bond issue and passed a bill to allow local governments to frontload part of their 2024 bond quotas in a move to support the economy. Funds raised from the new sovereign bonds will support the rebuilding of disaster-hit areas in the country and improve urban drainage prevention infrastructure to boost China's ability to withstand natural disasters, state news agency Xinhua said.


That will widen the country's 2023 budget deficit to around 3.8% of gross domestic product from a previously set 3%. Local governments had been told to complete the issuance of the 2023 quota of 3.8 trillion yuan in special local bonds by September to fund infrastructure projects. The government has not disclosed the size of local governments' 2024 frontloaded bond quotas.



The aim is to drive more domestic spending and “further cement the recovery momentum of the Chinese economy,” the official Xinhua News Agency quoted Zhu Zhongming, a vice minister of finance as saying. “This decision suggests a commitment to supporting economic growth and addressing fiscal challenges at various levels of government. It also hints at a potential future shift in China’s fiscal approach.” Chinese state media said the 1 trillion yuan in central government issuance is set to be transferred to local governments in two parts, half for this year and half for next year.


However, officials said the funds would not be channeled into China's ailing property sector, which has weighed heavily on growth as developers struggled to meet repayment obligations for massive debts while demand has weakened.


Property market drag

S&P Global Ratings said in a separate report Monday that if real estate sales drop dramatically next year, real gross domestic product growth will fall to 2.9% in 2024. The firm currently predicts a more modest 5% decline in property sales next year — after an anticipated 10% to 15% drop this year.


After easing a crackdown on property developers’ high reliance on debt for growth, Beijing has focused on ensuring the delivery of apartments, which are typically sold ahead of completion in China.


About 80% of residential sales in 2023 were of homes still under construction, S&P Global Ratings said in a report this month. China’s property slump is closely tied to local government finances. According to [People’s Bank of China] data, the central government’s outstanding debt is currently about RMB27trn, while we estimate local governments owe an exceptional balance of RMB87trn, including both explicit and hidden debt.


The world's second-largest economy grew faster than expected in the third quarter, improving the chances that Beijing can meet its growth target of around 5% for 2023. But economists say persistent drag from the property sector still weighs on the economic outlook. The property market collapse and the continued contraction in land sales revenue has exacerbated debt pressures on local governments, which has prompted Beijing to roll out a raft of measures to reduce the debt risks of local governments.


It is rare for the central governments fiscal plans to be revised outside the usual budget cycle, so this move signals clear concern about near-term growth. China has previously let local governments issue bonds ahead of the annual session of parliament, which approves government budget plans and is usually held in March.


The International Monetary Fund this month also cut its forecast for China’s growth in 2024 to 4.2%.




BOC rate cut, economic challenges &...

BOC rate cut, economic challenges & data transparency.

In a largely unexpected move, China cut a benchmark interest rate yesterday, marking the most significant rate cut since 2020. The news came not long after the release of disappointing retail sales and industrial production numbers, combined with rising fears around the weakness of China’s broader economy.


The Chinese central bank reduced the rate on its one-year medium-term lending facility loans by 15 basis points to 2.50%. The rate cut was mirrored by a dip in the yuan and bond yields.



Shaky property sector influences wider economy

Further to the less-than-stellar economic figures, the risk of contagion from a debt crisis in the property sector has sent ripples through global markets.


For instance, the revelation that property developer Country Garden Holdings teetered on the edge of default, coupled with the inability of wealth manager Zhongzhi to make certain client payments, sent the Australian dollar and iron ore prices into a tumble.


Nomura China economist Ting Lu described the potential fallout, stating, “The chain reaction triggered by slumping new home sales may lead to a rising number of developers’ defaults, a sharp contraction of government revenue, falling demand for construction materials, declining wages of employees in both the property and government sector, weaker consumption and faltering financial institutions.”


The troubles in the property sector, a significant contributor to China's economic engine, haven't gone unnoticed by global investors. Property investment dipped by 8.5% year-on-year in the January-July period, marking 17 consecutive months of decline.


Economic indicators signal caution

Hit by deflation, amongst a slew of other problems, the latest round of economic data further underscores the challenges China faces, including foreign investment plummeting to levels not seen since 1998. 


Retail sales did see an uptick of 2.5% year on year in July but it lagged behind the projected 4% growth. Industrial production figures also disappointed with a growth rate of 3.7%, down from June's 4.4%. The unemployment rate also marginally increased.


Interestingly, amidst these challenges, China has expressed intentions to relax tariffs and restrictions on pivotal Australian exports. This has sparked discussions about Australia's Beijing trade dependence. With President Xi Jinping’s government exhibiting unpredictable policy shifts, China appears to be a riskier trade partner than a decade ago.


Yet, in a bid to reinvigorate foreign investment, China’s State Council has introduced 24 guidelines to improve foreign investment conditions, with an emphasis on bolstering intellectual property rights.


Despite these efforts, the consensus among economists is that rate cuts and foreign investment initiatives might not suffice to stabilise the economy. Julian Evans-Pritchard from Capital Economics voiced this sentiment, saying monetary stimulus might be insufficient to establish a growth foundation.


This sentiment was echoed by the National Australia Bank (NAB), which suggested that China might fall short of its annual growth target of approximately 5%. The NAB maintained its projection of 5.2% growth for 2023, however.


Concerns over data transparency

While China's economic data has been a guiding tool for global investors, the recent decision to withhold youth unemployment statistics has caused some unease. Gerard Burg from NAB remarked on the lukewarm loan demand, hinting that any modest rate cut by the PBoC may not significantly boost the economy.


Ting Lu from Nomura added, “The declining availability of macro data may further weaken global investors’ confidence in China and impair Beijing’s ability in assessing the real situation of the Chinese economy.”


In addition to the release of the economic data and the rate cut, China also declared it would momentarily halt the publication of youth unemployment statistics. That decision has only increased speculation that youth unemployment now exceeds the last reported figures of 20%.


However, China's National Bureau of Statistics clarified that the jobless rate for the 16-24 age bracket wouldn't be released from August onward until improved surveying methodologies were in place. This means the awaited data for July will remain undisclosed for now.


With such multi-dimensional challenges facing the world's second-largest economy, the coming months will be pivotal in assessing China's economic resilience and adaptability.



China Begins Nationwide Push to Reveal...

China Begins Nationwide Push to Reveal Hidden Government Debt.

China has begun a fresh round of nationwide inspections to work out how much money local governments’ owe, according to people familiar with the matter, a sign that authorities are preparing to take concrete steps to tackle a key financial risk.

Local officials will be pressed to come clean about their so-called hidden debt as national leaders attempt to get a fuller picture of liabilities across all levels of government, the people said, asking not to be named discussing private information. The campaign is being led by the Ministry of Finance, one of the people said.


It’s not clear when the survey will end or what will follow it, but an accurate accounting of the size of the liabilities would be key to formulating policies to address the problem. The assessment has been underway at least since May, one of the people said. The people asked not to be identified as the discussions were private.


There are more than 3,000 individual administrative units in China, with 31 provinces, 333 cities and almost 3,000 counties. Many of them use companies called ‘local government financing vehicles’ to borrow money to pay for infrastructure and other services that can’t be paid for from their official budgets. The companies are controlled by the local authorities but are not officially part of the government so their debts don’t appear on official balance sheets, making local finances appear to be in better shape than they really are.


The central government officially denies that government is responsible for these debts, but investors and banks lend to the LGFVs at low interest rates because it is assumed that local authorities will not let any of them fail but will eventually repay their debts.


However, many of the investments made by the LGFVs have struggled to make a profit or even enough money to repay their loans, and investors increasingly see the whole sectors as a financial risk. LGFVs were the most frequently cited top risk in a Bloomberg survey earlier this year of 53 economists, money managers and strategists at financial institutions ranging from sovereign wealth funds to banks and pensions.



Official Debts

Ministry of Finance data showed governments across China had 37 trillion yuan ($5.1 trillion) in on-book debt outstanding at the end of April, but there is no official total for how much hidden debt there is and who owes it.


The International Monetary Fund estimated in February that nationwide there was 66 trillion yuan of LGFV hidden debt at the end of 2022, up from 40 trillion yuan in 2019, with that quick increase underscoring how local governments ramped up off-book borrowing and spending during the pandemic to support their local economies.


China has already conducted several audits of local debt over the past decade. After a 2013 audit, Beijing banned local authorities from borrowing except through the sale of official bonds, and then in 2015 launched a campaign to swap local governments’ off-balance-sheet debt for bonds.


The Ministry of Finance more recently allowed some regions to issue bonds to repay LGFV borrowings in an attempt to eliminate the remaining hidden debt, after another round of checks in 2018. Guangdong province became the first to claim it had successfully done so in 2021. Other LGFVs have been allowed to renegotiate their loans, including one in Guizhou province agreeing with its banks in December last year to extend its loans for two decades.


This new audit of local government debt risks comes just as China’s economic recovery is losing momentum. The real estate sector shows no sign of rebounding, global demand for Chinese goods and domestic consumption are both weakening, and local authorities’ ability to spur growth with infrastructure spending has been limited by their massive debt stockpile and falling income.


Expectations for more monetary and fiscal stimulus have risen following the surprise rate cut last week by the People’s Bank of China. The State Council, China’s cabinet, said late last week it was discussing stimulus proposals, and a major policy announcement is expected to come after the July meeting of the Communist Party’s powerful Politburo.


Morgan Stanley analysts expects China to roll out rate cuts, widen the fiscal deficit by expanding government bond quotas, announce more infrastructure investment, provide tax incentives to support high-end manufacturing and ease home purchase restrictions. The government announced Wednesday that it would extend tax breaks for people to buy electric cars through 2027, in an effort to boost both demand and industrial output.


However, more and more domestic economists are urging Beijing to shift the focus of fiscal stimulus toward boosting household income, as the return on investment of infrastructure projects has declined, leaving local authorities struggling to repay the debt taken on to fund the constructions.


Source: Bloomberg



China’s state banks cut deposit rates...

China’s state banks cut deposit rates in bid to lift economy.

China’s much-anticipated economic recovery isn’t turning out to be as ebullient as some bullish investors hoped. And yet investors looking to policy makers to power stocks higher with aggressive stimulus might be disappointed. China’s growth is indeed recovering—a contrast to slowing economies in the U.S. and elsewhere—but not at the robust pace expected. That leaves the world’s second-largest economy in a difficult in-between.


Just on Wednesday, data showed that China’s exports fell 7.5% in May from a year earlier, a much steeper drop than economists had projected and the first contraction in three months. That, along with other weaker data points lately, has sparked hopes for more stimulus to rev up growth. But policy makers so far appear more intent on stabilizing the economy rather than supercharging it.



Chinese stocks, in turn, have lost  7% over the past three months. It’s a stark comedown from the fall, when Chinese stocks surged for three months after Beijing lifted its harsh Covid-19 restrictions in late October.


Of course, policy makers have rolled out some efforts to help the recovery—like lowering deposit rates to nudge Chinese savers to spend more. Lenders including Industrial and Commercial Bank of China, China Construction Bank and Bank of China are now offering 2.45% and 2.50%, respectively, on three- and five-year time deposits, down by 15 basis points from September.


But so far, these efforts don’t seem to have persuaded households—or companies—to do so. For that to happen, TS Lombard Chief China Economist Rory Green says employment and income prospects need to improve to help repair confidence.


BCA Research Chief Strategist Arthur Budaghyan in a recent note said consumer spending will likely keep growing since Covid-19 restrictions have lifted, but at a slower pace than in the past.


As for companies, those on China’s mainland are among the most debt-laden in the world, Budaghyan adds. Combine that with a lack of government stimulus and lackluster demand, and these businesses likely won’t rush into investing, expanding, or hiring. That could be yet another obstacle for continued economic momentum.


For now, Chinese policy planners are in a “wait-and-see mode” about whether the economy will regain momentum on its own, says Shehzad Qazi, managing director at research firm China Beige Book.  If growth disappoints in the second quarter, Qazi expects Beijing will roll out more stimulus. TS Lombard’s Green also expects more measures, along the lines of accelerated use of local government bond quotas, cuts to the required reserve requirements at banks to spur lending, and support for the real estate market with reduced down payment requirements.


But it isn’t clear if such measures would jump-start growth. And Beijing remains wary of exacerbating the longer term challenges it has tried to tackle in recent years, such as high levels of debt throughout its economy, including at the local level, financial speculation, and the excesses in the property market.


Another reason China might not be able to rely on its old playbook of leaning on infrastructure and construction to juice its economy: It might not have enough blue-collar workers to take on these projects. By 2025, the manufacturing sector is expected to see a shortfall of 30 million workers, according to Budaghyan. The silver lining: China is likely to keep rolling out efforts to put a floor under its economic growth.


Source: Baron's




China GDP growth well below official...

China GDP growth well below official target for 2022.

China’s GDP expanded at its slowest pace since the mid-1970s bar the Covid-hit 2020 year, as the world’s second-largest economy struggled under tight pandemic restrictions that were abruptly ditched late in 2022.


The economy grew 3% last year, well shy of the 5.5% pace the government had targeted at the start of the year and the 8.1% recorded for 2021. The actual rate though, was better than the 2.7% predicted by the World Bank earlier this month.


Analysts will focus on the December quarter growth tally of 2.9%, which exceeded market forecasts of 1.8%, according to Reuters. The economy was roughly static compared with the previous three month, dodging the 0.8% retreat pundits had tipped.


The figures meant China’s GDP rose at the slowest pace in about half a century if the 2.2% expansion in the first Covid year of 2020 is excluded.


For most of the last three years, the Chinese government persisted with rolling lockdowns and mass testing under its Zero-Covid strategy to stop the virus spreading. It abandoned the policy early last month with little warning and without preparations for vaccination campaigns or other medical measures.


Still, the policy shift has been widely interpreted as likely to help spur economic growth in China in 2023 and beyond. The World Bank forecasts GDP growth will quicken to 4.3% this year and 5% the next, expectations that are now being exceeded by many private economists.


Uncertainties include how the soaring death toll – officially 60,000 in the last month or so, will affect wider confidence among consumers. Disruptions to supply chains as workers call in sick may dent the recovery and affect economies reliant on Chinese imports.


The health of the giant property market will be another threat to an economic revival with real estate prices continuing to fall in the final months of 2022. New government support packages to encourage buyers are likely in coming months.

China’s growth has a big influence on its neighbours – and nations such as Australia – with its voracious demand for iron ore, gas and other commodities. In the wake of the GDP release, shares in BHP, Rio Tinto and Fortescue – Australia’s three largest iron ore miners – were down 1.1%-1.7% compared with a 0.1% decline for the overall market.


David Bassanese, chief economist for Betashares, said that while official statistics always needed “to be taken with a grain of salt”, the GDP figures were “much better than feared in the final months of 2022”.


Retail spending and industrial production were also stronger than market expectations in the month of December alone, he said.


“This suggests the economy may have already begun to benefit from the partial reduction in Covid restrictions last month and is well placed to rebound even more strongly in the first few months of this year,” Bassanese said.


Shares of commodity producers should benefit from any acceleration of growth, he said, adding: “it also suggests this could be a banner year for the Chinese stock market”.


Some critics, though, raised doubts about the veracity of annual data that are released early in the new year – despite the size and complexity of the economy – and typically don’t get revised until years later, if at all.


Bloomberg cited Kang Yi, director of the national bureau of Statistics, as saying consumption contributed one-third, or one percentage point of China’s annual growth rate. Higher consumption appeared at odds, though, with the scale of the country’s lockdowns during 2022.


In December alone, retail sales were down 1.8%, a much better result than the 9% slump economists surveyed by Bloomberg had predicted.


After the dismantling of the zero-Covid policy, the virus spread rapidly through the economy, with millions of people catching it, leaving many sick off work.


The retail figure for December “jars with the turmoil and fear reported across major cities as Covid-zero was abandoned, but the survey detail makes sense of the situation,” said Elliot Clarke, Westpac’s senior economist.


Services such as catering came under substantial pressure as fears over the virus spread, with annual growth in the sector sinking from a minus 8.4% annual rate in November to minus 14.1% in December, he said.


This decline in activity was offset by precautionary purchases of medicine – which quickened 39.8% year on year in December, from an 8.3% rate in November – and food spending jumped to an annual pace of 10.5% in December, almost tripling the 3.9% rate in November.


Capital investment contributed 1.5 percentage points of growth last year as authorities continued to pour funds into new rail lines, bridges and other infrastructure. Resource exporters will be banking on further expansion in 2023 particularly as net export growth will be harder to achieve as rich economies in Europe and North America slow with some headed for recession.


“Overall, the December data round supports our long-held view that China’s economy is well positioned to not only rebound from Covid-zero, but also to grow strongly into the medium-term, averaging growth of 5% or more through 2022-2024,” Clarke said.


Source: The Guardian




China economic outlook 2023.

China economic outlook 2023.
  • China’s economic growth profile in 2023 will be characterised by a weaker first six months and a stronger second half. As in other Asian economies that lifted zero-covid policies, re‑opening will not result in an immediate acceleration of growth, as a surging viral caseload causes disruption to supply chains and consumption. However, after a difficult first quarter, China’s economic momentum will probably build in the second quarter, before a strong recovery sets in during the second half of the year, when the public health situation will be manageable. We also expect global demand for Chinese exports to recover in the second half of 2023. The lagged effect of pro‑growth policies (to be announced) will underpin stronger economic performance in 2024.


    China’s growth pattern over the next two years will differ in important ways from the post-pandemic recovery in other major economies. In the US, for example, strong and prolonged private consumption—stemming from stimulus-backed savings—supported growth. China will also experience an initial rebound in consumption, driven by pent-up demand, but the recovery will be relatively mild, owing to the negative impact of zero-covid on personal incomes and the absence of household-focused stimulus. Similar to consumption, private investment will also take time to rebound. To lift sentiment, we expect the government to announce expansionary fiscal measures—supported mostly by bond insurance and a wider fiscal deficit—and to front-load its spending in 2023, stimulating the economy and financing treatment for covid‑19. 


    The first sectors to benefit from China’s exit from zero-covid will be healthcare and pharmaceuticals, followed by offline consumption such as catering, transport and tourism. We expect increased spending by both the government and households, in preparation for the near-term and repeat waves of coronavirus cases. The property sector will also benefit from supportive policies and improving income expectations.



  • After an uneven growth performance this year, China’s economy is projected to recover in 2023. Activity in China has followed the ups and downs of the pandemic—outbreaks and economic slowdowns have been followed by uneven recoveries. Despite policy support, real GDP growth is expected to slow to 2.7 percent in 2022, before recovering to between 4.3-5.2 percent in 2023 (World bank and Economist Intelligence Unit estimates) amid a reopening of the economy.


  • The growth outlook is subject to significant risks. Recurrent COVID-19 outbreaks, the possibility of renewed mobility restrictions and precautionary behavior to slow the spread of the virus could lead to longer-than-expected disruption in economic activity. Continued adaptation of China’s COVID-19 policy will be crucial, both to mitigate public health risks and to minimize further economic disruption. Persistent stress in the real estate sector could also have wider macroeconomic and financial spillovers. China’s economy is also vulnerable to climate change, highly uncertain world growth prospects, greater-than-expected tightening in global financial conditions and heightened geopolitical tensions.


  • The continued adaptation of China’s public health policies will be crucial to mitigate public health risks and also minimize further economic disruption. Accelerated efforts on public health preparedness now could enable a safer and less disruptive re-opening. Public health measures could include focused efforts to increase vaccination rates among vulnerable groups, rollout of a booster campaign, increased access to effective COVID-19 treatments, and efficient use of limited hospital capacity for severe cases.


  • Continued macroeconomic policy support will be needed in the near term, as the economy remains below potential and the global environment is weakening. China has adequate fiscal policy space, especially at the central level, that could be deployed to bolster a stronger recovery. Directing these fiscal efforts toward social spending and green investment rather than traditional infrastructure would not only support short-term demand but also contribute to more inclusive and sustainable growth in the medium-term.


  • Deeper structural reforms, put on hold by the pandemic, will have to be restarted to successfully achieve more balanced, inclusive, and sustainable growth. Reform priorities include creating a level playing field for the private sector by ensuring a predictable regulatory environment and addressing distortions in the access to credit. Such measures could be complemented with reforms to strengthen social security and reduce inequalities in access to quality healthcare and education. At the same time stronger efforts are needed to accelerate the transition to a low carbon economy through more market-based instruments and investment in climate-smart infrastructure.


  • Increasing youth unemployment rates have highlighted the emergence of another pressing challenge for policymakers. Employment subsidies and public works programs have provided near-term support to youth employment. The special topic of this report argues that these short-term measures could be complemented with structural measures to strengthen the skillset of the youth, improve labor market mobility, address information asymmetries, and strengthen labor market statistics.



Source: World Bank & Economist Intelligence Unit


Why Beijing Wants Bolsonaro to Win:...

Why Beijing Wants Bolsonaro to Win: the Brazilian president is an ally against the West.

When Jair Bolsonaro won Brazil’s last presidential election in October 2018, an editorial in the China Daily, a newspaper owned by the Chinese Communist Party, reflected Beijing’s cautious optimism about the new leader. Though Bolsonaro had sounded “less than friendly to China on the campaign trail,” the China Daily expressed “sincere hope” that he would “take an objective and rational look at the state of China-Brazil relations,” opining that the two countries were “hardly competitors.”


At the time, the far-right Bolsonaro had a track record of systematically attacking Beijing. Ahead of the election, he had warned that “China is not buying in Brazil; it is buying Brazil” and visited Taiwan, tweeting that he planned to break with previous Brazilian left-wing governments that had been “friendly with communist regimes.”



Bolsonaro’s decision to make anti-China rhetoric such a key element of his campaign was a first for a politician who successfully sought national office in Latin America. Prior to the Chinese-fueled commodity boom in the 2000s, the region’s ties to China had been of limited economic and political relevance. Brazil is a case in point: At the turn of the century, Beijing did not figure among its five leading trading partners. Merely nine years later, however, China overtook the United States as Brazil’s top trading partner, a position it now holds in several of the region’s countries, including Chile, Uruguay, and Peru.


Since then, regional actors have generally viewed China as an indispensable economic partner—as well as a useful ally to balance U.S. influence. Former Brazilian President Luiz Inácio Lula da Silva, who governed from 2003 to 2010, institutionalized the China-Brazil bilateral relationship, most critically by helping to found the BRICS grouping of Brazil, Russia, India, China, and South Africa in 2009. Lula’s successors from both left and right continued along a similar path until Bolsonaro promised to take a sledgehammer to Brazil-China relations in 2018.


Four years later, however, China has proved to be the biggest beneficiary of the Bolsonaro presidency. While Bolsonaro demonized China during the first two years of his administration, he also become persona non grata in the West—and began to see his fellow BRICS members in a different light. Ahead of Brazil’s presidential elections on Oct. 2, policymakers in Beijing are far less concerned about the possibility of Bolsonaro’s reelection than their counterparts in Europe, the United States, and Latin America. And, in a remarkable turn of events, China stands to benefit far more from another four years of Bolsonaro than of erstwhile ally Lula, who has launched a new bid for the Brazilian presidency and currently leads Bolsonaro in the polls.

After Bolsonaro’s inauguration in January 2019, Beijing’s hopes that he would soften his anti-China rhetoric were initially frustrated. Bolsonaro was a proud acolyte of then-U.S. President Donald Trump, and several of his key advisors regularly condemned Beijing to strengthen their proclaimed anti-communist credentials. The new president also chose as foreign minister Ernesto Araújo, a Trumpist conspiracy theorist who described the science behind climate change as a Marxist plot to benefit Beijing and warned that “Maoist China” was facilitating the emergence of socialist rule across Latin America. Though the two sides saw some rapprochement when China publicly lauded Bolsonaro’s environmental record during large fires in the Amazon in 2019, it proved only temporary.


When Bolsonaro, his legislator sons, and several ministers mimicked Trump’s strategy of blaming China for the COVID-19 pandemic—for example by using the term “China virus” and suggesting the virus was the result of China’s “chemical warfare”—the countries’ bilateral relationship entered a profound crisis. China’s consul general in Rio de Janeiro lashed out against the president’s son Eduardo Bolsonaro and suggested he had been “brainwashed” by the United States. In the end, however, things did not escalate beyond a war of words. Beijing was able to significantly improve its standing in Brazil by providing the country with vaccines at a time when the United States and Europe still prioritized their own populations.


It was Trump’s tumultuous departure from the White House in January 2021, however, that forced Bolsonaro to take a permanent pragmatic turn toward Beijing. Aware that geopolitical realities had changed—and that Brazil would now face near-complete diplomatic isolation in the West—his government largely stopped attacking China. At the same time, Brazil’s politically influential agribusiness—highly dependent on China—signaled that it was losing patience with the government’s anti-China rhetoric. As a result, the Brazilian Senate announced that it would not approve Bolsonaro’s ambassadorial appointments if Araújo remained foreign minister. The president obliged and replaced Araújo with a middle-of-the-road technocrat. (Minister of Education Abraham Weintraub, another leading anti-China voice in Bolsonaro’s cabinet, had already been sacked after tweeting that COVID-19 was part of China’s “plan for world domination.”)


Since then, BRICS summits have become something of a diplomatic life raft for Bolsonaro. Largely shunned in Western capitals for his villainous environmental record, COVID-19 denialism, “anti-globalist” rhetoric, and increasingly explicit authoritarian ambitions, the yearly photo-ops with leaders from China, Russia, India, and South Africa have become the main pillar of the Brazilian president’s diplomatic calendar. The importance of the BRICS grouping to Bolsonaro’s global standing has become even more pronounced with the election of left-wing leaders in such countries as Chile and Colombia—which previously had conservative presidents—over the past year.


A reelected Bolsonaro would face unprecedented isolation in South America, where virtually all countries except Uruguay, Ecuador, and Paraguay are governed by leftists. Since Russia’s invasion of Ukraine in February, Bolsonaro has also proved a committed BRICS ally to Moscow, criticizing Western sanctions on Russia and abstaining—together with China—on highly symbolic United Nations votes.

As October’s presidential election approaches, decision-makers everywhere from Washington and Madrid to Paris and Berlin are doing little to hide their antipathy for Bolsonaro, and it is no exaggeration to say that Bolsonaro’s reputation in the West is largely beyond repair. This fact complicates U.S. and European efforts to defend their waning economic and political influence in Latin America as China’s role in the region grows.


Reelection would most likely embolden Bolsonaro to become more authoritarian and further weaken Brazil’s ties to the West; for example, both Brazil’s accession to the OECD and the ratification of a pending trade deal between the European Union and South American bloc Mercosur—stalled by Brussels to protest Brazil’s destruction of the Amazon rainforest—seem unlikely as long as Bolsonaro is president. Should Lula win, by contrast, European countries plan to relaunch environmental cooperation efforts with Brazil—such as via the Amazon Fund, financed by Norway and Germany—and otherwise resume broad multilateral cooperation that was common prior to Bolsonaro’s rise, such as the EU-Brazil Strategic Partnership.

Beijing, on the other hand, seems far better positioned to deal with another Bolsonaro term. Granted, Bolsonaro is not China’s dream candidate—and Lula is remembered fondly in Beijing for transforming bilateral ties between the two countries. Yet despite Bolsonaro’s frequent anti-Beijing rants during the Trump years, trade between Brazil and China has grown considerably throughout Bolsonaro’s first presidential term, from about $100 billion in 2019 to $135 billion in 2021—a remarkable achievement, especially during the pandemic. 2021 also saw the second-largest Chinese investments in Brazil to date, at $5.9 billion. And Bolsonaro has resisted U.S. pressure to ban Chinese telecommunications firm Huawei from providing components for Brazil’s 5G network. In short: Brazil’s economic dependence on Beijing has never been greater than under Bolsonaro.



Beyond economics, Bolsonaro’s growing isolation in the West offers a strategic opportunity for Beijing to develop a stronger foothold in Brazil and beyond, in some cases due to Bolsonaro’s neglect of his own neighbors. While Brasília and Beijing competed for influence in Latin America in decades past, Bolsonaro’s decision to turn its back on the region has facilitated China’s strategic engagement: In 2019, for example, China temporarily overtook Brazil as Argentina’s most important trading partner. Rather than seeking to find ways to retain lost influence in Argentina or contain China’s growing role, Bolsonaro was busy attacking the newly elected government in Buenos Aires as “leftist bandits.


This does not mean that China has soured on Lula. But if Lula were to win the Brazilian presidency, the country’s isolation in the West would end—and Beijing would face far more intense competition to consolidate its influence across Latin America. (Lula, however, is still expected to be friendly to China, as he was during his first two terms.)


After starting out as a presidential candidate running on an anti-China platform, Bolsonaro has now become—above all—anti-Western. That tendency will only intensify if he wins reelection. And Beijing is taking notice.


Source: Foreign Policy


Will infrastructure investment become...

Will infrastructure investment become the key growth stabilizer in 2022?

Recent Omicron outbreak and the lockdown measures in China significantly changed the previous soft-landing
story of Chinese economy in 2022. In March and April, Shanghai and other mainland cities’ lockdown led to supply-
side stagnancy and supply-chain disruptions. Coincidentally, the recent trending-up inflation, tumbling exports and
RMB sharp depreciation etc. have shrink the authorities’ policy room for more aggressive easing measures.
Chinese authorities indeed face an “Impossible Trinity” in 2022 among “Zero Covid”, financial stability and 5.5%
growth target. Given that the authorities still stick to “Zero Covid”, there are only two possible choices of the policy

(i) if the authorities want “Zero Covid” and 5.5% growth target together, they have to conduct aggressive
easing monetary measures which are unsynchronized with the US FED, leading to financial instability such as
capital flight and sharp RMB depreciation etc.;

(ii) if they want “Zero Covid” and a synchronized monetary policy
with the US FED to circumvent financial instability, they have to accept a lower growth rate than 5.5%. The
authorities are probably trying to experiment (a) with aggressive easing measures at the current stage, although the
real-world scenario might be (b) ultimately.


Under this “trilemma” circumstance, Chinese authorities have already made some significant policy turnaround and
reverted to “old growth model” in the recent months to stimulate growth. The so-called “old growth model” highly
depends on real estate, exports and infrastructure investment to boost economy, the model that Chinese
authorities have always implemented during the business cycle downturn in the past decades.

Some of the recent policy moves tilting towards infrastructure investment boost include but not confined with the
following policy initiatives: In the State Council executive meeting in January 2022, the authorities prioritized the
102 infrastructure projects outlined in the 14th Five Year Plan, including new infrastructure projects, new
urbanization projects, transportation and water conservancy projects, storage and postal facilities etc. In the
Central Financial and Economic Committee Conference on April 26 2022, President Xi re-emphasized the
importance of infrastructure investment to support growth in this year and clearly signaled that China’s
infrastructure still has large potential to grow.

These high-level meetings also outlined the principles of infrastructure investment in 2022: (i) to construct the
modern infrastructure system with the balance of development and security; (ii) to comprehensively consider the
benefits of the economy, society, environment and security etc. when conducting the new infrastructure projects; (iii)
to take the equal emphasize on the “old” and “new” infrastructure investment; and (iv) to expand financial channels
and to include social capital into the infrastructure investment, such as PPP (public-private partnership).
In a bid to stimulate infrastructure investment, the authorities also recently promulgated a series of monetary and
fiscal easing measures. Regarding fiscal stimulus, the pace of special local government bond issuance reached historical high in Q1, indicating the authorities have strained every nerve to stimulate infrastructure investment. In particular, the new increase issuance in Q1 reached 36% of full-year budget of local government bond issuance (RMB 3.65 trillion) and 89% of quota for the early issuance (RMB 1.46 trillion). The Q1 issuance level is significantly higher than that of the same period of 2021 and 2020. On the front of monetary policy easing, the PBoC recently cut the 5-year LPR from 4.6% to 4.45%, the largest cut since the LPR reform in August 2019, suggesting the expansionary stance of monetary policy to support infrastructure long-term investment financing.


Infrastructure investment has always been an important counter-cyclical measure for China in the past decades.

Infrastructure investment constitutes a large ratio of Chinese total GDP and has been the main growth engine for
Chinese economy in the past decades. It contributes around 6.5% of the total GDP in 2021. (Figure 3 and 4)
However, these figures only consider the direct effect while ignore the indirect effect. Infrastructure investment,
whether they are “new” or “old”, has large externalities to other sectors. For example, a better infrastructure may
benefit a province or a region’s tourism, FDI, real estate investment, etc. If we consider its strong linkages to its
upstream and downstream sectors, such as construction, architecture raw materials, etc., as well as its extremities
to tourism, industrial investment, real estate and FDI etc., infrastructure is estimated to contribute around 20% of
GDP for Chinese economy for the past decades.


In the past two decades, infrastructure has always been the stabilizer and the main counter-cyclical measure to
stimulate growth amid business cycle downturns. Through fiscal expansionary measures particularly the issuance
of local government bond, infrastructure investment has always been the main pillar to smooth the business cycle.
During 2007-2016, infrastructure investment has remained double-digit growth in China and it is not difficult to
understand that Chinese business cycle has always been deemed to be “infrastructure cycle” in the past decades.

Take 2008-2009 Global Financial Crisis as an example, Chinese authorities injected RMB 4 trillion into the
economy, most of them went to the infrastructure investment, which successfully secured a soft-landing of the
economy when other countries went into recession. (Figure 6) Including the Global Financial Crisis period,
historically, there were three times of expansionary infrastructure investment policy in China, in 2008-09, 2012 and
2016, respectively. Every time, infrastructure investment expansion played a counter-cyclical role and successfully
pulled the economy out of the mud.

However, the “golden time” of China’s infrastructure investment gave way to the deleveraging campaign and
supply-side reform since 2018. Due to the tightening regulation on local government debt and the stricter scrutiny
process of infrastructure projects in a bid to fulfill the deleveraging targets, the infrastructure investment growth has
gradually dipped from 2018 to 2020. Worse still, during 2021, the post-pandemic time, due to the early exit of fiscal
policy stimulus as China “first-in, first-out” of the pandemic, infrastructure investment even plunged to as low as an
average growth of 0.4% in 2021.
However, history always repeats. The recent growth headwinds stemmed from Omicron outbreak and lockdown
measures again brings infrastructure investment from back to the front. Why infrastructure investment becomes
important again? Here are some important factors which determine its counter-cyclical role during the pandemic

First, among the traditional “Troika” of China’s growth engine, namely exports, infrastructure investment and
consumption, infrastructure is the most controllable by the authorities. Through issuing local government bond, it is
the most efficient way which could be fully controlled by the authorities to stimulate growth during the business
cycles downturns in the past decades, while the other two engines are much more ambiguous. For instance,
consumption bears the most severe economic blow by the “zero-Covid” policy while exports are external-demand
determined which is going to experience a significant slowdown as the US and Europe is entering into recession
due to the aggressive central bank interest rate hike this year.

Second, among the three categories of the fixed asset investment (FAI), namely housing, infrastructure and
manufacturing, only the former two are domestic determined while manufacturing investment heavily depends on
the external demand due to the dominant position of China’s processing trade in the manufacturing sector. In
addition, due to the regulatory storms and housing market crackdown in 2021, it is very difficult to stimulate growth
through real estate this year, as it is difficult to alter people’s expectation on the housing price slowdown once it
was formed.

Third, infrastructure investment still has a large room to grow in China. In particular, China’s infrastructure stock per
capita is only around 20-30% of that of the developed countries. As the urbanization progresses in China, together
with the national strategy of developing the western and middle region of China, infrastructure investment has large
potential to grow. In addition, the authority’s priority to develop “new infrastructure” such as artificial intelligence,
block chain, cloud computing, big data and 5G etc. also brings about many new opportunities to infrastructure
Finally, “new infrastructure” investment is in line with China’s “new growth model” which is underpinned by common
prosperity, high-tech self-sufficiency and green economy (see our recent Economic Watch: China | Understanding
China’s New Growth Model) In particular, high-tech self-sufficiency requires a large-scale “new infrastructure”
investment and China’s carbon neutrality target in 2060 also prospers green economy infrastructure investment,
such as photovoltaic infrastructure, hydroelectricity, wind power infrastructure etc.

The authorities promulgated a series of projects to construct a modern infrastructure system under the 14th Five-Year Plan.

In this section, we summarize the infrastructure projects that the recent State Council and Central Financial and
Economic Conference wanted to prioritize in a bid to construct the modern infrastructure system. These projects
are in line with the 102 strategic infrastructure projects in the 14th Five Year Plan. They are divided to four sections
of infrastructure investment: network infrastructure, industry infrastructure, urban infrastructure, rural infrastructure
and national security related infrastructure. (Figure 7) And we believe these pipeline projects will provide a large
amount of infrastructure investment projects in 2022

The role of New and Old Infrastructure investment.

We normally categorize China’s infrastructure investment into “new infrastructure” and “old infrastructure”. Old
infrastructure means traditional investment in airplane, high-speed road, train trail and public facilities such as
water conservancy projects, etc. New infrastructure includes but not confined with “ABCDG”, namely Artificial
Intelligence (AI), Blockchain, Cloud computing, Big data center and 5G infrastructure etc. In a more generalized
sense, new infrastructure investment also indicates the digital and intelligent transformation of the traditional
infrastructure such as energy, transportation, urban, water conservancy, agricultural infrastructure, etc.

Some statistics and estimations from Cyberspace Administration of China show that new infrastructure investment
has a much higher multiplier effect than that of old infrastructure investment. For instance, the multiplier of high-
speed railway is estimated by this institute to be around 3, while the multiplier of 5G, AI, industrial internet etc. isestimated as high as 6. Some other research such as Wang (2020) in a working paper of China Academy of Social
Sciences also has similar result in which they estimated the multiplier for traditional infrastructure investment is 1.7
in the long term and could reach 3.65 with a higher public goods spillover effect.

Although the New Infrastructure investment will have a long-term positive spill-over effect to the economy and
support China’s technology advancement, its total scale, at least at the current stage, remains much lower than the
Old Infrastructure investment. For instance, in 2021, the scale of new infrastructure investment reached RMB 1.16
trillion, only around 7.7% of total infrastructure investment. Although this ratio is expected to rise to 15-20% in 2025,
it could not wobble the role of the old infrastructure to stimulate the growth.

Regarding the capability to drive GDP growth, at the current stage, old infrastructure also has larger direct effect.
Take 2019 and 2020 as an example, based on the GDP expenditure method, old infrastructure could drive GDP
growth by 0.4% and 1.2% respectively, while new infrastructure investment could drive around 0.2% and 0.8%

Given that the new infrastructure investment has a higher multiplier effect but old infrastructure has a larger total
scale at the current stage, fiscal expansion in 2022 needs to synergize both old and new infrastructure investment.
In addition, “new infrastructure” such as infrastructure of digitalization, AI and big data etc. could significantly
increase efficiency of “old infrastructure”, indicating a necessity of synergizing the two.

How to finance 2022 infrastructure investment?

The market has started to worry about fiscal burden of this year particularly at the local government level. Thus,
how to finance 2022 infrastructure investment becomes an impending issue.

These worries come from a significant dip of fiscal revenue in April (-41.3% y/y) when lockdown measures imposed
in Shanghai and other pandemic affected cities, while fiscal expenditure keeps rising, not only for large-scale
infrastructure investment but also for ever-increasing universal and regular Covid-19 PCR tests etc. (Figure 10) The
worries are also from the expansionary fiscal measures on tax cuts and fee reductions which significantly shrinks
fiscal revenue. In addition, land sales revenue amid a downward housing cycle which used to be the main pillar of
local government fiscal income also tumbled by -34.4% y/y in April and -26% ytd y/y accumulatively for Jan-May.
Combined together, the fiscal revenue for Jan-May dipped by 10% y/y, while fiscal expenditure increased by 6%
y/y for Jan-May, leading the augmented fiscal deficit in January-May 2022 reached RMB 3 trillion.

Under this circumstance, the market estimates the fiscal expenditure-revenue gap will be around RMB 1-2.8 trillion
in 2022, given the assumption that Q3 and Q4 GDP will bounce back to 5-6%. That means, it is probably difficult to
strike a fiscal balance this year with a shrinking fiscal revenue and an expansionary fiscal expenditure. If the
authorities do not want to break the fiscal budget of 2.8% which was set in the 2022 “two sessions”, the authorities
have to reduce the fiscal stimulus in 2H 2022 particularly on the infrastructure investment, which may deteriorate
economic recovery; or if the authorities want to maintain the ongoing fiscal support, more policy-oriented bond or
Covid bond needs to be issued and more unutilized fiscal budget in 2021 should be transferred to this year.

There are several options to finance infrastructure investment this year amid an expansionary fiscal gap and
dipping fiscal revenue:
First, to transfer payments of the profits gained by the PBoC and the SOEs at the central government level to
Ministry of Finance to fill in the fiscal gap. Indeed, the profits transferred from the PBoC and large SOEs to Ministry
of Finance is a usual way in China to finance the fiscal expenditure in the past decades. On March 8 2022, the
PBoC transferred RMB 1 trillion accumulated by foreign reserve management gains to Ministry of Finance to
support fiscal transferring to local government and the fiscal stimulus measures such as tax cuts and fee reduction
etc. The SOEs at the central government level, such as China Investment Corporation (CIC), China Tobacco etc.,
have also submitted their revenues to Ministry of Finance to support fiscal expansion.
Second, to issue special government bond to support infrastructure investment is also an option. Although the “two
sessions” in March just promulgated the fiscal budget this year to 2.8%, issuing new special government bond at
the current stage might have some procedure challenge, the market still calls for the new issuance of special
sovereign bond to fill in the fiscal gap and to break the pre-set fiscal budget amid “zero Covid” policy and economic
slowdown as the March “two session” did not anticipate the a sudden change of pandemic circumstances in China
as well as Shanghai lockdown in end-March.

Third, the transfer from 2021’s residual fiscal budget to 2022 could also help to make up for the fiscal gap of this
year. As the authorities conducted an early fiscal policy normalization in the past year, the actual utilized fiscal
budget was lower than the fiscal budget set in 2021’s “two sessions”. The amount of residual budget in 2021 was
amounted to RMB 2.5 trillion, among which, only half of it (around RMB 1.25 trillion) was transferred into the 2022
fiscal budget while the other half could still be utilized to make up for the fiscal gap in 2022 to support infrastructure
investment and other fiscal expenditure.

2022 Infrastructure investment growth prediction and the economic growth outlook.

Chinese authorities have already pressed ahead at least three directions of policy initiatives to stimulate
infrastructure growth in 2022, which could be summarized below:

(i) There are abundant infrastructure investment projects outlined in the recent high-level State Council and
Central Government meetings in a bid to construct modern infrastructure system, in line with the 102
projects raised in the 14th Five-Year Plan.
(ii) The authorities have pushed forward a series of monetary and fiscal easing measures to stimulate
infrastructure growth, such as the recent 5-year LPR cut, three RRR cuts, the early release of local
government bond quota to stimulate infrastructure investment in 1H 2022, etc.
(iii) The motivation of the local government officials to push forward infrastructure investment is much larger
than that of 2021. As the 5.5% growth target for 2022 amid Covid-19 flare-ups and lockdown measures is
quite challenging, while local government officials at the beginning of the year even set higher growth
target than the nationwide target, it is challenging for them to achieve the goals thus they are much more
motivated to take use of available sources to press ahead local infrastructure investment.

Under all of these pro-infrastructure investment measures, for this year, infrastructure investment growth is
predicted to be 10-13% based on the expansion of the local government bond issuance (RMB 4.73 trillion) and the
fiscal surplus transferred from 2021 to 2022 (around RMB 1.5-2 trillion). Given that infrastructure investment is
around 15% of China’s total GDP on average in the past 10 years, it is estimated that infrastructure investment will
contribute to around 1.5-2% of total real GDP growth. And it will lead the total fixed asset investment to reach 6.5%
in 2022 (manufacturing investment estimation: 7%; housing investment estimation: 0.6%).

However, we have to at the same time realize that larger-scale infrastructure investment cannot sufficiently offset
the consumption and exports plunge as well as a downward real estate cycle in 2022. The tumbling economic
activity figures particularly in March and April reflected that the authorities’ lockdown measures under “zero
tolerance” strategy significantly weighed on growth. Given that Chinese authorities will continue to stick on “zero
Covid” policy in the rest of the year, there will be “impossible trinity” for China’s policy setting in 2022: either China
needs to give up synchronized monetary policy with the US FED to continue aggressive easing in order to achieve
5.5% growth target which might lead to financial instability, or, the authorities have to give up 5.5% growth target to
accept a lower growth in a bid not to conduct aggressive easing measures to circumvent capital flights and sharp
currency depreciation.

Under the current situation, we predict the real-world case would be the latter one, as the policy room of aggressive
easing has been shrinking significantly amid a trending-up inflation, sharp RMB depreciation and capital outflows.
Look ahead, we predict GDP growth in the second half of the year will gradually recovered from the Q2 downturn
caused by the Covid flare-ups and resultant lockdowns. For 2022 as a whole, growth will reach 4.5%, lower than
the authorities’ 5.5% growth target.
Source: BBVA Research


Development of the semiconductor industr...

Development of the semiconductor industry 2022

The Fifth Session of the 13th National People’s Congress and the Fifth Session of the 13th National Committee of the Chinese People’s Political Consultative Conference (the “Two Sessions”) were held in Beijing as scheduled. From the “Government Work Report” to the proposals of representatives from all walks of life, the semiconductor industry is one of the most important technology topics.  


To keep you updated on the key developments in China’s semiconductor industry, this article summarizes the discussions on the development of the semiconductor industry at this year’s Two Sessions and draws out the following four keywords. 



Encourage Investment 

In 2021, the global IC industry will continue to be in the predicament of shortage of upstream production capacity and insufficient downstream supply. Although global semiconductor companies continue to expand production capacity, the inflection point of supply and demand balance has not yet been seen in the short term. In this context, the chip industry has received unprecedented attention. At this year’s two sessions, many representatives also put forward suggestions for promoting investment in the semiconductor industry. The overall attitude is to encourage domestically and welcome externally.


Deng Zhonghan, an academic, commander-in-chief of the Starlight China Chip Project, and founder of Vimivro, suggested further expanding the investment scale of the National IC Industry Investment Fund and further accelerating the pace of listing and financing of core chip and vertical innovation enterprises in the “post-Moore era” on the “Science and Innovation Board.”


Tian Yulong, chief engineer and spokesman of the Ministry of Industry and Information Technology, stated: “We should also continue to provide a good policy and market environment for domestic and foreign IC enterprises, treat all kinds of market players equally, give equal treatment to domestic and foreign investors according to the law, especially strengthen the protection of intellectual property rights, jointly promote the innovative development of the IC industry, and maintain the stability of the global IC industry chain and supply chain.”


Increasing Support  

This year’s “Government Work Report” clearly pointed out that it is necessary to accelerate the development of the industrial Internet, and cultivate and expand digital industries such as integrated circuits and artificial intelligence. The report also proposes to further support China’s localities and enterprises to increase investment in scientific and technological research and development and increase the additional deduction ratio of research and development expenses for technology-based small and medium-sized enterprises from 75% to 100% to stimulate technological innovation.


Zhang Zhanbin, director of the College of Marxism at the Party School of the Central Committee of C.P.C, suggested that new types of infrastructure should be promoted following development needs and industrial potential. Focus on key areas to actively expand new infrastructure application scenarios and explore the planning of sustainable business models.


Independent Control of Chips

Due to the impact of the international trade war and the problem of chip shortage in 2020, the independent control of chips has become a concern for China’s semiconductor industry. Among them, the shortage of serious automotive chip localization issues has been hotly discussed.


Li Biao,  a representative of the National People’s Congress and CEO of Hite Group, pointed out that high-quality private integrated circuit enterprises, especially private integrated circuit manufacturing enterprises play an important role in the localization and independent control of chips, which is an important link in China’s integrated circuit industry chain, but also the weakest. The compound semiconductor manufacturing industry meets long build lines and high technical barriers. Some enterprises are in long-term loss and need  the government to formulate targeted policies to help.


Zhang Xinghai, a deputy to the National People’s Congress and founder of Xiaokang, said that it is urgent to improve the localization rate of automotive chips and achieve import substitution. National ministries and departments in charge of automotive chips need to develop top-level design and support measures to promote the development of domestic automotive chips.


Chen Hong, a deputy to the National People’s Congress and CEO of SAIC, said  that: policy guidance can be used to establish unified technical specifications and standards for vehicle-grade chips, and establish a third-party testing and certification platform; in addition, the government can take the lead in setting up special funds to encourage chip companies and automotive enterprises to participate together to accelerate the formation of domestic large-calculus chip research and development, manufacturing and application capabilities.



Filling the Gap

The industry chain of the semiconductor industry is complex and interlocked. To achieve independent control, China first needs to fill the gaps in the industry to start. This is also one of the topics of concern to the delegates.


Shao Zhiqing, a deputy to the National People’s Congress and a full-time vice chairman of the Shanghai Committee of the Zhigong Party, is concerned about chip materials and suggests building a platform for IC material characterization and testing and application research to provide R&D institutions and enterprises with a “one-stop” solution for material characterization and testing. The combination of process and material development solves the problem of missing application scenarios for IC materials, especially for forward-looking specific materials, providing a total solution that integrates the “material-process-equipment-test” to fill the industry gap.


Following the industrial development trend and the current situation in China, Wang Yu, a member of the National Committee of the Chinese People’s Political Consultative Conference (CPPCC) and a researcher at the Institute of Microelectronics, Chinese Academy of Sciences, suggested that – the development of silicon optical chip industry should be listed as the scope and list of government support. China should encourage and support relevant enterprises, around silicon optical chip design automation, mass production manufacturing, other industry chain gaps, and capital. The country ought to accelerate investment and entrepreneurship, and actively guide local governments to create policy and resources to support and promote the project to take effect. He also points out opening the industrial chain as early as possible, supporting the industry to develop sustainably, and having strong capabilities in negotiations internationally.


China “Chip” Attitude

IC Insights estimates that global semiconductor industry capital expenditures will reach a record high of $190.4 billion in 2022, up a whopping 24% year-over-year. Various regions of the world, such as the European Commission, the U.S. Department of Commerce, and the South Korean government, have provided financial support to semiconductor companies to enhance the competitiveness of the local semiconductor industry. In China, the IC industry is a strategic, fundamental, and pioneering industry that supports the country’s economic and social development, and its importance is gradually gaining more recognition due to the trade war and chip shortages. With the convening of the two sessions this year, China’s next phase of development goals and directions for the IC industry has become clearer. Overall, encouraging the industry’s development and enhancing independence through various means will become the keynote of China’s semiconductor industry next.


Source: Influence Matters/ IC Insights


China’s cryptocurrency crackdown

China’s cryptocurrency crackdown

Moves by the Chinese central bank and government officials to curtail the use of Bitcoin and other digital currencies stretches back almost to their inception. The last week has seen crypto markets battered by news that the Chinese government is firmly clamping down on digital currencies within its borders.


Multiple provinces, many of which host large crypto mining operations, have moved to ban or severely restrict the ability of the industry to operate in compliance with the mood in Beijing, while the country’s central bank recently ordered all financial institutions to stop facilitating transactions in digital currency.


The actions of China’s authorities sent the price of Bitcoin and several other cryptos tumbling earlier this week, with Bitcoin briefly dipping below US$30,000 on Tuesday afternoon for the first time since January. However, for many long-time observers of the Chinese crypto market, Beijing’s moves are nothing new and such an outcome may have been inevitable.



Tightening the screws

The Chinese government’s hostile attitude to crypto goes back to when digital currency first rose to prominence in the early 2010s.


Bitcoin transactions were banned by The People’s Bank of China (PBOC) all the way back in 2013, while initial coin offerings (ICOs) and cryptocurrency exchanges were halted in 2017 amid worries they could be used in illegal financing and money laundering.


Some have even said that the reaction by officials to crypto represents a fundamental concern about whether digital currencies represent a possible challenge to the dominance of the ruling Chinese Communist Party (CCP).


Another reason for the renewed crackdown may be the imminent introduction of the Digital Yuan, China's attempt to introduce a digital currency that is both backed and controlled by its central bank, and a joint venture with SWIFT (the international payment and cross-border payment gateway). Although China’s not going to replace its fiat currency with the Digital Yuan completely, it’s too soon to tell as trials are still going on with central banks, like the People’s Bank of China, leading the operation.


What is the Digital Yuan?

Officially known as a Digital Currency Electronic Payment (DCEP), China wants to replace its fiat currency with the digital one to encourage cashless transactions, ushering in a new era for world economics. Like Bitcoin, it also relies on blockchain technology to facilitate and verify transactions, but unlike Bitcoin, it is centrally controlled by regulatory authorities and backed up by fiat currency reserves.


The rest of the world’s gain?

Novogratz added that while a lot of crypto-related activity and trading is currently focused within Asia and in China specifically, the latest crackdown could result in a shift of the industry elsewhere that could prove a boon for participants in the rest of the world.


Possible beneficiaries could be non-China based miners such as Argo Blockchain PLC, which operates Bitcoin mining facilities in Canada and the US, as well as non-Chinese crypto exchanges such as Coinbase Global Inc.


Countries with less strict rules around digital currency could also see an influx of miners, particularly those offering cheap electricity or favourable regulation. A notable example may be the Central American nation of El Salvador, which made Bitcoin legal tender earlier this month.


Some of China’s biggest players in the sector are also seeking out greener pastures following the latest crackdown, with both mining machine maker Canaan Inc and crypto mining heavyweight BIT Mining setting up bases of operation in neighbouring Kazakhstan.


Or the planet’s loss?

There’s also speculation that the Chinese government may be concerned about optics: crypto mining’s reputation as an environmental disaster doesn’t square with the China’s desire to be seen as a leader in green energy, with XiJinPing pledging that the country will be carbon-neutral by 2060. China still accounts for more than half of Bitcoin mining: concerns related to the climate as bitcoin mining requires tremendous amounts of energy to run Application-Specific Integrated Circuits (ASICs) – computers that solve complex cryptographic mathematical problems part of the verification process in the blockchain.


The move of mining operators to Kazakhstan may be a particular concern, given the country derives over 90% of its electricity from fossil fuels. By contrast, the Chinese province of Sichuan, which until recently served as a crypto mining hub, derives large portions of its electrical power from hydroelectricity.


Any move toward less climate-friendly energy usage is also likely to give institutional investors pause when considering crypto investments.



Future Cryptocurrency Regulations

There’s no indication that China intends to lift or loosen its ban on cryptocurrencies anytime soon but recent developments suggest that the government intends to position the country as a leader in the crypto space. Those developments include statements by Chinese government officials endorsing blockchain technology, the extensive trial and testing of the central bank’s digital currency.



China’s 14th Five-Year Plan, full...

China’s 14th Five-Year Plan, full summary: a blueprint for growth

China’s annual National People’s Congress parliamentary session will take place in March to approve the country’s social and economic development plans for the period 2021-25. This 14th Five-Year Plan (Plan) will be released against a backdrop of a challenging domestic economy, an increasingly complex international environment, and China’s plans to play a bigger role in the global economy.


An outline of the Plan was released late last year, so the broad direction is clear. It is ambitious and confident, covering climate, tech self-reliance, promoting domestic demand (featured in the ‘dual circulation’ strategy) and much more. It marks a fundamental shift to China’s economic trajectory, setting out a framework for how China can draw on domestic sources to sustain its growth. 


In this update we set out our views on key themes that we expect will shape and underpin the execution of the Plan, and some implications for foreign businesses. 



But first, some context…

China plans its economy in five-year increments, and this is perhaps one of the more consequential plans in China’s history.


It will be released as China celebrates in 2021 building a “moderately prosperous society in all respects”, thus achieving the first of its Two Centenary Goals, and moves towards its second centenary goal of building a “modern socialist country” by 2049 so confirming its status as a fully developed global economy.


To reinforce this longer-term intent, the outline Plan was accompanied by Vision 2035, a blueprint for China’s economic trajectory which highlights China’s longer-horizon goals including self-sufficiency in key technologies, a fall in absolute carbon emissions, a universal coverage of basic public services and a 2035 gross domestic product (GDP) per capita on par with “moderately developed countries” (which is generally estimated to be in the US$20-30,000 range). The 14th Five-Year Plan is the first building block to achieve this vision.


…and a reality check.

When the 14th Five-Year Plan is released it will be big – expect thousands of pages that will expand upon the themes and goals that have been socialised already.


But we will need to look beyond the issued Plan to understand its detail and assess its implications for foreign businesses.


More detailed plans will follow in the months and even years ahead for major sectors, ministries, state-owned enterprises, provinces, and regions, although drafts of some of those detailed plans already in circulation.


“Dual Circulation” set to be the defining economic strategy for the new era…

The 14th Five-Year Plan adopts the idea of “dual circulation” as its core concept for future economic growth.  The term has been around for several years but now features prominently in policy statements.


There is no official interpretation of the policy and we will need to see how it is put forward in the Plan. What is certain, however, are its desired outcomes.


The overarching economic goal is to transform the old growth model to a more sustainable path, in the context of a much more complex domestic and international environment.


In simple terms, the idea is for China to rely predominately on its domestic system (internal circulation) to drive growth but this will be supported by an international cycle of trade and foreign investment (external circulation).


Domestic circulation is expected to focus on:

  • expanding, deepening, and strengthening the domestic demand (consumption) by improving the social safety net, undertaking rural reforms, and generally improving people’s sense of security such that they are willing to spend money; and
  • increasing industrial capacity and productivity by focussing on technological innovation to support domestic growth and self-reliance. Self-reliance in this context is not a push for economic independence, but rather a shift towards a managed integration into global markets and economies that enhances China’s development process while allowing it to build its own capabilities and mitigate the risks it sees in a more uncertain global outlook.


External circulation, in the new era, introduces some new concepts. China’s engagement with the global economy has to date been seen through the familiar prism of trade (historically exports but with a more recent focus on imports). It is expected that new policies will emphasise Beijing’s desire to remain deeply engaged in the global economy, but the way in which this takes placed is likely to be reframed.


We can expect that there will be efforts to maintain and enhance China’s support for multilateral trade institutions and a rules-based global trading framework but with a push for greater recognition of China’s role in the global trading system and renewed emphasis on the adoption of Chinese standards and protocols.


It’s likely that the blockchain, new technologies and digital currencies will be promoted to create more resilient supply chains, Belt & Road 2.0 is likely to appear (perhaps with a new focus on projects that address some of the global health challenges the world faces).


Mega economic regions, such as the Greater Bay Area in southern China, will take a more visible role as regions for piloting new domestic policies and new technologies, as well as connecting China to the world and the world to China.


…but how it will operate in practice remains to be seen.

China has been attempting to grow the consumption side of its economy for some time. The trend has been generally positive, but to achieve the sort of growth in the domestic economy that will be necessary to ‘move the dial’ away from the investment and export drivers, will require an economic and social transition on a massive scale.


What is now looming as a burning platform for more decisive action is the far more challenging external environment China faces.  Amid a changing relationship with the US and an ageing population, the need to focus on reducing vulnerability to international supply chain disruptions, boosting domestic consumption and productivity, and increasing the sustainability of economic growth is becoming greater. 


If this shift occurs, China’s sheer size and global engagement will have major and long-term implications for both China and the world. 


Increased reliance on domestic supply has the potential to shift China's trade patterns and domestic supply chains and alter the products and services that its consumers and businesses purchase. Productivity growth meanwhile will be supported by an upgrade of manufacturing industries and the development of advanced technologies to reduce reliance on imports and support domestic consumption. 


Technology and innovation are elevated to national strategic priorities… 

While innovation and technology development are not new themes, the 14th Five-Year Plan elevates them to core national priorities and critical to achieving technological self-reliance.   


This marks a significant shift in priorities towards industrial and national security, as well as reduced reliance on tech imports. 


The draft Plan does not define which technologies will be emphasised over the next five years nor what precisely it hopes to achieve. No doubt, this will come later as various ministries elaborate on the plan. 


But it is clear that investment in technology will go into overdrive and will undoubtedly focus on frontier fields that have already been highlighted for further exploration: artificial intelligence, quantum information, integrated circuits, life and health science, neuroscience, genetics, deep earth and sea exploration, and aerospace technology. 


Alongside this, there will be measures to encourage traditional sectors to move up the value chain; strengthening improved farming quality and competitiveness; as well as a greater emphasis on protecting intellectual property rights and talent attraction. 


… which is already influencing the global business landscape. 

The three major industries that have supported China's rapid economic development in the past - traditional manufacturing, construction, and real estate – are being be replaced rapidly by three new pillar industries: strategic emerging industries, services, and modern manufacturing. 


Technology and innovation have become the driving forces for this trend. As an emerging tech giant, China has demonstrated it can be a leading innovator both globally and domestically. 


Already China is leading the development of entire new industries (built around digitalisation, artificial intelligence, big data, fifth-generation telecommunications networking (5G), nanotechnology, biotechnology, robotics, and quantum computing), new types of businesses (like electric vehicles, e-commerce and payment systems) and new business models (including new digital business-to-consumer (B2C) business-to-business (B2B) applications and channels). 


The impact of these changes, and the speed with which they are occurring, is resonating across the world, bringing both extraordinary opportunities and complex challenges. 


China is fast becoming a global hub for accelerated innovation, not just for Chinese companies but for foreign firms wanting to leverage its pool of research talent, cost-effective and flexible R&D capacity, and manufacturing ecosystem to efficiently commercialise concepts and designs into products. 


On the flip side, security and privacy risks abound; competing visions of digital sovereignty are impacting supply chains, currency usage and cross border financial flows; and the formation of divergent regulatory regimes is presenting barrier to companies’ ability to transfer data across borders and develop globally integrated digital solutions. 


Businesses are very much in the crosshairs of these issues, squeezed between conflicting political and policy pressures, public opinions, laws, and regulations. 


The challenge ahead for all nations will be to reach a level of understanding and create a common international framework to manage these emerging risks and allow these new technologies and innovations to evolve and be utilised for the benefit of all. The consequences of not doing so could lead to the crippling of global value chains, economies of scale and innovation systems.  


Climate change initiatives to support the green economy

China is currently the world’s largest energy user with the highest greenhouse gas output. It consumes 50 per cent. of coal produced worldwide annually and is the top importer of oil and natural gas. 


Last September, President Xi reiterated the goal that China will reach peak carbon emissions before 2030 and stunned the climate community by pledging that it would become carbon neutral by 2060.  


Unlike most nations that have committed to carbon neutrality, China’s economy is still growing rapidly, and that growth is not yet uncoupled from carbon emissions. Accordingly, how these commitments are integrated into the 14th Five-Year Plan will attract global attention. In many respects, the Plan will be seen by many as a test of whether economic growth and deep decarbonisation can be achieved simultaneously. 


The transition to a zero-carbon economy will require a consistent, all-of-government effort. Net zero will have to serve as a guiding principle for policymaking that is comprehensively embedded into structural reforms, investment policies and innovation priorities. 


Particular attention will be paid to binding targets on carbon intensity, the proportion of non-fossil fuels in the primary energy mix, and coal power capacity, in both the general 14th Five-Year Plan and the more specific plans that will emerge in due course. 


These de-carbonisation policies will have the potential to generate growth and employment in China and accelerate clean energy progress in the rest of the world. 


China’s financial reforms likely to accelerate

Financial sector reform has been a key component of China’s multi-decade economic restructuring plan. Indeed, while the speed of the reform process has at times lagged China’s obvious China’s commitment to financial market reforms, the 14th Five-Year Plan will send clear signals to the international community that China is determined in efforts to open its financial markets to the outside world. 


There already exists a broad reform agenda, and an understanding of the sequencing required to bring about change, so it’s unlikely that the new Plan will deliver major new developments. However, given the crucial role that the financial markets play in supporting the domestic economy, and in linking China to global capital markets, the likelihood is that this trajectory may even accelerate. 


The opportunity for foreign financial institutions and funds to participate actively in this next stage of market expansion in China is something that will undoubtedly be explored by those firms. Sensing this, the flow of investment capital into China from investors in the US, Europe and elsewhere reached record levels in 2020, although aggregate foreign participation in the domestic markets is still relatively low. 


The new Plan also reaffirms Beijing’s long-standing desire for its currency, the renminbi (RMB), to become a widely trusted and globally traded and used currency. The disruption of global trade flows and geo-political tensions have hampered the RMB internationalisation process over the last year, but the Plan is likely to contain a range of measures to reinvigorate this process, particularly through efforts to support its use in Asian regional trade and within Belt & Road countries (where the RMB is already widely used as an invoicing and payment currency). 


Supporting the RMB internationalisation process, China’s central bank is also moving closer to a full roll out of its sovereign digital currency, with tests having already been conducted in pilot cities. Sovereign digital sovereign currency is one that is used only electronically and (unlike other cryptocurrencies) is backed by the full faith and credit of the country. Central banks around the world are investigating its feasibility, but China remains well advanced in its plans. Its adoption will certainly accelerate the use of RMB in cross-border financial flows. The longer-term implications of this will be significant. 


Megacity regions herald a new era of urbanisation

The trend towards urbanisation has been underway for decades and recognised as crucial in supporting China’s economic growth strategies. That trend still has a way to go with forecasters suggesting that the urbanisation ratio could increase to 75 per cent. by 2030 (from 60 per cent. at present), translating into 220 million new urban dwellers.


The 14th Five-Year Plan is expected to highlight a new direction for urban growth, with efforts to encourage a significant proportion of those moving from rural areas (perhaps as much as half) to settle in five super-city clusters.


The process is already underway. The Greater Bay Area (GBA), the Yangtze River Delta, the Beijing-Tianjin-Hebei region (Jing-Jin-Ji), the Mid-Yangtze River area and the newly announced Chengdu-Chongqing area are the top five clusters that will be promoted to be power-house regions designed not only to promote domestic circulation but also act as bridges to support external circulation between China and the rest of the world.


The central and provincial governments are already making massive investments into these regions to support new high-speed rail, autonomous electric vehicles, smart grid technology, shared mobility, powerful 5G networks and big-data technologies.


For many observers, the development of the GBA offers insights into this new urban growth strategy. It features prominently in the 14th Five-Year Plan as an initiative to drive deeper regional economic and financial integration between key cities in the Guangdong Province (including Guangzhou and Shenzhen) and Hong Kong and Macau SARs.

With a population of around 70 million people, a GDP equal to that of Australia, the highest per capita GDP in China, the GBA is already moving to become an important global centre for advanced manufacturing, the home to some of the most innovated technology companies in the world, a centre for finance, technology and innovation, trade and tourism and leisure, with Hong Kong SAR seeking to cement its role as the go-to financial centre for capital flows between the markets of mainland China and the global economy.


China sees itself at the centre of Asian growth

China is already deeply enmeshed into the global economy.


The outline 14th Five-Year Plan calls for “comprehensively improving the level of opening to the outside world and the promotion of trade and investment liberalisation and facilitation” and provides indications around how China sees the world and its emerging role.


While the global environment continues to evolve and many views abound, there is a growing consensus that China sees itself moving into a new paradigm where the global system is divided into three main regions: Asia, North America and Europe, with each region being led by a super-regional power.


This trend is already evident in Asia, with the ASEAN region surpassing North America, in 2019, as China’s second largest trading partner, after the European Union (pre-Brexit), underscoring the huge potential of economic linkages in the Asian region.


Apart from the trade linkages, China engagement with the ASEAN region is developing rapidly. It is seeking to cooperate to support digital trade, and to promote its Health Silk Road initiative as a public health mechanism to fight the COVID-19. Beijing is also encouraging Chinese enterprise to invest in the region and the new Hainan Free Trade Zone is expected to have strong regional focus.


At more formal level, the full significance of the recently signed Regional Comprehensive Economic Partnership (RCEP) between China, ASEAN nations, Australia, Japan, and New Zealand has yet to emerge, but over coming years this is likely to stimulate intra-Asian economic integration with China a key driver of economic growth. It’s also signed an investment agreement with the EU and expressed interest in acceding to the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP). RCEP and CPTPP belong to a more advanced category of ‘next generation’ free trade agreements that regulate not just the free flow of goods and services, but also encompass a set of political and social objective related to free markets and fair competition.


China’s size matters a great deal for the world in coming decades. China will be vying for economic parity with the U.S. in 2035, if not before. 


But it’s not just size that matters. The structural economic transformation that China is undergoing matters even more deeply to the future world.


China is preparing for a fundamental shift of its economic growth drivers from traditional methods of production to innovation and technology. The growth of its “new economies” - new industries, new types of business, new business models - is growing exponentially and are influencing economies globally.


China’s strategic interests are becoming clearer and it is gaining further confidence in its ability to engage more proactively in global affairs.


How nations and companies chose to respond to these changes will be matter for them to decide, but what is important is that we don’t cut ourselves off from an understanding of China’s new economic direction and priorities. The upcoming 14th Five-Year Plan and Vision 2035 are a good place to start.



Source: King & Wood Mallesons


Enstrusted lending in China: a shadow...

Enstrusted lending in China: a shadow banking primer

By Luke Deer


Entrusted lending became the second largest source of financing in China in 2013 after bank loans and the largest shadow lending channel. This article explains the entrusted lending channel, looks at why it grew and at how recent changes to inter-enterprise lending rules may impact on entrusted loans.



Entrusted lending is a unique feature of shadow banking in China.  The ‘entrusted loan’ (委托贷款) channel was set up after a 1996 People’s Central Bank regulation which prohibited direct lending between non-bank entities, primarily between enterprises but also by government entities.



The first decade and a half of reform and opening after 1979 opened up informal non-bank financing activity on a large scale.



Together with widespread capital and goods shortages, the effect of these reforms by the late 1980s was a stop-start inflationary growth cycle at the macro-level, a crisis in profitability in the state-owned enterprise system and a major non-performing loan problem in the bank system.



China’s authorities’ were therefore seeking to bring non-bank financing channels under control. But legally choking off direct all forms of non-bank lending posed a problem for ‘legitimate’ financing and liquidity management, particularly among corporate affiliates and from local government financing entities.



Thus the ‘entrusted loan’ channel was set up as an official work-around to allow non-bank institutions to lend to each other indirectly via the official banking system.



Moreover, until very recently, China’s central bank, the Peoples’ Bank of China (PBOC) had sought to conduct monetary policy by directly controlling monetary aggregates through lending targets–and the ‘entrusted loan’ channel allowed the the PBOC to account for non-bank lending activity via the banking system.



Under the ‘entrusted loan’ facility banks conduct an agency businesses to facilitate loans between corporate and other non-bank entities for a fee.



Formally, the non-bank enterprise lender retains the risk on the principal and interest of its loan to its designated borrower and the banks get the right to fee income from the ‘entrusted loan’. But banks and non-banks entities could also use the entrusted loan channel to circumvent regulatory restrictions.



Until September 2015 regulators had sought to manage bank balance sheet risk by enforcing a 75 percent loan to deposit ratio, which stipulated that banks could not loan more than 75 percent of their deposit base. Because ‘entrusted loans’ do not appear as loans on bank balance sheets’ and are treated as an ‘other investment asset’ banks could use ‘entrusted loans’ to circumvent the 75% loan to deposit ratio by using the ‘entrusted loan’ channel.



The attempt by China’s monetary authorities to reign in bank lending between 2010 and 2013 led to a sharp growth in alternative balance sheet lending strategies by the banks, primarily through entrusted lending but also through issuing bankers’ acceptances.



As Chen (2016) explain in a recent paper, monetary tightening between 2010 and 2013 led to a worsening LDR ratio for banks, especially for smaller second banks who were more easily squeezed by falling deposits.



It was these banks who turned aggressively to alternative lending strategies, such as ‘entrusted lending’ to mitigate regulatory risk of their worsening LDR ratio.



Banks could also trade ‘entrusted loan’ assets on the inter-bank market, and this provided further incentives for enterprising banks to build ‘entrusted loan’ businesses.



The result, according to Chen (2016), was that “the share of entrusted loans in the sum of entrusted lending and bank lending tripled during the monetary tightening period [from 2011 to 2013].”



While entrusted lending could provide corporate and other non-bank affiliates with a liquidity and investment facility, entrusted loans could be used to lend to non-affiliates at interest rates above the prime lending rate to restricted industries as well for purely speculative financial investments.



From 2005 to 2010 the China Banking Regulatory Commission and the State Council passed a series of increasingly stringent restrictions on bank lending to overcapacity, polluting and ‘risky’ industries – especially real estate related sectors.



However, ‘entrusted loans’ did not count as bank loans so they could be used to circumvent lending to restricted industries.



The entrusted loan channel could also be used by companies with good access to official credit channels, such as large publicly listed enterprises and local State Owned Enterprises, to borrow at low cost from the banks and to lend at high interest rates to non-affiliates in restricted sectors.



For mature firms facing slowing growth, increased credit during the stimulus failed to offset the declining returns on investment in their core businesses, and instead they turned to speculative investment through high interest rate lending, including financing positions in the stock market.



A recent paper by Yan (2015) found that speculative lending through the entrusted loan channel was more common among publicly listed mature firms with lower growth opportunities, particularly where their earning capacity was below the prime lending rate.



While the growth of entrusted lending has attracted scrutiny, there has been little firm evidence about the the extent of speculative lending through the entrusted loan channel.



However new data reported by Chen (2016) concludes that: “more than 60% of the total amount of entrusted loans was channelled to the risky industry between 2007 and 2013; out of these risky entrusted loans, 77% was facilitated by commercial banks.”



Recent policy moves may reduce ‘entrusted lending’

The entrusted loan channel was continued to grow in 2014 before eventually provoking a response from the authorities.



In January 2015, the CBRC brought in 5 restrictions on ‘entrusted loans’ designed to mitigate speculative investment though this channel by requiring that ‘entrusted loans’ only be used for lending to the ‘real economy’ purposes–and not for investing in stocks, bonds and other purely financial instruments.



Two further decisions in by the authorities in China may see a declining role for the entrusted loan channel.



First, as part of a wider shift in China’s monetary policy framework away from controlling credit aggregates, the loan-to-deposit restriction was removed by an amendment to the Law on Commercial Banks passed by the National People’s Congress Standing Committee in August 2015.



According to the CBRC spokesperson, the LDR ratio had been set up “to control liquidity risk” but it now longer fitted the reality of more diversified bank balance sheets and would instead be used as a ‘a liquidity monitoring indicator’.



The LDR ratio became a reason for banks to engage in regulatory arbitrage — and by removing the LDR ratio, banks would no longer be as constrained by the composition of the assets they could hold on their balance sheets.



Then, in October 2015, the Supreme People’s Court (SPC), ruled that direct inter-enterprise lending for ‘real-economy’ purposes would also be allowed between non-bank entities–removing the restriction on direct lending between non-banks which had been in place for nearly 20 years.



The SPC ruling on inter-enterprise lending was also subject the same 5 restrictions as had previously been applied to entrusted loans in January 2015, including the stipulation that loans must be for ‘real economy’ production and business activities.



The move towards an increased role for direct lending also fits the authorities desire for a more asset-based growth strategy.



Opening direct lending channels between enterprises will allow corporate affiliates to circulate working capital more easily, but it is not clear how the restrictions on types of allowed lending will be enforced by the courts.



Non-bank entities can go to the courts if their loan contract is breached, but they are unlikely to do so if the loan was used for investment in restricted industries or for purely speculative financial investments, which are explicitly prohibited loan use purposes under the SPC ruling.



The ‘entrusted lending’ channel will remain, but the incentives for using it are reduced because because corporate affiliates can now legally lend to each other directly and bank lending is not subject to the 75% loan-to-deposit restriction.



However, the extent to which the the ‘entrusted loan’ channel will be by-passed remains to be seen.



While enterprises can now legally engage in direct lending, finding partners and enforcing contracts can be costly and banks and other other financial institutions have an incentive to engage in the match-making inter-enterprise loans for fee income.



The opening of legal direct lending between enterprises also means we can expect more complex structured financing deals to be a growing feature of China’s financial system.





This article was originally published in Frontiers of Finance in China

Luke Deer is a post-doctoral researcher at the University of Sydney and a Research Associate with the University of Cambridge Centre for Alternative Finance and with the Cambridge Judge Business School. Luke researches alternative finance in China and the Asia Pacific--with a focus on peer-to-peer lending and crowdfunding, and on financial innovation and central banking in China.

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