Xi is fattening up China's debt "gray rhino", Plus Europe is "backing away" from Xi's Belt-and-Road & US hunts for PRC malware in military systems -- China Boss News 8.04.23
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What happened.
Last week South China Morning Post’s Amanda Lee reported on China's local government debt and why it has become a "gray rhino" for Beijing.
Local governments whose access to financing had been restricted in the ‘90s by budget laws created local government financing vehicles (LGFVs) as a “workaround.” The pseudo-private investment companies (“hybrids”) had more freedom to take advantage of emerging commercial opportunities, unhampered by Beijing’s borrowing rules.
The move was actually encouraged by Beijing, who had “been pushing many LGFVs to diversify, hoping they could generate more revenues and depend less on local government coffers,” Chi Lo, a BNP Paribas Senior Market Strategist for Asia Pacific said in a report on the risk of hybrid LGFV defaults in May.
Unfortunately, hybrid LGFVs “have become more fragile due to excessive risk-taking and poor risk management,” Lo warned. Worse, “Beijing views hybrid LGFVs as more dispensable than quintessential ones.”
The commercially diversified nature of hybrid LGFVs means they function like (local) SOEs. As Beijing retreats from its implicit guarantee policy, which has resulted in rising defaults in recent years … it has allowed (local) SOEs to fail in the hopes of imposing market discipline on the state sector to reduce moral hazard.
Hybrid LGFVs are thus not on the bailout priority list and will have to deal with their debt obligations on their own rather than count on the local or central government.
Why it matters.
Fattening the calf
Easy access to financing at state-run banks coupled with growth goals made LGFVs very popular with officials in the provinces and cities who used them to meet administrative and career goals.
Lee, SCMP:
LGFVs were actually a cornerstone of Chinese development over the last few decades. . . . There are now thousands of such vehicles in China, driving investments in bridges, roads, homes and industrial parks, and boosting the country’s gross domestic product (GDP).
But alongside unprecedented positive development, came unprecedented waste.
Stories of fiscal recklessness shocked even Chinese citizens used to seeing government excess. (One about a small, rural county in poorer Guizhou that “rack[ed] up 40 billion yuan ($5.7bn) in debt with dozens of white-elephant projects” got 27 million views on social media.)
Then, in 2017, Chinese leader Xi Jinping took a firm step towards ending the feverish market speculation that made housing unaffordable the only way he knew how - by breaking the backs of its biggest high rollers.
In October that year, Xi uttered the words that would guide government policy until now: “Housing is for living in, not for speculation.”
Soon after, the government launched a $1.3 trillion real estate crackdown that "left few winners," Bloomberg said.
Xi’s “politically acceptable” property bail-out
By September 2022, however, things were very different. Although LGFVs traditionally invested in public infrastructure, they went on a new kind of debt-fueled "spending spree" designed "to prop up the real estate sector” which had been blindsided by, both, Beijing and Covid, Financial Times reported at the time.
FT:
A plunge in land sales and softening prices have exacerbated the pressure on local governments already grappling with shrinking tax bases amid the wider economic downturn. This has led many cities and provinces to ask LGFVs to fill the vacuum left by private developers.
“We have played a critical role in keeping the land market and government revenues from falling off a cliff,” said an executive at Yueyang Urban Construction and Investment. The LGFV, based in central Hunan province, spent Rmb1.3bn on land purchases in the first half of [2022].
With only weeks remaining until Xi would be appointed to an unprecedented third term at the 20th Party Congress, China’s local governments again gorged themselves on eye-watering levels of debt in what one expert described as “a politically acceptable” bailout.
Now those same LGFVs, who “typically have little experience in property development” and “are known for their sluggish financial performance” are faced with paying back their debts while China’s economic growth stalls.
The IMF estimate of LGFV debt “ha[s] swollen to a record 66 trillion yuan (US$9.23 trillion) this year – more than doubling since 2017, when the total was 30.7 trillion yuan,” SCMP’s Lee said. In 2017, China’s economy grew by nearly 7%. However, Fitch anticipates growth will slow to 5.6% in 2023, 4.8% in 2024 and 4.7% in 2025.
Where “central planners rule”
That China's fiscal administration today is, often, described as one of the most de-centralized in the world is misleading.
Although Deng Xiaoping famously opened China to foreign investment and created “special economic zones,” early post-Mao attempts at fiscal decentralization failed to put most local governments on "a self-financing basis," according to Christine P.W. Wong at the National University of Singapore.
The reason, Wong says, is because “the old fiscal order was thrown into considerable disarray by the elimination of control of entry into industry, a mechanism through which the government had exercised control over the creation and placement of revenue surpluses.” In other words, the Chinese government, including Beijing, was about to go broke.
A 1994 VAT rule significantly improved the state’s finances, but made local governments increasingly dependent on state-owned banks to meet their expenses.
Nicholas Borst, director of China research at Seafarer Capital Partners, told SCMP that China’s current leadership would be “reluctant to change the fiscal structure because it gives Beijing significant financial control over the provinces.”
“The policy direction under Xi Jinping is towards greater centralization and reinforcement of state control over key parts of the economy. Fiscal reform would likely cut against both of those tendencies,” he added.
Xi’s return to Mao-era mass mobilization governance has only compounded the problem. One example can be seen “[i]n a growing list of places” where local cadres are answering his calls for food security “with more zeal than common sense,” the Economist’s Chaguan said last week.
In Xi Jinping’s China, central planners rule, The Economist:
In and around Chengdu, the capital of Sichuan province, officials are focusing on Mr Xi’s current priority. That means growing grain. They are making their obedience visible. Mr Xi visited the fertile Chengdu plain last year, recalling how it was known in history as “heaven’s granary”. Those words, along with Xi-isms about food security and cropland, now appear on village walls and roadside propaganda posters.
Another of Xi’s top priorities is to win the tech-war with the United States using “‘high-quality’ growth, a strategy that favors tech industries over the vast manufacturing hubs that churn out basic consumer goods,” Financial Times recently reported.
Yet factory activity - which is currently in its fourth month of contraction - was “one of the pillars” which supported China’s economy during the worst of the pandemic.
Worrisomely, Robert Carnell, ING’s regional head of research for Asia-Pacific, said China's poor manufacturing purchasing index (PMI) data is the latest evidence its economic recovery is not "turning the corner.”
Carnell noted that the Chinese government’s vocal support for the economy “has not translated into the sort of sizeable fiscal policy stimulus many in the market have become used to expecting.” “We don’t think it is coming,” he said.
Earlier this year, local governments began "doubling down on cash incentives and policy support for home-grown semiconductor companies," as TechWire Asia reported.
The old LGFV term has a lot of land investment baggage, and so they called the new scheme something entirely different. But is it? To answer that, you should read more about the Big Fund.
TechWire Asia:
Announced over the weekend, local authorities in Guangzhou said 150 billion yuan would be injected into an Industry Investment Fund of Funds (FoF), focusing on financing activities in semiconductors, renewable energy, and advanced manufacturing. An FoF, designed to allocate cash to a portfolio of investment funds, is increasingly used by Chinese local governments to develop preferred industries.
. . . Guangzhou’s latest initiative is basically in line with calls made by China’s leadership to help revitalize the country’s beleaguered private sector during the 20th Party Congress last October.
This Week’s China News
The Big Story in China Business
EUROPE “BACKING AWAY” FROM BELT AND ROAD: Europe is "backing away" from Chinese leader Xi Jinping's Belt and Road Intiative, amid tensions with China and Russia's war in Ukraine, Wall Street Journal reported last week.
“Sending our regrets”: Many European countries are “skipping” China’s 2023 Belt and Road Forum which Beijing promotes as a “high-level ‘brainstorming’ session,” designed to foster “an open and efficient international cooperation platform; a closer, stronger partnership network; and to push for a more just, reasonable and balanced international governance system.”
Russian President Vladimir Putin's confirmation of attendance likely made turning down the invitation a whole lot easier for “European leaders, many of whom have hardened their stance toward China because of Beijing’s support for Moscow since the start of its war in Ukraine.”
According to WSJ, leaders from France, Germany, Italy, Switzerland, Greece and Czech Republic have confirmed they won’t attend the forum.
Joining BRI was “improvised and wicked”: In an interview on Sunday, Guido Crosetto, Italy’s defense minister, called his country's decision to join China's Belt and Road "improvised and wicked."
"The choice to join the Silk Road was an improvised and wicked act, made by the government of Giuseppe Conte, which led to a double negative result. We exported a load of oranges to China, they tripled exports to Italy in three years," Crosetto said.
Crosetto also said that Italy plans to leave the BRI, but did not when an official announcement would be made.
In other China business news
HOUSE COMMITTEE SAYS BLACKROCK, MSCI FUNDED PLA: BlackRock and MSCI have been accused by the US House of Representatives China committee of "profiting from investments that help the Chinese military and undermine American values and security," Financial Times reported.
The committee sent letters to both firms' CEOs as part of "a series of investigations into Chinese activities and investments by US companies in Chinese groups," news staff said. A BlackRock spokesman said it would “‘continue engaging’ with the China committee on the issue,” while MSCI said it was “reviewing” lawmakers’ questions.
SIEMENS SIGNALS MOVE OUT OF CHINA: In a recent Politico op-ed, American Enterprise Institute’s Elisabeth Braw said German engineering giant Siemens is signaling a manufacturing move out of China.
After “announcing a €140-million investment in the industrial city Chengdu,” CEO Roland Bush announced much larger factory investments in Singapore, the US, and, even, Germany. “[A] sign of the times,” she said.
Law and International Xi
US HUNTS FOR PRC MALWARE IN MILITARY SYSTEMS: New York Times reporters David E. Sanger and Julian E. Barnes reported that officials and analysts suspect Chinese malware has infiltrated systems linked to US military operations and could be “hidden deep inside the networks controlling power grids, communications systems and water supplies."
Last May, Microsoft announced it found Chinese malware in Guam, home to Andersen Air Force Base. The discovery “turned out to be only the narrow slice of the problem” and was the catalyst for a broader investigation.
“More than a dozen U.S. officials and industry experts said in interviews over the past two months that the Chinese effort goes far beyond telecommunications systems and predated the May report by at least a year,” Sanger and Barnes said.
PRC’S LONG ARM FINDS HUMAN RIGHTS LAWYER IN LAOS: Activists and family members of Chinese human rights lawyer Lu Siwei are pleading for intervention after Lu was taken into custody by Laotian officials last weekend. Lu was on his way to join his family in the United States when he was arrested.
Lu’s license to practice law was removed for defending human rights activists and Hong Kong protesters in China. Read more about his story here.
Geopolitics
CHINA-RUSSIA JOINT PATROL IN SEA OF JAPAN: Last weekend five Chinese and five Russian naval vessels "sailed through the Soya Strait between Hokkaido and Sakhalin island to the Sea of Okhotsk," Japan Times said. Beijing earlier blasted Tokyo for “escalating tensions in the region” after the release of a defense whitepaper which highlighted China asthe country’s “greatest strategic challenge,” JT staff said.
The report shared with Cabinet said, projected that Chinese would increase efforts to develop a world-class military on par with United States, and “devot[ed] an entirely new section” to China’s military moves around Taiwan, news staff said.
EIGHT NEW PLA NAVAL BASES IN THE WORKS, ANALYSTS SAY: Finally, a new report by a former British Royal Navy officer and AidData's Chinese Development Finance Program analyst has identified eight Chinese-funded port investments most likely to become new locations for PLA naval bases.
After examining a “detailed data set [of] 123 seaport projects at 78 ports in 46 countries,” authors Alexander Wooley and Sheng Zhang shortlisted: Hambantota, Sri Lanka; Bata, Equatorial Guinea; Gwadar, Pakistan; Kribi, Cameroon; Ream, Cambodia; Luganville, Vanuatu; Nacala, Mozambique; and Nouakchott, Mauritania.
Best Reads
Tears in Heaven - Organ Trafficking in Asia (Martin Purbrick, The Asian Crime Century): Purbrick surveys the “fraud epidemic” of illegal organ trade across Asia.
‘A Trojan horse’? Taiwanese islands weigh plan for ‘peace bridge’ to China (Amy Hawkins, The Guardian): Taiwanese citizens living on Kinmen, a tiny group of islands three miles away from China, would like to build a "peace bridge.”
From salesman to ‘spy’: An inside account of arbitrary arrest in China (Vic Chiang and Christian Shepherd, The Washington Post): A Taiwanese electronics salesman tells the harrowing story of his political detainment and exit ban in China.
Middle Kingdom Surreal
CHINA'S IMAGE AS ECONOMIC POWER “FALTERING”: Public perception of the second-largest economy in the world is "faltering across high-and middle-income countries, Aljazeera staff said, citing a Pew Research Center survey.
China is viewed increasingly negatively “by two-thirds of people in 24 countries, while “[p]ublic perception has fallen particularly hard in Europe, notably in Germany, the Netherlands, Poland and Sweden” news staff said. Read Pew’s latest survey results here.
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Have a great weekend.
