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from Global Investing:

Quiet CDS creep highlights China risk

As credit default swaps (CDS) for many euro zone sovereigns have zoomed to ever new record highs this year, Chinese CDS too have been quietly creeping higher. Five-year CDS are around 135 bps today, meaning it costs $135,000 a year to insure exposure to $10 million of Chinese risk over a five-year period. According to this graphic from data provider Markit, they are up almost 45 basis points in the past six weeks.  In fact they are double the levels seen a year ago.

That looks modest given some of the numbers in Europe. But worries over China, while not in

the same league as for the euro zone, are clearly growing, as many fear that the real scale of indebtedness and bad loans in the economy could be higher than anyone knows.  Above all, investors have been fretting about a possible hard landing for the economy, with the government unable to control  a growth slowdown.

The CDS rises have coincided with worsening economic data -- state-owned companies' profits have fallen 8.6 percent in the January-April period from year-ago levels while industrial production weakened sharply in April. Fixed asset investment - a key driver of the economy - has hit its lowest level in nearly a decade.

CDS fell slightly today after Premier Wen Jiabao called for more efforts to support growth. His comments also provided a mild boost to China's stock markets.  Gavan Nolan, Markit's director for credit research, says Wen's comments suggest growth is taking precedence over inflation in policymakers' minds:

from Breakingviews:

Samsung investors should worry less about Apple

By Wayne Arnold

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Samsung investors are worrying too much about Apple. The company’s shares have slid on concern the iPhone’s maker might be buying Japanese memory chips to cut its dependence for parts on its South Korean rival. But Apple’s diversification only reflects how smartphone demand is outpacing parts supply. Apple still needs Samsung and Samsung’s valuation has fallen too far.

The gadget-maker’s shares fell 6 percent on May 16 on reports from Taiwan that Apple was putting in big orders for memory chips with Japan’s Elpida Memory. Apple might like to diversify: Samsung is not only a major supplier of parts, but its biggest rival. Samsung toppled Apple in the first quarter as the world’s most popular smartphone maker, according to research firm Gartner. Because Apple is Samsung’s biggest single customer, investors worry a shift by Apple will hurt Samsung’s 45.3 trillion won in quarterly revenue.

They can relax: sales of memory to Apple account for less than 1 percent of Samsung’s overall sales, according to Citigroup. Samsung makes more selling it logic chips and screens, but even those add up to only about 5 percent of total sales. Samsung’s parts by contrast make up an estimated 25 percent of the iPhone. Apple’s Elpida purchases most likely result from a shortage of supplies as it ramps up production of the iPhone 5. Samsung can’t easily dedicate more capacity to its U.S. rival.

The launch of the new iPhone in June may be a bigger worry for Samsung, particularly amid slowing growth in China. But global smartphone sales still grew by roughly 45 percent in the first quarter, with Samsung’s mobile sales soaring by 86 percent thanks to the popularity of its larger, 5.3-inch, Galaxy Note phone-tablet. Apple is following suit by swapping the iPhone’s 3.5-inch screen for larger 4-inch LCDs in the iPhone 5.

Investors are discounting Samsung too much. The company’s should grow by 62 percent in 2012, according to consensus forecasts, yet after this week’s decline, the shares trade at just 8.2 times projected 2012 earnings. That’s below Apple, and other peers like LG Electronics and SK Hynix. Investors should have more faith.

from Global Investing:

Battered India rupee lacks a warchest

The Indian rupee's plunge this week to record lows will have surprised no one. After all, the currency has been inching towards this for weeks, propelled by the government's paralysis on vital reforms and tax wrangles with big foreign investors. These are leading to a drying up of FDI and accelerating the exodus from stock markets. Industrial production and exports have been falling.  High oil prices have added a nasty twist to that cocktail. If the euro zone noise gets louder, a balance of payments crisis may loom. The rupee could fall further to 56 per dollar, most analysts predict.

True, the rupee is not the only emerging currency that is taking a hit. But the Reserve Bank of India looks especially powerless to stem the decline. (See here for an article by my colleagues in Mumbai) .  One reason  the RBI's hands are  effectively tied is that  India is one of the few emerging economies that has failed to build up its hard currency reserves since the 2008 crisis and so is unable to spend in the currency's defence. Usable FX reserves stand now around $260 bilion, down from $300 billion just before the 2008 crisis.  See the following graphic from UBS which shows that relative to GDP, India's reserve loss has been the greatest in emerging markets.

But there is worse. The relative decline in reserves since 2008 coincides with a ballooning in India's external debt, both private and public. Comprising mostly of corporate borrowing and trade credit, the debt stands at $350  billion, up from $225 billion four years back.

No wonder investors have upped their bearish bets on the rupee: a Reuters poll of Asian fund managers shows these at a six-month high and significantly higher than any other Asian currency. For now, the trade  looks worryingly like a one-way street.

from Breakingviews:

Asia’s bonds look shinier as Europe and China slump

By Wayne Arnold

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Asian bonds seem likely to gain from growing anxiety about Europe and China. The region’s robust finances have made its sovereign debt a safe haven as larger economies sputter. An indiscriminate sell-off would hurt everyone, but Indonesia, Japan and the Philippines all have qualities that should give them greater resilience.

Worse-than-expected economic data from China and the prospect of a Greek exit from the euro zone have sparked a stampede from risk assets. Investors fear global growth will slow, and that the sell-off will snowball. One way bleaker conditions in Europe could reach Asia is through its banks. European lenders pulled at least $135.8 billion in credit out of Asia in the second half of 2011, according to the Bank for International Settlements.

Asian sovereign bonds should benefit from weaker growth, lower inflation and lower interest rates. The safest are those that are also less vulnerable to outflows. Indonesia, for example, has public debt of less than a quarter of GDP - even Germany owes three times as much. It has relatively little short-term external debt and a much lower reliance on credit from European banks than other Asian economies. Yet the government’s 10-year bonds yield 4.7 percentage points more than Treasuries.

Japan, despite bonds that yield less than Treasuries and a government debt 1.5 times larger relative to its economy than Greece’s, is safer still. Foreigners own less than 7 percent of its bonds, which limits the potential for forced selling, and Japanese deflation has kept demand steady. By contrast, foreigners hold 80 percent of Australia’s government debt.

The most unlikely refuge is the Philippines. Though impoverished, its government has managed to build a $76 billion foreign reserve buffer, equivalent to almost six times its short-term external debt, and finances 95 percent of its public debt at home. Yet Philippine bonds still pay 4 percent more than U.S. Treasuries. Such trades are still risky - not everyone wants to go long the Philippine peso. But the worse things get elsewhere, the more palatable that risk may seem.

from Breakingviews:

China has strongest hand in Philippine stand-off

By Wayne Arnold

The author is a Reuters Breakingviews columnist. The opinions expressed are his own. 

China’s stand-off with the Philippines over disputed islands in the South China Sea puts Manila in a difficult spot. While the Philippines has the support of U.S. military muscle, China is its number-three importer, and it needs China to help fund new mines and fill new casinos. Whoever gets to tap the oil and gas beneath the South China Sea, China would be the biggest buyer. That argues for a peaceful, face-saving solution.

What’s at stake is an atoll called Scarborough Shoal, roughly 200 kilometres from the Philippines and four times as far away from China. China has 13th century records it says establish its claim to the shoal, the entire South China Sea, its fish, and the 2 quadrillion cubic meters of natural gas it estimates lie beneath it - 30 percent of proved global reserves. Its trawlers already have free roam, and the sea’s claimants have agreed to exploit its hydrocarbons jointly. So China already has what it wants in function if not in form.

Manila has taken advantage of Washington’s recent tilt toward East Asia to reaffirm military ties. That buys it insurance and can mollify local nationalists. But Beijing is unlikely to react well to any real sabre-rattling: with its Politburo in transition, leaders can’t afford to seem weak on sovereignty. China hasn’t yet overplayed its hand, but that doesn’t mean it won’t.

Economic threats can be equally potent. China is already discouraging tours to the Philippines and threatening trade and investment. China’s $790 million in direct investment into the Philippines in 2011 was tiny, but stands to grow as Manila tries to double mining exports by 2016. China’s $6.1 billion in imports make it the Philippines’ third-largest export destination. And developers are building four casinos in Manila to lure Chinese gamblers.

Even if the Philippines managed to shoo China from Scarborough’s undersea riches, it would ultimately have to negotiate with China to buy them. Manila thus needs a way to defend its claim without demanding China abandon its own. As the Middle Kingdom expands, its economic heft will inevitably chafe its neighbours. Its challenge will be to create as little offence as possible; for neighbours it will be to avoid taking any.

from Breakingviews:

Chongqing won’t be allowed to fail with Bo

By Wei Gu

The author is a Reuters Breakingviews columnist. The opinions expressed are her own. 

China’s most populous city won’t be allowed to fail the way its disgraced former leader did. With Bo Xilai ousted, a bailout is already being assembled, with new funds from the country’s main policy bank, and help from state-owned firms. Chongqing’s debt-financed growth model is discredited, but the need for stability and growth prevails.

Bo’s dramatic removal as party secretary in March is a turn-off to foreign investors. Korea’s Samsung Electronics in April chose another western city, Xi’an, over Chongqing for its new flash memory factory. And U.S. private equity firm TPG Capital, which has been raising funds for investment in Chongqing, is considering shifting more resources to Beijing and Shanghai, according to the South China Morning Post.

The city’s stretched finances look even more worrying. With Bo gone, the risk is that his pet projects may also be abandoned, leaving Chongqing with lots of unfinished buildings, and lenders waiting to be repaid. Much of the city’s 26 percent nominal GDP growth in 2011 was funded by debt. The local government’s fiscal deficit was 11 percent of GDP in 2011, far more than Beijing and Shanghai’s 3 percent.

The central government is stepping in. China Development Bank signed a memorandum with Chongqing in May to provide more capital for roads and social housing. This may look risky now, but makes long-term economic sense. The west presents better catch-up growth opportunities compared to the maturing east, and should helps promote healthy consumption, as poor people tend to consume more of their income than the rich.

State-owned companies have also offered symbolic support. The heads of China’s top 117 SOEs were set to meet on May 17 in Chongqing, according to local government officials. That raises the possibility that Chongqing may get preferential access to key inputs like power. The city’s bid to become a new technology manufacturing hub has been held back by energy shortages.

from Breakingviews:

Property slowdown leaves China on shaky ground

By John Foley

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

China’s property chickens are coming home to roost. Last week’s economic data shows that a year of falling prices is finally changing developers’ speculative behaviour.

After years of boom, most developers, like many investors, have acted as if the downward move were no more than a blip. When barred from getting bank credit, many property companies found funds elsewhere, notably through so-called trust companies, which make loans funded by short-term retail funding. Throughout 2011, developers merrily continued to add new floorspace at the same rate as they had a year earlier.

April’s data shows there has been a rude awakening. The amount of housing floorspace completed dropped off 56 percent from the total figure for January and February, months usually lumped together to account for the New Year’s holiday. The shift is more than seasonal - the drop off was a milder 35 percent in the previous two years.

Space under construction also failed to show its usual post-New Year spike. Overall, residential real estate investment grew 4 percent year on year in April - a tenth of the rate of a year before. Adjust for inflation, and that’s equivalent no growth at all.

Since new property development accounts for about a tenth of China’s GDP building, a modest slowdown will be enough to cause overall economic activity to sputter. Then there is the second-order effect - local governments depend on proceeds from land sales to fund spending on infrastructure projects. According to the official data, the value of land sales in April was only a little more than half that of March - and was a third of the monthly average for 2011.

from The Human Impact:

Climate change means doing Asian development differently

In the face of climate change, is it time to re-examine the way we do development in Asia?

For years, many developing countries have believed it can be only one or the other - economic growth or reducing carbon emissions.

But a new report by the United Nations Development Programme (UNDP) says it’s possible for countries in the Asia-Pacific region to do both.

"High human development usually means high emissions, but there are ways to do things differently," says Anuradha Rajivan, lead author of the report.

Everyone agrees that Asia-Pacific - which accounts for one-third of the world's greenhouse gases and is home to two-thirds of the world's poor - needs more economic growth if it is to lift millions of its people out of poverty.

But Asia must also do its part to address climate change, not only by adapting and preparing for extreme weather events, but also by reducing its carbon footprint, experts say.

from Global Investing:

Not everyone is “risk off”

Who would have thought it. As fears over the euro zone's fate, Chinese economic growth and Middle Eastern politics drive investors toward safe-haven U.S. and German bonds, some have apparently been going the other way.  According to JPMorgan, bonds from so-called frontier economies such as Pakistan, Belarus and Jordan (usually considered high-risk assets) have performed exceptionally well, doing far better in fact than their peers from mainstream emerging markets.  The following graphic from JPM which runs the NEXGEM sub-index of frontier debt, shows that returns on many of these bonds are running well into the double digits.

NEXGEM returns of 8.4 percent  are on par with the S&P 500, writes JPMorgan and outstrip all other emerging bond categories. Clearly one reason is the lack of correlation with the mainstream asset classes, many of which have been selling off for weeks amid growth fears and in the run up to French and Greek elections.  Second, investors who tend to buy these bonds usually have a pretty high risk-tolerance anyway as they keep their eyes on the double-digit yields they offer.

So year-to-date returns on Ivory Coast's defaulted debt are running at over 40 percent on hopes that the country will resume payments on its $2.3 billion bond after June. The underperformer is Belize whose bonds suffered from a default scare at the start of the year.

JPMorgan said NEXGEM, accounting for 9 percent of the broader emerging debt index and containing 18 countries, offers the best investment opportunity for the rest of 2012:

Stay overweight NEXGEM credits, including Belize, Dominican Republic, Georgia, Sri Lanka and upgrade Gabon to overweight this month.

from Breakingviews:

“Cabbage in formaldehyde” is toxic dish for China

By John Foley

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

China’s food industry is accident-prone. Milk laced with melamine, fake eggs, glow-in-the-dark pork and cadmium-tainted rice have all made headlines. Now there is formaldehyde-laced cabbage, found in Shandong province. Thus treated, the vegetables will last for a week. The economic effect of food-scares can last far longer.

Food accounted for just 2.8 percent of China’s overall goods exports in 2010, according to the World Trade Organisation. But the WTO reports that food exports - such as seafood, apple juice and garlic - have tripled since China joined in 2000. Food scares are toxic for trade. Since chemical-tainted milk killed six children and sickened 300,000 in 2008, China’s exports of powdered milk collapsed to almost nothing, while imports have roughly quintupled. Non-food products too may suffer from a kind of reverse halo effect.

However, the gravest side-effects of food scares are domestic. Cabbage fears are likely to lead consumers to pay up for guarantees of safety. That’s inflationary, since fruit and vegetables have the third largest weighting in the China inflation food basket, according to Rabobank. The poor get the worst deal, since they can’t afford to buy organic, or foreign goods as an alternative.

More subtly but more profoundly, such scandals undermine Chinese consumers’ faith in the country’s institutions and systems. Lack of trust lies behind many of China’s distortions, from too-high savings rates to frequently fraying tempers. Each report of poisoned meat, contaminated vegetables or undrinkable tap water erodes consumers’ sense that the rule of law is taking shape.

The answer is partly economic. Cabbage growers seemed to have used the poisoned spray because long transport times lead to rotting produce. Specific investments - think refrigerated vans and more mechanisation - can reduce this waste.