The Great Debate UK

from The Great Debate:

China can outgrow overcapacity, at least for now

-- Wei Gu is a Reuters columnist. The opinions expressed are her own --

China watchers are worried that excessive lending leads to massive overcapacity. However, the risk of Beijing pressing too hard on the brake is even greater. At least for now, China should be able to growing its way out of its bad debt problems.

Banking regulator Liu Mingkang recently told a conference that China's banks should lend out 6-7 trillion yuan next year, equivalent to about one fifth of China's annual output. Some think that is too much. However, these fears are overdone. Indeed, if new lending falls below 10 trillion yuan, bad debts will soar, private investment will be crowded out and the economic recovery may be derailed.

Since the stock of loans has been enlarged by this year's explosive credit growth, the regulator's target represents  a 15 percent increase in China's loan base. This is in line with past trends, but marks a sharp slowdown from this year's 30 percent growth in total loans.

Just to keep funding current ongoing projects, the economy would need 8.3 trillion yuan in new loans in 2010, according to Nomura estimates. So the current goal implies that here would be no money left for new projects, and some current projects will not receive funding.

Setting the credit growth target too low will make it hard for new borrowers, because banks naturally want to keep funding current projects. That puts private sector borrowers, who are expected to invest more next year following strong government investment this year, at a disadvantage.

What's more, if the banks sense the government might tighten lending targets next year, they are likely to lend as much as possible at the start of the year. This will increase the volatility of credit.

from The Great Debate:

Mickey’s Magic needed for Disneyland Shanghai

-- Wei Gu is a Reuters columnist. The opinions expressed are her own --

China has finally given a green light for Disneyland to build a theme park in Shanghai. Negotiations that started when Bill Clinton was in the White House have concluded just before President Barack Obama is due to visit. The approval looks like a coup for Walt Disney Co, but it will take all of Mickey's magic to prevent the park from becoming another government-financed loss maker.

Disney's last theme park in the region was anything but a hit. Hong Kong Disneyland was created in 2005 in an effort to boost employment in the epidemic-stricken region, but attendance numbers have fallen short of target. This hits the Hong Kong government harder than Disney, because the former not only took an initial 57 percent equity stake in the venture, but also spent $1.75 billion building related infrastructure like a metro line and ferry piers.

Shanghai Disneyland is likely to be financed in the same way. Estimates for the park's price tag are around $4 billion. The government and a group of Chinese companies will contribute about 60 percent of equity, with Disney paying for the rest. The Shanghai government is also likely to pay for the roads leading to the park.

The Hong Kong park has been a disappointment for a number of reasons, some of which might equally be relevant in Shanghai. It is the smallest Disneyland in the world, so it is crowded and not worth visiting for a second day. Culturally, locals identify more with the Ocean Park, which features pandas and sharks and is cheaper. Hong Kong Disneyland's public image has also taken a hit from a bout of food poisoning and accusations that it has exaggerated visitor numbers.

The Shanghai park will be 3-4 times bigger than the one in Hong Kong, making space for more visitors. But this will also increase the cost of relocating current residents. Some locals are busy adding a second floor to their homes so they can demand more compensation when they move out.

Shanghai has twice Hong Kong's population, but average income is only about a quarter that of its wealthier neighbour, so it's far from clear how many visitors will be able to afford a ticket that will cost the equivalent of two days of earnings for a college graduate. Then there is the possibility that the Shanghai park will divert visitors from Hong Kong.

from The Great Debate:

Winning the copyright battle in China

-- Wei Gu is a Reuters columnist. The opinions expressed are her own --

When it comes to protecting intellectual property in China, the United States often feels that its pleas are falling on deaf ears. Its best hope is that China recognizes that copyright protection is in its own interests. To achieve that, Washington needs to push for changes from within.

After a fruitless decade of lobbying China on intellectual property, Washington has reached for the microphone. This week, the U.S. Chamber of Commerce launched a high-profile international forum on intellectual property in Guangzhou, capital of Guangdong Province and best known as both China's manufacturing hub and the global centre for intellectual property theft.

Guangdong understands it cannot hold on to both titles forever. Its reforming leader Wang Yang has vowed to build an innovative Guangdong, but he and his deputies understandably do not want to be criticized in public. The U.S. delegation included high-ranking officials such as Commerce Secretary Gary Locke, but the very man they hoped to engage with didn't show up.

Foreign pressure can help, but changes rarely happen in public. First, both parties need to agree on what they are trying to achieve. As a manufacturer for the rest of the world, China has historically seen little upside in protecting copyright. The United States needs to convince Beijing that, if it wants to develop its own products, then protecting copyright is important.

Huawei Technologies, the telecom equipment maker based in Guangdong, could be a good partner in this. In 2003, Cisco sued Huawei for copyright violations, but dropped the suit after Huawei agreed to stop selling some products. Now, Huawei has emerged as a strong protector of copyright. Last year the company filed the largest number of patents in the world.

Song Liuping, Huawei's chief legal officer, advocates increasing the penalty for IP theft, a view shared by Americans. But he thinks the problem is not the lack of an adequate legal system or even lax enforcement, but the absence of a culture in China that values designs, patents, and copyrights.

from The Great Debate:

Imagine when China runs a trade deficit

-- Wei Gu is a Reuters columnist. The opinions expressed are her own --

If current trends continue, China might swing to a trade deficit in the not-too-distant future. Given that China has enjoyed more than a decade of strong exports, this may sound a bit far-fetched. But even if it happens, this would not necessarily be something for the world to worry about.

Some economists have recently sounded alarm bells about the possibility of a Chinese trade deficit. They argue that if the Chinese current account surplus shrinks, it would leave Beijing with less spare cash to buy U.S. Treasury bonds. Then who would fund the U.S. budget deficit -- and, by implication, U.S. consumers?

Those worries are largely misplaced. First, it is unlikely to happen any time soon. In order for China to have a trade deficit next year, imports would have to outgrow -- or shrink less than -- exports by at least 23 percentage points.

In August, exports fell 23.4 percent while imports fell 17 percent. So while the trade surplus is diminishing, a deficit is not around the corner.

If China's trade surplus shrinks, it will most likely be caused by a contracting U.S. deficit, in which case Americans will be saving more and the U.S. will be less dependent on overseas investors to finance its government debt. That would be a sign that the long-overdue rebalancing of the global economy was beginning to take place.

It would not be so bad for the Chinese economy either, because China is a lot less dependent on exports than many people assume. Although exports have accounted for a whopping 50 percent of the economy in the past few years, the contribution of net exports to economic growth is actually much smaller, because a lot of what China sells abroad is low value-added assembly work.

from The Great Debate:

For Chinese exporters, grass is greener abroad

- Wei Gu is a Reuters columnist. The opinions expressed are her own. -

The U.S.-China tire dispute threatens to spill into other sectors and squeeze Chinese exporters' already razor-thin margins further. It might seem mind-boggling to many that Chinese manufacturers are still hanging on to weak overseas markets even though the domestic economy looks much healthier and surely offers more potential.

But there are structural reasons why the grass is greener outside China. The risk of not getting paid, or getting paid late, is significantly lower when dealing with foreign buyers. The cost of international shipping has dropped so much that it can be cheaper to send goods over the Pacific Ocean than across the country.

In addition, selling to large buyers such as Wal-Mart creates volumes large enough to compensate for weak margins. Moreover, Chinese exporters get all sorts of export rebates and local government incentives which help to lower their costs.

But as the tire spat has illustrated, Washington can slap punitive duties on Chinese imports simply by pointing to a significant increase in imports from China. By imposing penalties in this case, President Obama has opened the door for a slew of similar complaints against Chinese goods. It will only be a matter of time before other countries, worried about where those displaced Chinese exports might end up, start to follow suit.

That's why Chinese policy makers need to get more serious about stimulating domestic spending. It is time for Beijing to revamp a system built over the past three decades that explicitly and implicitly favours exports and to encourage manufacturers to prioritise selling to the domestic market.

A good first step would be to reduce some of the export incentives China offers to certain industries. These effectively subsidise foreign consumers at the expense of domestic customers. For example, Chinese tyre-makers get a tax rebate of about 9 percent on the value of the products they sell abroad. That's why tyre makers can afford to price exported tyres more cheaply than ones sold at home, according to Xu Qiyuan, a researcher at China's Social Science Academy.

from Commentaries:

U.S.-China trade spat more about cars than tyres

Why are the U.S. and China trading blows about something as mundane as car tyres at a time when the world is trying to avoid slipping back into trade protectionism? It's not purely about the $1 billion worth of tyres China sells to the U.S. every year. It has more to do with the $100 billion of automotive vehicles, parts and engines America buys from abroad. China is worried about the direction of U.S policy. Beijing fears that the administration may find ways to thwart China's future plans to ship vehicles to America. China may not yet export cars to America, but it already exports a growing number of parts. Cars are in the pipeline. A recent spate of bids from Chinese companies such as Geely for failing U.S. and European auto brands have shown that it has the ambition to be the next Japan or Korea. Auto sales are the only bright spot in U.S. consumer spending due to the Treasury-financed "cash for clunkers" program. Fears about stimulus dollars leaking abroad are one of the reasons the U.S. trade unions have been aggressively pushing for anti-dumping tariffs. The worry is that the U.S. has imposed the tariffs under a law designed to protect domestic U.S. producers from being damaged by a sudden surge in imports from China. Determining whether this has occurred is a bureaucratic exercise in which experts determine whether such damage is occurring and propose remedies. But there is a political circuit breaker -- the president has discretion in whether to implement remedies. At least four similar, so-called Section 421 petitions were filed during the presidency of George W. Bush, according to the international trade commentator, Scott Lincicome, but none were approved. In this case, Obama came down on the side of the union. This has raised fears in Beijing that there will be more cases in coming months. The Chinese side seems to fear that Obama is bending too much to domestic constituencies such as union and producer interests. Washington needs to be careful about this. Since it wants to export its way out of recession, it should not agitate China, which is potentially a major purchaser of U.S. exports. China does not want the Obama presidency to set a precedent by discriminating against Chinese goods at this time. Moreover, it is concerned that other countries might follow suit and start to target Chinese goods as well. Its reliance on exports is potentially the big weak link among China's recovery. That's why Beijing, which has limited its protest mostly to words in recent years for fear of more retaliation, quickly spun into action this time. China's counterpunch is equally forceful. It is launching an anti-dumping investigation into imports of U.S. chicken products and vehicles. The idea is presumably to raise the political cost for Obama of taking his pen out of his pocket every time a Section 421 case, which specifically targets China, is presented for his signature. During the first half of this year, 89 percent of China's chicken imports came from America, representing a fifth of all U.S. chicken exports. In comparison, tyres account for just 0.4 percent of the value of goods what China sells to America each year and 0.07 percent of China's total exports. While it is no secret that America subsidises its agriculture industry, China also spares no effort in helping exporters and putting up import barriers to protect domestic manufacturers. For example, China agreed in August to stop some discriminatory charges it imposed on imported U.S. auto parts after a World Trade Organization ruling from September 1. After chicken, U.S. soybeans might be the next target. As much as 40 percent of China's soybean imports came from America last year. And this year, China's soybean imports increased by 28 percent. The last time China took retaliatory measures was during the "garlic trade war" against Japan and South Korea in 2000-2001. Washington and Beijing have vowed to cooperate in seeking to revive global economic growth, but the dispute over tyres has laid bare the two countries' continued friction over trade. This could spill into the G20 summit later this month and Obama's scheduled visit to China in November. In previous meetings between the top leaders of the two countries, mostly the U.S. lectured and China listened. Now Beijing is more outspoken about expressing its own concerns and many at home are calling for more tit-for-tat policies. It remains to be seen how the U.S. will react to a more assertive China.

from The Great Debate:

Ex-Google China chief’s dream factory

-- Wei Gu is a Reuters columnist. The opinions expressed are her own --

Google's former China head Kai-Fu Lee wants to create China's next internet giant in a factory. He believes that by combining the smartest entrepreneurs, the shrewdest businesspeople and the brightest business ideas, he will be able to create five highly sellable companies a year. That sounds like an ideal model for venture capital, but is he being realistic?

Lee's plan, formulated while he spent time in hospital over the summer, follows a battle with Beijing regulators who wanted to censor Google searches that lead to pornographic sites. It has drawn strong support from investors.

Lee has managed to raise $115 million in just one month, winning support from YouTube Inc. co-founder Steve Chen, as well as Foxconn Electronics Inc., Legend Group, New Oriental Education and venture firm WI Harper Group.

from The Great Debate:

China stock jitters look overdone

-- Wei Gu is a Reuters columnist. The opinions expressed are her own --

Just as Chinese stocks often rise without fundamental support, they are now tanking even though companies just had a better-than-expected earnings season.

Fears about a policy shift towards tighter liquidity are blamed for the 22 percent decline in the Shanghai market from its August peak. But those fears are largely overblown. Beijing might be talking about boosting domestic consumption, but structural reforms take time and there is little the authorities can do other than continuing to reinflate the economy in the short run.

There are encouraging signs that corporate profits -- the fundamental basis for share prices -- are on the turn.

Chinese companies' earnings for the past quarter rose 36 percent compared with the previous three months, helped by strong results from banks and property firms. Companies also offered a more optimistic outlook, propelling a string of earnings upgrades.

The purchasing managers' index, released on Tuesday, confirms that China's manufacturing sector is keeping up its steady recovery.

Stocks are now trading at about 20 times forecast profits for next year. This is higher than the rest of the region, but Chinese companies enjoy higher growth rates: earnings are projected to grow by 20 per cent this year.

from The Great Debate:

China’s bailout of Taiwan is good for the region

-- Wei Gu is a Reuters columnist. The opinions expressed are her own --

If market performance is anything to go by, Taiwan is the biggest beneficiary of China's economic stimulus.

Because of Taiwan's heavy dependence on exports to Western consumers, it was assumed there was little Beijing could do about its downturn. But Beijing has gone out of its way to take care of the recession-hit island. This year, it sent several procurement missions to Taiwan to buy billions of dollars of goods, even though Taiwan's trade surplus with China is already approaching as much as a fifth of its economy.

China might be pursuing its unification agenda. After all, it has vowed to bring the island under its rule, by force if necessary. But money is a lot better than missiles. The whole point of inter-dependency is that there will be less chance of confrontation. Taiwan could use more investment, particularly in properties and infrastructure, while China is looking for new areas in which to invest its excess liquidity.

In the short run, increased purchases from Taiwan may come at Korea and Japan's expense. For example, computer maker Lenovo <0992.HK> is increasing its orders from Taiwan companies, probably also because Taiwanese firms are happy to stay as contract manufacturers.

But in the long run, warmer cross-strait ties not only  benefit Taiwan and are a positive for China, but also are a very bullish development for the region, which should lead to lower risk premiums in Asia.

The wall of Chinese money has pushed Taiwan stocks up almost 50 percent this year, making it the second best performing market in the world after China itself and followed a decade of underperformance. Taiwanese stocks are currently valued at 26 times of 2009 earnings -- a premium versus the rest of the region.

from The Great Debate:

China’s banks, running hard to stand still

-- Wei Gu is a Reuters columnist. The opinions expressed are her own --

Chinese banks are like enthusiastic runners on an accelerating treadmill. The weakening economy means poor lending decisions are threatening to catch up with them, but the banks are sprinting ahead by expanding their loan books ever faster. They cannot keep this up for ever.

For now things still look fine. China Banking Regulatory Commission (CBRC) this week claimed that Chinese banks were managing credit risk sagely, pointing to record low non-performing loan ratios. Given the massive increase in the number of loans outstanding -- up 24 percent since the start of the year -- it's not surprising that the proportion of them that are non-performing at large commercial banks, which accounts for 60 percent of the lending, has declined from 2.4 percent to 1.8 percent in the past six months.

Chinese banks appear to be focusing their lending on regions which have suffered the most in the crisis. The five regions that have shown the largest increase in new loans are the ones that were hit hardest by the downturn, namely coastal cities such as Guangdong, Jiangsu, Zhejiang, and Shandong, plus Beijing. These are also the regions that have experienced among the slowest growth this year. This suggests that loan growth is being driven by official policy rather than the product of bankers seeking the most attractive investment opportunities.

Chinese banks had double-digit NPL ratios before Beijing cleaned them up in preparation for their listing on foreign exchanges. Foreign banks with risk management expertise were brought in, and offered cheap stakes in Chinese institutions to encourage them to share their knowledge. This led to an improvement in lending standards as Chinese banks installed expensive computer databases and formed central credit offices.

It is not clear however how deeply these reforms have been entrenched. The banks remain very decentralized and lending standards are generally lower than their foreign counterparts.

In the past few years, Chinese bankers were restrained by the regulator from going on lending sprees. Banks were given lending quotas to prevent the economy from overheating. This year, with growth the main concern, there were no ceilings.