By Wei Gu

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

Subsidies are an old Chinese practice that is causing new headaches. The European Commission is poised to launch a big trade case against China over state credit given to telecoms equipment manufacturers, according to the Financial Times. Yet the companies in question, such as Huawei and ZTE, are competitive enough not to need such perks. Beijing’s support for national champions makes it easy for others to cry foul play.

Huawei’s $30 billion credit line from China Development Bank is believed to be at the centre of the probe, according to a person familiar with the situation.  A European Commission report said in 2011 that China’s largest telecom equipment makers are benefiting from significant government at home, including “massive” credit lines from state-owned banks.

But the effectiveness of cheap state financing may be exaggerated. Huawei itself mostly uses foreign banks for financing, since they offer more competitive rates. Huawei’s customers also rarely tap into that CDB credit line for export financing, as the terms aren’t that favourable, according to a person close to the situation.

It may be sour grapes. Huawei, the world’s second-largest telcom equipment maker by revenue after Ericsson, has been grabbing market share from its Western peers. It spends a high ten percent of its revenues on research and development. Moreover, the company’s low-cost equipment gear may also be more suitable to developing markets, which are the main growth areas.

Tellingly, no European companies have formally complained, which suggests they are eyeing more business in China. The EU’s main goal may be to prize open the market to more European companies. China’s build-out of dozens of “smart cities” in its current five-year plan represents a $153 billion opportunity across 54 projects, and the bulk of them will be telecoms equipment, according to Boston-based Lux Research.

By Wei Gu

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

The last thing China’s economy needs now is another giant stimulus package. Premier Wen Jiabao has raised investors hope for a policy U-turn by saying that growth deserves more attention. But Beijing shouldn’t panic this time. Unlike in 2008, there are no massive job losses threatening stability, and still too much money sloshing around from the last stimulus. Structural reforms are the right remedy.

China’s economy is at its coolest level in three years. First-quarter GDP growth at 8.1 percent was the slowest since mid 2009. The World Bank has cut its forecast for 2012 GDP to 8.2 percent. China’s three growth engines – fixed investment, exports and consumption – are all losing steam. Fixed asset investment grew 20 percent year on year in April, the slowest since 2002.

Still, employment has been surprisingly resilient. The official unemployment ratio has remained at 4 percent since late 2010. The country added 12 million jobs in 2011, exceeding the 9 million goal, even after 10 percent annual minimum wage increases in the past few years. As China’s population ages, there is less need to grow as fast as before to absorb new workers coming into the market. China’s working population will stop growing in 2013, according to China Social Science Academy.

Moreover, there is a growing consensus on the side effects of a monetary stimulus – which would probably mean getting banks to lend more. Inflation dropped to 3.4 percent in April, but faces upward pressure as Beijing liberalises energy prices. Asset prices could also rise. House prices are continuing to climb in around a fifth of Chinese cities. The system is still coping with the last round of stimulus. China’s central bank was responsible for half of the new creation of “M2” money globally in 2011, according to Standard Chartered.

True there is room to give domestic demand a small boost, but this can be done through reforms rather than spending. On the investment side, Beijing is likely to push forward key infrastructure projects, especially in the underdeveloped west, to resolve logistics bottlenecks. Speeding up the modernisation of state-controlled sectors like railways, and breaking up remaining monopolies like healthcare, would help unlock potential demand. There’s no need yet to throw money at the problem.

By Wei Gu

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

High-growth Chinese internet companies may be surprisingly defensive investments. True, fears about the cyclical advertising business have driven down shares in Renren, China’s Facebook lookalike. But other Chinese dot-coms should suffer less. Strong roots in gaming, whose revenue is still surging, makes diversified players like Tencent and Sohu comparatively recession proof.

Facebook’s poor showing in its first few days as a public company has damped enthusiasm for social networks. GM, a large U.S. advertiser, recently dropped Facebook ads for fear it may be a less effective channel than other forms of internet advertising. Facebook’s ads garner just half the clicks per page view of the average ad-hosting website, according to internet ad consultant Wordstream.

China’s advertising spending can be particularly cyclical. Developers and auto companies, the biggest spenders on advertising, are suffering due to Beijing’s home purchase restrictions and slower domestic demand. Renren’s first-quarter advertising revenue tumbled 46 percent from the previous three months. Sohu’s Brand advertising dropped 22 percent quarter on quarter.

But China’s dot-coms have been focusing on a more resilient line of business: gaming. Sohu’s online game revenue rose 3 percent quarter on quarter to nearly a record high. Tencent’s gaming revenue grew 15 percent in the first three months of 2012. Internet games are cheaper than a night out, making them attractive during economic downturns.

The gaming business is not only steadier; it can also be more lucrative. Games tend to have a longer shelf life than movies and news, and it takes fewer people to develop. The gross margin of Nasdaq-listed Changyou is almost 90 percent, compared with under 60 percent at Sina, which mainly relies on advertising. The increasing popularity of mobile devices also favours gaming over social networks, as it is harder to display ads on small devices.

By Wei Gu

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

Alibaba has finally reached a truce with Yahoo. The Chinese e-commerce giant is offering at least $7 billion to buy back its own shares from the U.S. internet group, recapturing half the stake Yahoo acquired in 2005 for $1 billion. The timing is good, since Facebook’s IPO has left cashed-up investors who could help finance the deal. But a successful outcome will heap pressure on Alibaba.

Yahoo is making some compromises in giving Alibaba what it has long wanted. The new deal will expose it to a hefty tax bill – something it had hoped to avoid. Yahoo will also give up one of the two seats it currently holds on Alibaba Group’s four member board. Still, the U.S. group will keep some upside from Alibaba shares, by holding on to half of its 40 percent stake until Alibaba eventually lists its shares.

Alibaba too is taking the rough with the smooth. It has agreed to value itself at a minimum of $35 billion, compared with the $32 billion at which it sold shares in 2011. The final price, which will be decided by a sale of Alibaba shares, may be higher. Moreover, it must come up with at least $6.3 billion in cash in the next six months. That comes just months after it borrowed $3 billion from a group of six banks to privatise its B-to-B e-commerce portal, Alibaba.com.

Facebook’s recent initial public offering has probably helped, by creating substantial new wealth among Internet investors. Russia’s Digital Sky Technologies, which participated in Alibaba’s last round of fund raising in 2011, is one. It just sold $1.6 billion worth of shares in the U.S. social media giant. Others who invested in Alibaba in the past, such as Singaporean state investor Temasek, may also be interested.

Once the money is raised, Alibaba founder Jack Ma must deliver growth to justify its valuation. The $35 billion at which it must raise finance is equivalent to 130 times 2011 net profit, compared with 31 times for Tencent and 45 times for Baidu, China’s two biggest internet companies by market capitalisation. Moreover, new investors are likely to one day want an exit. In closing the door on the Yahoo saga, Ma may be saying “open sesame” to another.

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.

By Wei Gu

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

Hong Kong is playing the China card in the bidding for the London Metal Exchange. Proximity to the world’s largest consumer of metals might make up for the Hong Kong Exchange’s relative inexperience in trading commodities. But Beijing may open up regardless of who owns the LME.

For Hong Kong, the bid is a bold attempt to move beyond its main business of trading and clearing equities. A robust flow of listings from the mainland, and less intense price competition than that facing its rivals in the West, have made Hong Kong the world’s second-largest exchange by market value, behind CME Group. But the flow of new issues from China may have peaked. The LME could drive a new revenue boost.

There’s no question that China is under-represented on the LME. Though the country consumes 40 percent of the world’s metals, China-related trading is estimated to account for just 20 percent of LME volumes. If China-related ownership had helped lift that figure to, say, 30 percent, the LME’s 2010 revenue would have been boosted by roughly 10 percent.

Such a shift is largely in Beijing’s gift. The LME currently has just one Chinese member and a handful of companies which do business through other members, as Beijing restricts domestic firms from trading on foreign exchanges. Greater Chinese participation would also favour current LME members such as JPMorgan and Goldman Sachs, which make money from trading, financing and other services.

Hong Kong often stands first in the line when China opens up. But it’s unclear that the door for the LME will open faster under Hong Kong ownership. Chinese authorities are concerned that local firms’ risk controls aren’t up to global standards, after a few high-profile trading losses. They also want to give time for the Shanghai Futures Exchange to develop before allowing LME’s warehouses in.

By Wei Gu

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

Wall Street may be the winner from this year’s bilateral talks between the United States and China. Foreign banks who run Chinese securities joint ventures, including Morgan Stanley and Goldman Sachs, will soon be allowed to raise their stakes to 49 percent, according to a U.S. official in Beijing. It still doesn’t match the heavy lifting they do, but it is a breakthrough in an important market.

Global banks can own 33 percent of their joint ventures today. Most ventures can only underwrite stocks and bonds, and are not allowed to buy and sell securities on clients’ behalf. There are exceptions for those who got in early. Goldman has managed to effectively control its venture through a special arrangement with its partner, while UBS enjoys wider trading powers than its peers.

The new rules will give the foreigners more influence relative to their demanding Chinese partners. Domestic firms, which put in two thirds of the money, often chase short-term profits. Global players should care more about building a lasting franchise and avoiding reputational risks.

All this is in China’s interest. If global banks are better compensated for their work they will work harder to bring in global best practice in corporate governance. With a fairer share of the returns, they may also put more effort into the joint ventures, instead of trying to use their platforms to channel deals to their offshore investment banks.

In a further sign of opening, foreign ventures will be able to trade financial and commodities futures, though it remains to be seen whether all will be able to participate. The number of commodity transactions in China hit 3 billion in 2010, three times as many as the volume in the United States. Meanwhile the financial derivatives market has a long way to go.

By Wei Gu

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

China’s stock market is reforming fast, but investors hoping for higher stock prices may be disappointed. New chief securities regulator Guo Shuqing took office just half a year ago, but has already brought in a slew of new rules. The latest is to lower trading fees. The aim may be to pep up valuations across the market, but the biggest beneficiaries are likely to be China’s brokerage firms.

Chinese stocks need a boost of some sort. They trade at a discount to Asian peers, and the lowest multiple of forward earnings since late 2008. But investors are still staying on the sidelines. Bank deposits in China are equal to 3.6 times the country’s market capitalisation, according to Citi, far higher than other Asian countries. Earnings growth has disappointed as the economy slows, but new supply of stock keeps coming. Accounting and insider trading scandals have further eroded faith in the market.

The new rules are supposed to make investors feel safer. The China Securities Regulatory Commission has called for more comprehensive dividend policies, broadened delisting regulations, and disclosed previously secret approval procedures for new stocks. But enforcement is still weak. The power to delist companies is rarely used. Vested interests, such as local governments who may own stakes in listed companies, are strong.

In the short term, it’s China’s struggling brokerages who will benefit. That industry’s total profits fell 49 percent in 2011, hit by declining trading volumes and lower underwriting revenues, according to the China Securities Association. The CSRC promised to allow more derivative products, build an over-the-counter market for high-tech stocks, and cut the transaction fees collected by the exchanges. For companies like Citic Securities, and newly Hong Kong-listed Haitong, those measures should help drive up trading volumes, bring new businesses for brokerages, and lower their costs.

Chinese securities firms may have started to turn the corner. First-quarter profit was already an improvement on the previous three months, and the more reform the regulator brings in, the faster that trend should run. But when it comes to valuations in the market overall, there’s no quick fix.

By Wei Gu

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

After posting record earnings in 2011, Chinese banks are facing a squeeze this year. Weak external demand hurts lending and weakens its asset quality. Deposits are harder to find, due to the decline in the automatic inflow from the shrinking trade surplus. Hit by poor external demand, losses are rising on loans to smaller businesses.

Funding hasn’t been a problem until very recently. During the last decade, China’s central bank has massively expanded its balance sheet – pushing money into the banking system. The goal of printing yuan is to capture the excess dollars created by the trade surplus so the yuan doesn’t rise too quickly. The People’s Bank of China was responsible for 52 percent of new broad money creation globally in 2011, according to Standard Chartered.

But the trade surplus has been shrinking as the yuan’s real exchange rate has risen, so the PBOC has not needed to create as much new money. From January to March, the quantity of yuan injected into the system in exchange for foreign currencies was three quarters lower than a year earlier. The result is a slower pace of money creation: annual M2 growth decelerated to 13 percent in March, down from 30 percent in late 2009.

As the growth of money supply slows, banks will have more trouble finding deposits, especially cheap ones. Already, banks are being forced to rely more on higher cost sources of funding: asset management products and interbank borrowing. More expensive funding has reduced interest rate margins and could start to constrain credit creation.

The margin narrowing comes at a bad time for the banks. They’re being hit by higher losses, especially from small and medium-size exporters. The main problem is relatively weak export demand. Non-performing loans at Shenzhen Development Bank surged 35 percent during the first three months. Mingsheng Bank, which also focuses on small companies, saw a 40 percent jump in “special mention” loans in the second half of 2011.

By Wei Gu

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

While Western banks get criticised for rewarding failure, those in China are doing the opposite. Despite robust earnings growth, some top-paid Chinese bank heads took home less last year. This may be a response to public discontent over widening income gaps and a lack of competition in the banking sector. It doesn’t really address the problem.

Chinese banks have thrived because they get a guaranteed spread between deposit and loan rates. The industry’s net earnings rose 36 percent year-on-year to hit a record of $165 billion in 2011, according to the China Banking Regulatory Commission. That is a drain on other parts of the economy. Earnings of the 13 China-listed banks that have reported accounted for almost half of the total earnings of 1,800 listed companies in 2011, according to Thomson Reuters. Hong Qi, president of Mingsheng Bank, has said the mid-sized lender’s 59 percent earnings growth in 2011 were “embarrassingly high”.

At some banks, top earners saw steep cuts. The chairman and president of Minsheng, a mid-sized non-state bank, each took home $820,000 last year, a quarter less than in 2010. The chairman of China Merchants Bank got no raise, and the only top-paid banker with a sizable increase was a non-Chinese executive, who works at Shenzhen Development Bank.

Chiefs of the large state-owned banks got raises, but still received a pittance. Regulators cap their packages around $150,000 a year, so the gap with their peers in the government doesn’t get too big. The heads of China’s biggest state-owned banks are appointed by Beijing, and enjoy vice minister status. The 15 percent pay rise for the chairman of the Industrial and Commercial Bank and the 25 percent increase for the president of the Agricultural Bank thus raised few eyebrows.

This kind of populism comes with risks. Banks may find more creative ways to reward and retain their top bankers, such as through bigger perks and expense accounts – with the result that pay becomes less transparent. Rather than targeting CEO pay, China’s could try allowing more competition in China’s financial sector, say by easing restrictions for foreign and micro-lenders. It’s the banks’ excessively large profits that need a trim, not their bosses’ pay slips.