China maneuvers

Theatre in the capital
Not only the National People's conference but some of the sideline events grabbed press attention.  Comment about Bo Xilai has flourished this week as many have looked to interpret what it means for the Chinese Communist Party's strategic direction and generational handover which will see the ascent of Xi Jinping later this year.  The Daily Mail had a piece explaining there was nothing to worry about from this episode of party infighting, while pieces in the Economist and the Telegraph  helped put the events in broader context.  There were plenty of pictures of Bo seemingly looking rather unimpressed with the whole affair.  Bo's own comments to the media before his dismissal from the post of mayor of Chongqing had been to politely to defend his actions in office, while plenty of others commented on prospects of his allies also being purged.

Bo Xilai has been purged

However that was not the only sideshow, as late in the week saw reports of rumours of an attempted coup in the communist party headquarters in Beijing, though later dismissed in the media as misinterpretation of sightings of a military escort for a North Korean delegation.  Amidst tight monitoring of internet blogs, eager Chinese bloggers were reported to be using special code words to evade blocks by the authorities.

While the Chinese government will no doubt be taking many steps to reassume control of events and their reporting, one change reported mostly in the legal press was quite ominous.  Chinese lawyers must now swear an oath of allegiance to the Chinese Communist Party, which seems a regressive step.  Security officials have been summoned to Beijing for "retraining" and a pro-reform professor at the University of Peking was allegedly detained after calling for a national protest.

All in the details
As usual a rolling debate continued as to what sort of landing China would be having in the near future.  The latest instalment saw Patrick Chovanec exchange paragraphs with Andrew Batson in the Guardian.  And Jim Rogers, a previous China bull was announced to be bearish on Chinese stocks for the short term at least.  Amongst all such debates a point that should be considered is how reliable information experts rely upon about China is.

There have been doubts about the collection and reporting of government and private statistics - a recent article in Bloomberg explored the issue while new measures by the National Bureau of Statistics (NBS), hailed by state press as aimed to improve accuracy were also characterised as being aimed at stopping explicit manipulation.

A good example of the role statistics can play in the analysis came this week with two analyses of the Chinese property market which looked at whether there will be a crash in the sector.  Note that Chinese property prices have been sliding for months.  Not a collapse, but a slowdown and consistent with other emerging markets says Kenneth Raposa on a Forbes blog. Kenneth had based his analysis in a large part on statistics from the NBS which suffer from the flaws mentioned above.  Not so say the team from Societe Generale.  While they may be using the same figures as Raposa (along with a PPI metric) they seem to draw their conclusion from a national aggregated basis (the brief note I saw on FT Alphaville did not explain their methodology) to conclude "Chinese property sales and prices have made for dour reading recently" and that taking into account different metrics "arguably the results are a lot worse".

As with any statistics there remain outliers and there were a couple of reminders of the need to be vigilant for unlikely though extreme risks which could affect China.  Analyst Nick Lardy gave some comments on risks of Chinese citizens pulling funds from the property sector to invest in equities precipating a sector slump, while Yu Bin of the Development Research Centre noted remaining risks from the global downturn.

Banks under attack

In addition to criticism over the credit controls which allow banks to fix high margins and take excess profits, there was also futher comment as to the extent which they had underestimated bad loans.  Regulators are starting to take note of the criticisms and the China Banking Regulatory Commission (CBRC) was noted to have had direct communications with some lenders, in what could be the first steps of action which could lead to banks reclassifying the loans and suffering big losses.  A suitably stern looking picture of the coat of arms of the CBRC was also published:

At least one proper use for all the copper stored in Chinese warehouses

But aside from intervention at the top, there is likely to be more news of banking stress at the business level. Caixin magazine had an excellent report of malpractice and rising defaults at loan guarantee company Zhongdan.  What is worrying is not only the apparent prevalence of loan malfeasance (which reminds of the recent US mortgage auto-form filling scandal) but that the company was intermixing risky private lending activities with its regular guarantee business.

And stress in the financing sector seems to be feeding into the general economy.  Not only did this week see an increase in petrol prices for chinese consumers (with the largest increase in three years), but inflation in basic commodities has reappeared with increases in the price of onions.  As this note from an FT blog explains the price increase had been in part due to the tight financing environment: 

But farmers, who have difficulty obtaining bank loans, rely on money lenders to cover a large portion of their cold storage costs. So when the lenders' interest rates shot up last year to as much as 60 per cent, farmers cut their losses and let their green onions rot. 

As the blog noted there had been previous commodity panics, such as with garlic and pork. One hopes the Chinese consumer won't have his or her dinner interrupted by too many other factors any time soon!

Taming the galloping dragon?

Most economists understand an expression like the title to refer to the battle to restrain inflation.  For China, the dragon is a national symbol and in recent times the political elite have not only been battling inflation but struggling to steer China Inc.'s runaway growth.  Prime Minister Wen Jiabo's announcement of the lowered growth target at the annual National People's Congress this week was well covered in the international media, which used the opportunity to look back at the last decade of China's astonishing success story and speculate as to where China (and its trading partners) are now headed.

Speculation like this is not new, but it is an issue which divides - most analysts seem happy to quickly take a stand as either a China bear or as more upbeat.  Jim Chanos, famous for shorting Enron, has been one of the most vocal and consistent in pointing out the peril should a collapse in the Chinese model of over-investment and top-down directed rapid growth occur, in 2010 speaking to students at Oxford University, followed by a more recent explanation of his "long corruption short china" trade when discussing recent property price falls in China on CNN.  Meanwhile with Jim Rogers and other outspoken individuals coming to life, the Wall Street Journal felt compelled to track the ongoing exchanges in its "Chanos China Smackdown Watch" series.

Most will have seen a picture or two of an empty Chinese mega shopping mall, or even London hedge fund manager Hugh Hendry's form of disaster tourism, which involved him standing in front of lots of tall empty skyscapers in a third tier city.  What is interesting is a dynamic behind-the-scenes that may be equally or more important - weakness in the Chinese banking system.

Hugh Hendry in front of a building

This was touched on in Walter and Howie's book, though they covered all of the Chinese financial system, the domestic banks were at the core of the story.  And there was certainly at least one paradox they identified - how could China's large pillar banks, recently internationalised and amongst the largest banks in the world, be so reliant on external fundraising?  Why did rights issues follow soon after their IPOs?

Chinese banks have numerous advantages in their domestic market due to the regulation and restrictions on savings and capital in China - as one piece in the Sydney Morning Herald put it (when referring to the low deposit rates on offer to savers due to government regulation):

No wonder that one senior Chinese bank executive was embarrassed to reveal his bank's profit, or rather, the money his firm had fleeced from depositors.

The large banks have played an even larger role in executing government macro policy, including accelerating lending after 2008 and, with the People's Bank of China's elevating the reserve requirement ratio to its primary tool for slowing inflation, becoming the conduit for transmission of government targets into the economy.

Yet despite (or in spite of) such conditions, Chinese banks are not as necessarily healthy as they seem.  Not only is it likely that the size of their non-preforming loans is understated and likely to rise, there are more fundamental and deeper problems which are likely to manifest themselves.

Charlene Chu is a Fitch analyst who has brought to attention some of these weaknesses.  In this interview with Bloomberg she named a number of issues for concern.  Many are familiar and outcomes remain to be seen.  Of most interest I thought was the reference to questions about the level of capitalisation of banks.  For most the ultimate answer would be that the central government of China has sufficient foreign reserves to act as a backstop in the event of (or preventing any) contagion.  Of course as we know from the European debt crisis, any doubt or uncertainty about a government backstop can disrupt any attempts to bolster bank balance sheets.

There are plenty of toxic loans in China's banking system from legacy debt portfolios accumulated in the eighties and nineties to local government excessive borrowing in the 2000's.  This article by Anthony Hilton in today's Evening Standard (covering a gloomy note by Lombard Street Resarch) gives some more detail and it does not look pretty.  In sum, China's leaders are going to struggle with an unpredicatble dragon for some time to come.