Floating corpses...

In the wonderful booming economy of China, everything is in demand, or so the official line goes. Around the world, people and businesses expect China to have an insatiable demand for everything.  Even as a recent Beyondbrics post points out, burial space - the following extract gives some flavour of the demand for sea burials in Shanghai:

And not everyone is lucky enough to be buried in Shenyang – or in fact, in the ground at all. The Shanghai government recently increased subsidies it pays for sea burial fivefold, from Rmb400 ($65) to Rmb2,000, leading to an explosion of would-be seafaring corpses. Some families were told they would have to wait until 2015 to have their relatives buried, until the government was able to persuade another ship owner to add his vessel to the sea burial fleet. It is hoped this will clear a backlog of 2,000 urns of ashes waiting to be scattered at sea.
In 2010, government officials were predicting the city could run out of room to bury its dead by the end of the decade. Shanghai Daily says so far 25,000 urns have been emptied at sea, saving more than 75,000 square meters of burial land. The city wants to boost sea burial to 2 per cent of total burials, up from 1.5 per cent now.  

As the article notes (and has been extensively reported worldwide), these are not the only corpses which are floating around China now or into the future, as recent weeks have seen discoveries of large numbers of animal carcasses in waterways, including those feeding municipal water supplies.  No reasons have been given by officials for the discoveries, although there is speculation that it may be an unintended effect of recent food safety crackdowns.

This provides an interesting backdrop amidst attempts by the top leadership to focus on greater wellbeing of ordinary citizens.  But it is reflective of the corporate atmosphere in China at the moment as well.  Last week saw the first Chinese bond default as the main subsidiary of former solar giant Suntech entered into bankruptcy.  This had been predicted by many for some time (and noted on this blog) and the fundamental weaknesses remain in the industry, as the opportunities for solar panel cells remain troubling.

How many other floating corpses will there be in China?  Probably a lot.  In addition to other Chinese solar companies like LDK and Chaori which are also facing significant weakness, signs of trouble in bigger state-owned companies were also present with news that CNPC was planning to sell stakes in certain pipeline projects (the linked article mentions strained working capital - not a good sign).

Strong earnings in the corporate sector are supposed to ensure that there is a successful rebalancing of the economy- with growth in Chinese consumer spending and slowing of exports.  At least on the consumer side that does not seem to be happening.  Local sportswear retailers, once the darlings of various stockmarkets when they listed shares a couple of years ago, are predicting tough conditions for this year, while international brand Nike has seen declining sales in comparison to this time last year.

Any doubts as to the difficulty of the consumer story in China should be satisfied by the below picture - taken from queues of people who attend a McDonald's restaurant promotion which involved a free breakfast giveaway.  While the comments section of the article was full of debate as to why those queuing would cover their faces - the below image does not suggest a land of happy rampant consumerism!

Caption competition
On a final note we are welcoming suggestions for a caption for this picture, which is of the underside of a newly built bridge in Nanning city, which unfortunately only clears a pedestrian walkway by 1.3 metres.  Prizes to be announced!

Snakes and suitcases...

A year in review
Last year was a very generous year of gift giving it seems with many Chinese seemingly awash with cash and, in some cases looking to transport it out of China. Seizures were reported at airports in North America and a road checkpoint in France, while even within China bank staff at one bank in Henan province spent their time in the new year counting through a large mountain of low value bills deposited by one customer.  With the Year of the Snake soon approaching and awards season kicking into full swing, it seemed like a good moment to reflect on some of the achievements of 2012 and make some predictions.

China's latest export?

Intoducing the Moutai Awards"! 茅台奖!
Inspired by the longstanding favourite of Baijiu connisseurs (although since being banned at military banquets it has fallen in popularity as a luxury item), we now present our nominations for celebratory bottles of the oft-contaminated tipple to mark outstanding achievements (and notoriety) during the year.

Wedding of the year - At a price tag of approximately $150 million, the dowry given by Wu Duanbiao, a Fujian businessman to his daughter at the start of her 8 day marriage celebrations in December seemed to include everything but the kitchen sink, which presumably could have been manufactured by Wu's ceramics firm Fujian Wanli Group.

Scoop of the year - Although the Bo Xilai affair had readers worldwide captivated for many months and despite a commendable late effort by Bloomberg in exposing the complex web of connected Princelings ruling over China's Bureaucracy and Xi Jinping's family wealth, David Barboza of the New York Times stood out for his perfectly timed expose of Wen Jiabao's family business interests, on the eve of Wen's retirement.  Not only creating a lot of attention, it caused an immediate response from the Chinese authorities and was probably the reason for a number of recent measures, including the proposed removal of directors' personal details from the companies registry in Hong Kong (a key source for investigating officials' dealings) and the collapse of HSBC's exit from dominant insurer Ping An.  Special mention also to John Garnaut for his research into reshuffles of the Chinese military leadership prior to the leadership handover.

Broadcast of the year - Congratulations to the team at Sinica who delivered a highly insightful discussion on the eve of the party congress and leadership handover.  Featuring a heavyweight panel of John Garnaut, Patrick Chovanec, Jamil Anderlini and regular hosts Kaiser Kuo and Jeremy Goldkorn.  The explanation of the history of Bo Xilai and the leadership was very precise and revelations, including Bo's penchant for Sylvester Stallone, quite surprising!  A runner's up award for Max Keiser who over a number of broadcasts on Russia Today has been seeking to highlight China's buildup of gold reserves which could shock markets in 2013.

Most creative use of official resources - in a crowded field, Wusu City police chief Qi Fang stood out for his resourcefulness, in housing his twin mistresses and employing them in the city's police department.  Equal second place goes to Lei Zhenfu, who found time to star in a sextape, and Yang Dacai, a Work Safety official from Shaanxi province who managed to amass a collection of luxury watches on his official salary and keep smiling amidst the human and machine wreckage of several traffic accidents. Definitely hard work did not go unrewarded this year.

For services to architecture - Developers of the Meiquan 22nd Century building were a late contender, having commenced a Chongqing development due to be completed before the Zaha Hadid designed Wangjiang SOHO development (which it is a poor copy of) is finished.  Earlier in the year, plans announced for the completion of the world's tallest (and possibly ugliest building), Sky City in Changsha, in an unbelievable 3 months, were noteworthy, as was the world's largest, the New Century Global Centre in Chengdu.  But for sheer pointlessness the planners of the ghost town of Ordos in Inner Mongolia are the winner in particular because it was also able to be used this year as the world's largest skate park.

Most subsidised sector - Jury remains out on this one.  Railways seem to be the winner with about $104 billion announced for 2013 (following similar amounts in 2012).  Shipbuilding and solar were notable also.

Congratulations to our winners!  They or their representatives can get in touch for some fine baijiu tipple!

(c) Shenzen Standard

Coming up next - some predictions for 2013...!

Seeking cash...

Holes emerging in the edifice
Some of the headlines in the last couple of weeks:
- China's WMPs - wealth management products suffered their first recorded default.  Called "Weapons of Mass Ponzi" by some commentators, these lightly regulated or unregulated products are managed by various financial businesses but sold through banks and other networks to retail customers.  They are high risk and offer a higher return than typical bank products such as deposit accounts, which offer mostly negative rates of interest after inflation.  Customers of a mid-size bank Hua Xia protested when notes sold to them in one of the bank's branches defaulted.  The notes paid income from a domestic issuer unrelated to the bank and streamed income from a pawn shop and car dealership (details here).  As had previously been seen in the Zheijiang Guarantee scandal, part of the structure involved guarantees which were not met and bank staff were blamed.  More importantly questions were raised as to how many other schemes were likely to fail.

Despite assurances from regulators during the recent party congress, regulators do not know the extent of exposure and so this week the China Banking and Regulatory Commission ordered banks to check and ensure management of non-traditional products.
Take away: Expect vast amounts of these sub-prime style investment products to be flooding through the Chinese financial system.  It is doubtful that the regulators or the banks will be able to contain them for much longer or prevent contagion if too many collapse.

- Unimaginable sums of money have been flooding out of China - A report out this week covering illict flows from developing countries in 2000-2010 listed China as the top source of all flight money, with more funds leaving the country clandestinely ($2.74 trillion) than all of the other top 10 countries combined.  This is broadly in line with other studies on corruption in China (link here).  The atmosphere of corruption has remained pervasive since the recent party congress and Vice magazine had a great article covering the scope of illict behaviour of officials being reported daily across China ("Chinese officials at it again...").
Take away:  Victor Shih of Northwestern University has looked at the impacts sudden acceleration of capital flight could have on China's foreign exchange and fiscal position and this could be an unstabilising factor going forwards.

- China is seeking to attract massive amounts of new foreign capital from sovereign wealth funds and central banks - A recent relaxation by the State Administration of Foreign Exchange of an investment quota of $1 billion under the QFII program means that now, through small changes to their portfolio, reserve managers could cause large shifts of capital into China (details here).  There was speculation about motives and questioning as to how such a policy interacted with efforts to liberalise its currency,
Take away:  At a time when banks are seeing increasing shortages of cash towards the end of the year this move does suggest signifcant sums to flow into China in future.

- Chinese corporates facing tough times - An interesting piece describing actions on the ground at LDK, once the world's largest solar panel maker, but now subsisting on funds from its main state-bank creditors under the weight of an impossibly sized $3 billion debt is here.
Take away: Industries like shipbuilding and solar are at the forefront of the Chinese slowdown.  Expect to see a greater spread across industries, including the property sector and eventually (when problems find their way back to the creditors), to the financial system.  

Generation game

Solar flare up
Since the last post there have been moves to further consolidation and government control of the solar industry as two of the largest players, LDK and Suntech are facing increased state involvement and even takeover.  Amidst global oversupply, plummeting prices and possible trade law sanctions, a couple of themes are present (i) use of bankruptcy is not prevalent yet (with rollovers of debt preferred) and (ii) increasing state involvement.  An excellent article by Tim Worstall in Forbes had a headline which summed up the situation - "China still hasn't got the hang of this capitalism thing", namely the importance of unprofitable enterprises going bankrupt.  It would seem fairly obvious that there are plenty of impediments to swift and orderly wind-down of institutions - loss of face, bureaucratic interference, vested local government interests and the like.

But it wasn't supposed to be like this - the article refers to an official who pronounced that the government intended the industry to consolidate - i.e. a large number of enterprises close or merge - intentions which were complicated by unwillingness of banks and local governments to toe the line.    And what a contrast from the fanfare in a previous Forbes article announcing the launch of the new US style bankruptcy regime China in 2007 - the predictions of a "high level of sophistication" and "determination to build a sound legal system" seem over-enthusiastic statements now.  Possibly due to the need to promote stability ahead of the leadership change next month, officials seem to be falling back to tried and tested methods of state interventionism, which will only continue to propagate distortions in the current financial system.

It's a family affair
At the time of writing there has been an overwhelming response to the New York Times' investigation into the wealth and connections of Chinese Premier Wen Jiabao's family.  It is not just that the Chinese administration has blocked access to the Times' website (as it did with Bloomberg and the Brookings Institution when they released similar findings regarding incoming Xi Jinping and Li Keqiang), responded with what the Financial Times referred to as a "hatchet job" piece in the People's Daily, or that unusually the administration has instructed lawyers to deny and  look at pursuing legal redress (which members of the legal community thought were poorly thought out) With the Guardian comparing it to the Pentagon Papers as the most "direct challenge to a sitting government", it is clear that the investigation has ruffled feathers at a sensitive time.

It is not clear yet if there will be a lasting impact from these revelations about China's leaders - the Economist which has a special report covering the upcoming Party Congress, concludes that all the disclosures strengthen the case for reform.  Like many similar autocracies the connected elite of China have had an entrenched position for a long time in China and it seems unlikely that this will change after the handover beyond certain personnel changes (which was the conclusion of Katherine Hille in the FT).  But could tensions between ruling factions and their connected others spillover after the transition?

Factional tension was suggested by Hille (noting rumours on Chinese social media that information in the New York Times had been provided by factional opponents of Wen) and more broadly the Wen revelations have opened a greater discussion on corruption in China, which as the FT Alphaville blog noted that perceptions of corruption were reaching levels where they could be destabilising.  Cue then a closed door lecture from a Chinese (or Hong Kong-based) academic arguing that China is in fact nearly bankrupt and a warning from permanent China bear Gordon Chang warning that there is now a "stampede" of money and even officials are now fleeing China and all does not seem well.

A light-hearted piece in the Daily Mail might suggest otherwise (with news of a marriage of the niece of president-in-waiting Xi Jinping to a young unknown British businessman, Daniel Foa) but there is a very deep family tension involved in this year's leadership trauma.  Forming part of a highly recommendable podcast of experts (comprising Chovanec, Garnaut and Anderlini) was a real insight into the the deep inter-generational enmity between Jinping and Xilai (and their factions in the Party), which had arisen between their fathers, Xi Zhongxun and Bo Yibo, during the cultural revolution.  Garnaut in particular has been in explosive form revealing casualties of the factional struggles for position in both the military and political leadership. Add to this interventions of factions led by Hu Jintao/Wen Jiabao and Jiang Zemin and things look set for an explosive mix.

An Englishman called Daniel Foa holds a book (c) ImageChina

As has been noted China's new leaders are likely to signal a clear directional change in policy very soon after the handover (as has been customary).  Whether they retain a princeling dominance and an absolute autocracy or opt for a more compromising approach (such as a management focussed Singaporean model) will remain to be seen.

The audacity of hope

Bears rally
A couple of provocative headlines hit the newsfeeds this week as some notably bearish Chinese analysts digested the recent stimulus announcements.  Gordon Chang's article "China is running out of money"  certainly grabbed attention and while much of the discussion about the country's central bank, the People's Bank of China (and its ability to maintain the system of foreign exchange inflows) has been covered before, details of how short some local authorities are of money right now is rather new (and emerging).

In contrast, investors' optimism about the extent of the current stimulus is well illustrated by a slide from a recent Rio Tinto investor presentation (below).  Frequent readers will recognise one of the project leaders - the National Development Development and Reform Commission (NDRC) which Victor Shih and others have identified as being at times a very effective rubber stamp executing little scrutiny of projects it approves (including earlier in the year a project to influence the weather).

Michael Pascoe of the Sydney Morning Herald is one China bull who saw only a soft landing from the stimulus and in pro-reform comments of a Bank of China official.  Similarly doveish comments from Jiang Chaoliang, chairman of pillar bank AgBank (Agricultural Bank of China) suggested a benign situation of measured reform.  However it is questionable how much the necessary reforms and consumption increases will proceed during a stimulus given fairly little progress made on such things during the last round of stimulus in 2008-9.

Meanwhile at respected magazine Caixin, Andy Xie sought to put recent conditions into perspective, with some dire forecasts for the property and finance sectors:

China's land market will experience a dramatic adjustment ahead. In most cities, land prices may fall by 80 percent. The financial consequences will be severe. Most bank loans are backed up directly or indirectly by land. If land prices fall so much, the banking system would suffer a crippling level of bad loans. Local governments increased their spending appetite during the heyday of land sales. They will have a difficult time adjusting to the new reality. Their struggle to source new revenues will be the main reason for social instability ahead.

And adding difficulty the FT's Beyond Brics blog noted, was that the fact that many statistics releases which drive the China news cycle seem to increasingly split analyst opinion (pointing to more or less future growth in equal measure).  Similar to the debates as to whether key Chinese statistics are falsified - a recent report examined opposing interpretations of rising non-performing loans data by Reuters and Bloomberg. Reuters' conclusion, that it was a positive sign (looking at the overall ratios provided by the China Banking Regulatory Commission), was favoured.

Chinese property, it's a long way down...

Reluctant consolidations
While questions remain over the long term outcomes from the new stimulus, other commentators have noted falling profits across a number of sectors and in some cases a run of bankruptcies is looking likely.  Three industries which have been observed to be at risk of widespread bankruptcies are the solar panel makers, shipbuilders and automakers.

For manufacturers of photo-voltaic cells there have been plenty of headlines for Chinese companies, themselves struggling against a backdrop of oversupply and falling prices. Suntech, the largest solar panel maker in the world, announced it had been defrauded by an Italian co-investor (who offered fake German bonds as security for a payment guarantee) and just recently obtained a worldwide freezing order against its Italian partner's assets.  Even without this, the company is struggling under a weight of debt.  LDK Solar, based in Xinyu was bailed out by the local authority last month, although some commentators doubted whether even this would be sufficient to restore the companies' prospects.

Chinese shipbuilders meanwhile are continuing to tread water through the worst conditions in a decade.  Major builders including Rongsheng and Cosco have recently been hit by profit concerns amongst falling orders and shrinking backlogs, while there have been several bankruptcies including Dalian Oriental Precision & Engineering and a major shipbuilder in Zheijiang province.

And local car manufacturers (who have been flooding dealers with unsold inventories) face the prospect of being forced into bankruptcy by local authorities due to widespread anticipation of failures.  As this report from Ken Rapoza in Forbes explained:

The Ministry said in a note published on Tuesday that it is considering the introduction of a withdrawal mechanism to force near-bankrupt automakers out of the bloated automotive industry.  China has around 1,300 automobile makers, including 171 car, truck and bus makers and more than 900 specialty vehicle manufacturers, according to the government.
Nearly a quarter of these manufacturers are on the verge of bankruptcy, barely producing anything despite obtaining production approvals from supervising authorities, the statement said.

Restructuring with Chinese characteristics
The announcement of forced restructuring of the automotive sector is interesting because it shows the role of the state in dictating the policy direction for much of the industry.  State involvement has been a feature of industry restructuring throughout China's history, and most notably during the aftermath of the Asian crisis, when  many International Trading and Investment Corporations (ITICs) - forerunners of current Local Government Financing Vehicles and investment trusts, collapsed and when the banking system was restructured.

At the time, there was no advanced nor comprehensive bankruptcy law governing the restructuring of state-owned entities and private entities.  As William Gamble, an investor with experience in that period has noted, the bankruptcy legislation applicable in 1998, when GITIC collapsed, did not recognise security interests or allow for restructuring (nor could foreigners' investments into ITICS even be registered with Chinese regulators).

A new bankruptcy regime, which is more sophisticated and borrows elements from US legislation and other jurisdictions was implemented in 2007, but its effectiveness remains to be seen as courts and other officials establish a practice of using and enforcing the new regime.  Also in a new trend, Simon Rabinovitch in an FT article this week, noted that more parties seem to be using local courts to resolve contractual and debt claims across a number of Chinese regions.  

It seems there is much more than just a simple increase in litigation volumes - generally speaking local and regional state authorities, with their close ties to businesses seem to play a very dominant role in either leading arrangements to stave off bankruptcy (causing a lighter caseload and a slimmer practice of dealing with bankruptcies) or as in the case of the automotive industry - taking a dominant role in which foreign investors may be marginalised and/or unfamiliar.  Reports of the pending bankruptcy of the Zhongdan Guarantee company (which was exposed by the collapse of the Tianyu Construction Company and 600 companies which were connected to it by a network of guarantees) indicate that the Beijing city government is directing the restructuring response which is expected to get underway later this month.  And Zhongdan apparently was also involved in selling WMPs (below).  Should there be more businesses like Zhongdan to be bankrupted, this could lead to a deterioration of market sentiment and intensification of any crisis, should it arise in China.

"No touch" regulation
Watchers of Chinese bank finances noticed a shrinking of deposits and increase in interbank liabilities in bank capital reports which many commentators are blaming on the rise of WMPs - wealth management products, unregulated speculative investments which Chinese banks have been using to source new loan capital and which are popular with bank customers as they offer interest rates far above regulated deposits.

Nothing wrong with little or no regulation in the short term (in China) you might think, however it has emerged that many of the products do not have recourse to specific assets and are increasingly appearing to have the characteristics of a pyramid or ponzi scheme (with there not being enough assets to cover redemption requests or meet all obligations), the collapse of which could trigger financial contagion.  An excellent Reuters piece uncovered one product which it likened to an American subprime mortgage (of dubious quality), being marketed to the public under the name "Golden Elephant" and whose source of income derived from property assets which were yet to be built.

While Chinese regulated banks themselves have questions to answer regarding their NPLs (which may challenge their solvency) the growth of WMPs and so-called "shadow banks" could threaten a significant crisis in the Chinese financial system.  Recent discussions on various blogs this week reminded that there are a number of precedents of this sort of scheme which could equally apply to China.  For both Russia and Albania in the 1990s (and Poland in the last few years), pyramid and ponzi schemes were able to flourish escaping weak and slow moving regulators in a changing environment and, upon collapse, causing great damage to the economy.  A great paper on the Albanian pyramid scheme phenomenon is here, while in Russia, the famous MMM and GKO scandals (the latter of which contributed to the collapse of the Russian government and precipitated the 1998 Asian crisis) have been well written about (Sergei Mavrodi restarted a new MMM-style scheme online last year).

How it all plays out in China will remain to be seen.