The Economist: July 8th – 14th, 2017

The great unbanking

“Correspondent banks” are international banks that clear the foreign currency transactions of smaller banks through big financial centers.  Such banks are dropping customers in places or sectors deemed to pose a high risk of money-laundering, sanctions evasion or terrorist financing.

Based on data from the Financial Stability Board, The Economist writes:

the number of correspondent-banking relationships fell in all regions between 2011 and 2016… Worst-hit was eastern Europe, which saw a decline of more than 20%

According to The Economist, smaller firms that handle remittances are suffering too:

Some have given up their independence and become agents of giants such as Western Union and Money-Gram, for whom international clearing is not a problem.

An American payments firm goes online and buys British

“Merchant acquirers” are companies that have contracts with sellers of goods and services and also licenses from credit- and debit-card companies to accept and process card payments.

On July 5th, Worldpay – a British payments processor – said it had accepted a cash-and-shares bid from an American payments firm – Vantiv – worth 7.7 billion pounds ($10 billion USD).

Until a few years ago, acquirers in both America and Europe had to have banking licenses.  In fact, Vantiv was spun off from an American bank (Fifth Third) in 2009, and the Royal Bank of Scotland was forced to sell Worldpay in 2010 as a condition of its bail-out by the British state.

According to The Economist:

The deal marks a further step towards the industry’s consolidation.

Last year, Global Payments bought Heartland.  TSYS bought TransFirst.  Vantiv bought Moneris USA.  On July 3rd,  Nordic payments company, Nets, said it had been approached about a takeover.

Bond markets fret about a change in central-bank policy

Since 2009 central banks have been incredibly supportive of the financial markets – keeping short-term interest rates at historic lows and buying trillions of dollars worth of bonds.  But in recent weeks, several of them have been hinting at reducing their largesse…

Central banks will have to tread very carefully.  Global debt is higher as a proportion of GDP than it was before the financial crisis started in 2007…

It is a lot easier to begin monetary stimulus than to end it… central banks cannot always arrange a happy ending.

The Economist: July 1st – 7th, 2017

China’s “regulatory storm” hits four of its most global companies

Chinese regulators want banks to check their loans to HNA (海航集团), Dalian Wanda, Fosun, Anbang, and also Zhejiang Rossoneri (owner of AC Milan).

The regulator’s instructions were simply that the banks take a closer look at loans to these companies to guard against risks… but it was unusual for it to specify the firms by name.

How to explain?

the government has ratcheted up capital controls since last year… 

 and

HNA, Wanda, Fosun, and Anbang have been some of China’s most aggressive investors abroad

According to the Economist:

Within ICBC, China’s biggest bank, an internal e-mail about the order does not mention the companies’ domestic operations.  Rather, it focuses on what the government has termed “irrational outbound investments”, referring to highly leveraged deals, especially in industries such as property, hotels, entertainment and sport…

More broadly, there has been a sharp decline in international deals:

Chinese firms announced about $45bn of overseas investments in the first half of 2017, down from nearly $140bn during the same period in 2016

Britain and Diego Garcia

Diego Garcia is the largest island in the Chagos archipelago.  In 1965, Britain detached the Chagos archipelago from the British colony of Mauritius for inclusion in the newly created British Indian Ocean Territory (BIOT).  In December 1966, the US and UK executed an agreement which permits the US to use the BIOT for defense purposes.

On June 22nd, 2017, the United Nations General Assembly voted in favor of referring the territorial dispute between the UK and Mauritius over the Chagos islands to the International Court of Justice (94 in favor, 15 against, with 22 EU members abstaining).

The importance of the vote should not be exaggerated.  It refers the case to the ICJ, whose opinion will be non-binding.

Still:

Other far-flung British territories, such as the Falkland Islands, might face new challenges from rival claimants.

and Richard Whitman, director of the Global Europe Centre at the University of Kent says:

“If you’re an Argentinian diplomat, you may start recomputing how much international support Britain has”

Liberia

Liberia was pulverized by civil wars between 1989 and 2003.  Since 2006, Liberia has been run by Ellen Johnson Sirleaf, Africa’s first elected female leader.  In 2010, Ms Sirleaf won a colossal write-down of Liberia’s debts under the Heavily Indebted Poor Countries program.

Almost as soon as Ms Sirleaf formed a government, foreign aid began to pour in… the West resolved… where possible, aid would flow through poor-country bureaucracies…

However:

Only 12% of aid to Liberia in the 2015-2016 fiscal year was “on-budget”.

Although the civil service is gradually improving, it cannot draw the most talented Liberians.  Starting salaries are too low… aid agencies and charities pay about three times as much…

Clarence Moniba, a minister who chairs the Philanthropy Secretariat… says the state has little sway over the roughly 330 charities working in Liberia.  “They come and tell us what they are doing, and we agree.”

A single education scheme paid for by USAID and delivered by a Boston-based charity, which aims to reach 48,000 out-of-school children, has a budget of $34m.

The capitol building in Monrovia, which is being enlarged, is plastered with China Aid signs.

The most tangible thing aid has done in Liberia is a smooth 250km Chinese-built road from Monrovia to Ganta… paid for from an infrastructure trust fund overseen by the World Bank and the government

Borrowers have the whip hand in the credit markets

Once upon a time, corporate loans had many covenants offering safeguards for lenders if the debtor’s financial position deteriorated.

2005-06 saw the emergence of “covenant-lite” loans in which such restrictions were virtually non-existent.

In 2008, when the financial crisis hit, companies scrambled desperately to get the financing they needed.

The cycle has turned again.  Analysis by Moody’s… shows that the proportion of the loan market that is “covenant-lite” has risen from 27% in 2015 to more than two-thirds in the first quarter of this year.

Why?

Investors.. are desperate to earn some kind of yield on their assets

Have we reached another period of speculative excess?

It is hard to escape the feeling that the market is being kept aloft by the actions of central banks.  The European Central Bank (ECB) and the Bank of Japan are still buying tens of billions of dollars’ worth of assets every month.  That keeps yields down and prompts investors to seek alternatives.

BRICS threaten to rebel against the ratings agencies

Brazil, Russia, India, China and South Africa plan to set up an “independent” ratings agency that is likely to be launched at their BRICS summit this September in Xiamen.

According to Bloomberg, in 2016 three agencies took a record 1,971 negative actions on the debt of emerging-market government and related entities.

A World Bank study last year, on the ratings of 20 developing countries between 1998 and 2015, found that a downgrade to junk raised the yield on a country’s short-term bonds by an average of 1.38 percentage points. 

Did Asia learn the lessons of its financial crisis?

According to Hyun Song Shin of the Bank for International Settlements, countries with floating exchange rates and little visible foreign-currency debt can still suffer financial strain if their companies’ foreign subsidiaries borrow too much.

IMF research shows that from 2009-2013 firms from middle-income countries both raised a lot of offshore debt and expanded their onshore deposits, leaving their home-country banks flush with cash.

Unfortunately, when the Federal Reserve tightens, the dollar strengthens and the offshore markets become less accommodating… Multinationals that suddenly cannot raise money abroad make greater demands on domestic banks, withdrawing deposits and requesting loans.  This tightens financial conditions, even if the local central bank…has not itself raised interest rates.

Mixed Signals on China’s Energy Picture?

If you think understanding China’s energy future is difficult, it may not be you…

Coal on the rise in China, US, India after major 2016 drop                        (Matthew Brown and Katy Daigle, AP, 06.26.2017)

China energy demand may already have peaked: researchers                   (David Stanway and Alister Doyle, Reuters, 06.30.2017)

To be fair, the AP article focuses on domestic Chinese coal production, finding:

China’s production rose more than 4 percent through May, according to government figures, compared to a drop of more than 8 percent for the same period a year earlier.

while the Reuters article focuses on China’s total energy consumption, noting that, according to a study by the China Academy of Social Sciences (CASS):

China’s total energy consumption is expected to fall to the equivalent of 4 billion tonnes of standard coal in 2020, which would represent a decline of 8 percent from last year.

The Reuters article also quotes Qiang Liu, director of CASS’s Institute of Quantitative and Technical Economics, as saying:

“(Peak demand) could be this year or next year”

Of course, the Reuters article goes on to say:

The CASS study suggests Beijing is cutting coal use far faster than expected

which does bring the subject of coal directly into the article, at least in terms of consumption, if not production.

Perhaps CASS is just wrong?

As Reuters notes, the study comes weeks after President Trump decided to quit the Paris agreement on climate change and ahead of the July 7-8 Group of 20 summit in Hamburg, Germany.

Moreover, according to Reuters:

The CASS forecast contrasts with China’s 2016-2020 energy plan that said total energy use would grow around 2.5 percent a year until 2020 and a forecast by state-owned China National Petroleum Corp for energy consumption to peak by 2035.

Is there anything else that could explain the seeming divergence between trends in domestic Chinese coal production and consumption?

Perhaps.

Don’t fight China, the Federal Reserve of Coal                                 (Nathaniel Taplin, WSJ, 06.29.2017)

According to the Taplin article, China – far and away the world’s largest producer and user of coal – has been struggling with excess capacity at home for nearly half a decade, and:

China is now poised to curtail coal imports

in particular:

Chinese state-owned media said Wednesday that many of China’s small or midsize ports were already refusing imported coal shipments, although major ports appear to still be open.

The rationale:

State media said regulators want any benefit from its “supply side reforms” – that is supply curbs – to remain in China.  Translation: higher coal prices and profits at home, not abroad.

Now, if the decline in coal imports were large enough, it is possible that domestic coal production could increase even as overall coal consumption fell.

Is that what’s going on?  Who knows.  An increase in domestic coal production coupled with flat or declining coal consumption is also consistent with an increase in domestic coal inventories.

They say patience is a virtue; so stay tuned, and in time, maybe we’ll learn more.

 

Mixed Signals on China’s Energy Picture?