The Economist, July 29th – Aug 4th, 2017

Didi Chuxing, SoftBank grab stake in Uber competitor

SoftBank and Didi Chuxing provided the bulk of a recent $2.5 billion investment in Grab Taxi, a ride-hailing firm headquartered in Singapore and operating in seven countries.

AI in China

A cyber-security law that came into force in June requires foreign firms to store data they collect on Chinese customers within the country’s borders; outsiders cannot use Chinese data to offer services to third parties…

AI is a technology with the potential to change the lives of billions. If China ends up having the most influence over its future, then the state, not citizens, may be the biggest beneficiary.

China and Russia

Russia needs China far more than China needs Russia. And Russia feels uncomfortable about such an unbalanced relationship…

Since 1991, Russia has provided nearly 80% of all China’s arms imports (worth about $32 billion over the period).

The Kremlin used to worry about China’s efforts to reverse-engineer them. But Alexander Gabuev of the Carnegie Moscow Centre says that Russia now recognizes that China’s technological advance is unstoppable. Russia might as well make money from selling arms to China while China still has an interest in buying them from abroad rather than making them itself.

In terms of finance:

With Russia’s access to international capital markets now severed as a result of sanctions, China has become Russia’s main source of funds.

A senior Russian banker in China says, “Our government wants Chinese money without the Chinese.”

Meanwhile:

China has become the leading trading partner for all the former Soviet republics (apart from Uzbekistan), as well as the region’s largest investor.

The Economist, July 22nd – 28th, 2017

Sun’s out

On July 15th, Sun Zhengcai (孙政才) (孫政才) – the Politburo’s youngest member, who was seen by some as a potential successor to Xi Jinping – was sacked from his position as Chongqing’s Party Secretary.

After a brief interregnum, Sun succeeded Bo Xilai (薄熙来) (薄熙來) as Chongqing Party Secretary, and according to the Economist:

A cloud appeared over Mr Sun in February, when party investigators accused him of failing to clear Mr Bo’s “toxic residue”.  Now Mr Sun is said to be under investigation for violating party rules…

the new chief of Chongqing, Chen Min’er [(陈敏尔) (陳敏爾)], is Mr Xi’s man.

China in Africa

China will soon open a military base in Djibouti, its first military base abroad since the Korean War.

According to the Economist:

In 2014 the number of African students in China surpassed the number studying in either Britain or America…

Afrobarometer, a polling firm, found that 63% of people in 36 African countries consider China to be a positive influence.

McKinsey… looked at five measures of Africa’s economic connection with the world: trade, investment stock, investment growth, infrastructure financing, and aid.  It found that China is among the top four partners in each of these.  “No other country matches this depth and breadth of engagement,” it enthused.

McKinsey’s work suggests that there are as many as 10,000 Chinese companies operating in Africa, 90% of them privately owned.  Many also reported earning juicy returns…

However:

It is far less certain that Chinese investments in big infrastructure… will ever show a return… there is even less chance of recovering the cash sunk by Chinese state-owned firms into poorly governed places such as Angola and the Democratic Republic of Congo…

In a decade or so China may find itself in the position the West once did, of having to write off many of their loans to African governments.

China Inc

Chinese state-owned enterprises (SOEs) are on the march, drawing on government support and making conquests at home and abroad.

While SOEs account for less than a fifth of Chinese output today, there are still more than 150,000 of them, and those enterprises take in about half of all bank loans. Since 2008, the ratio of company liabilities to equity for state-controlled companies in China has exceeded that of non-state controlled companies. In addition, investment by SOEs has grown faster than private-sector investment since 2015.

According to the Economist:

The “One Belt, One Road” strategy – the core of Mr Xi’s foreign policy – has made foreign expansion an explicit part of their mandate.

and Chinese policymakers are using mergers to create “national champions.”

Indeed, part of the rationale for the mergers is to prevent SOEs from butting up against each other as they go abroad to win business.

In addition, quick progress in establishing “state capital investment and operation” companies (SCIOs) to invest in new high-tech sectors seems to set to extend the state’s reach into the private sector, just as

State-backed private-equity funds, which can be seen as forerunners to the investment function of the SCIOs, are already making a big impact.

The Economist, July 15th – 21st, 2017

China’s conscience

Liu Xiaobo (刘晓波) (劉曉波) was a supporter of the 1989 Tiananmen Square protests, and in his non-violent struggle for democracy and fundamental human rights in China, he went to prison multiple times.

He was an active participant in the writing of the Charter 08 manifesto, which called for human rights, more freedom of expression, more democratic elections, the privatization of state enterprises and land, and economic liberalism.  He signed it along with more than three hundred Chinese citizens, and the manifesto was released on 10 December 2008.  Two days before the official release of Charter 08, Liu was taken into custody by the police.  On December 25, 2009, he was sentenced to 11 years in prison and 2 years’ deprivation of political rights.

While in prison, he was awarded the 2010 Nobel peace prize.  In May, 2017, while still in prison, he was diagnosed with terminal liver cancer.  He died on July 13th.

According to the Economist:

His dignified, calm and persistent calls for freedom for China’s people have made Mr Liu one of the global giants of moral dissent…

 A Bolshevik in Beijing

In May, Cai Qi (蔡奇) was elevated to the post of Communist Party chief of Beijing.   The previous occupant was Guo Jinlong (郭金龙) (郭金龍), a holdover from Hu Jintao’s time in power.

According to the Economist:

There is no doubt that Mr Cai… is the president’s man.

Moreover, Mr Cai is:

…all but certain to be elevated directly to the ruling Politburo later this year, without first tarrying on the lower rung of the Central Committee.

Ethnic minorites

In the early 1950s, a census was conducted in China which allowed respondents to describe their ethnic identity in any way they liked, producing more than 400 categories.  Researchers were dispatched to look more closely at the situation, and officials decided that China had a total of 38 indigenous ethnic groups.  By 1979 the number had increased to 56.  Since then, no further groups have been recognized.  The biggest group is the Han, which reportedly makes up 92% of the population.

The algorithm kingdom

In January, Qi Lu, one of Microsoft’s bosses, announced that he was going to become chief operating officer at Baidu.  According to Lu, “We have an opportunity to lead in the future of AI.”

In October 2016 the White House noted that China had overtaken America in the number of published journal articles on deep learning.

What does China have going for it in the realm of artificial intelligence?

According to the Economist, in addition to computing power and money, the country also has data, and increasingly, research talent.  Government support has also been important.

As far as research talent is concerned, China has strong skills in math and a tradition in translation research.  Also, most big universities have launched AI programs.

As far as data is concerned, China has 1.4 billion people and about 730 million Internet users, more than any other country.  In addition, almost all go online from smartphones, which generate much richer data than desktop computers because of their sensors and propensity to be carried around.  Also, people in China tend to use voice-recognition services more often than in the West, so firms have more voice snippets to improve speech offerings.

Among other companies, according to the Economist:

Megvii Technology’s face-recognition software, Face++, identifies people almost instantaneously

and:

The firm already enables Alipay and Didi, a ride-hailing firm, to check the identity of new customers (their faces are compared with pictures held by the government).

Container shipping

On July 9th, the owners of Orient Overseas Container Line (OOCL), the world’s 7th biggest container shipping line, announced sale of the company to the China Ocean Shipping Company (COSCO), a state-owned Chinese shipping giant, for $6.3 billion, valuing OOCL at 40% above its book value.  The deal would make COSCO the third largest container shipping line worldwide.

A Hong Kong company, OOCL was founded by Tung Chao-yung.  Under his eldest son, Tung Chee-hwa, the company survived financial difficulties in the early 1980s with the help of Chinese money, and Tung Chee-hwa went on to become Hong Kong’s first leader after Hong Kong was handed over to China in 1997.  OOCL’s current chairman is the founder’s second son, Tung Chee-chen.

 

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?