Saturday, January 31, 2009

China Likes Germany Now

Because another European leader (Sarkozy) has met with a certain Monk from India since Angela Merkel last met with him, Germany is no longer getting the could shoulder from China. In fact, Merkel and Wen Jiaobao seem to have become fast friends recently.

Perhaps this is because, as the world's two largest economies that are running trade surpluses, China and Germany are beginning to feel a little heat from the likes of the U.S., Britain and Spain who have the deficits that support those surpluses.

According to Merkel:
China and Germany have similar interests because both depend strongly on exports and believe protectionism is not the answer (to the financial crisis)

Well, duh!

The question is, what are these two countries doing to reduce their excess export capacities so that other countries are less likely to resort to protectionist measures?

If I read Michael Pettis correctly, China and Germany have plenty of reason to concerned about protectionism -- all the more reason for these two countries to do everything they can to stimulate domestic demand.

China appears to be making great efforts to boost domestic auto consumption thus far, and while they should be commended, this particular measure doesn't take much pressure off G7 countries running trade deficits with China. China's auto exports go mainly to
Africa, Latin America, the Middle East and Russia (which is already starting to raise protectionist barriers).

On the one hand, maybe China need not be worried about protectionism since WTO rules prohibit most obvious forms of protectionism. On the other hand, the WTO investigation process can take up to two years -- plenty of time for protectionism to have a devastating effect on the world economy. And anyway, despite China and the U.S. adhering to WTO rulings thus far, I wonder whether either country may later decide to turn its back on the WTO if the global recession becomes longer and deeper. Any thoughts?

Thursday, January 29, 2009

China's Auto Stimulus Having an Effect

Anecdotally, at least.

After a tough 2008, this dealership in Beijing is working overtime to satisfy demand for small cars. The dealer says that he regularly sold about 10 cars a day in 2006 and 2007, but his average dropped to only four in 2008. Since the announced tax cuts on smaller cars went into effect on January 20, he has returned to his average of 10 cars per day.

If this phenomenon is repeating itself throughout China, it could provide quite a boost to its flagging GDP growth.

This seems especially significant in light of the historical seasonality of car sales in China. The graph below is from an auto industry analysis provided by Shanghai Securities Co., Ltd. (乘用车市场需求仍相对较好, 20 January 2008).



Note that there is traditionally a significant dip in sales every February, followed by a big increase in sales every March. If dealerships all across China are currently experiencing a surge during what should be their lowest sales point of the year, then this gives reason to believe that the tax cuts are having their intended effect.

Chinese Firms Interested in Volvo

In an effort to raise much needed cash, Ford is looking for a buyer for its Volvo unit. The Wall Street Journal reports that Chinese automakers Geely, Shanghai Auto and Chongqing Changan are expected to express interest.

Geely, a private firm listed in Hong Kong, recently announced that it hit its sales target of 225,000 cars in 2008, with domestic sales up by nearly 12% and exports up by 80%. I cannot find any announcements on Geely's earnings yet, but on the surface, it looks like they've had a pretty good year.

The other two firms, Shanghai and Changan, are both SOEs owned by the city governments of Shanghai and Chongqing, respectively. Both recently announced pretty big hits to earnings in 2008.

Shanghai Auto will be taking a big loss on its 51%-owned Ssangyong unit in Korea which recently declared bankruptcy.

Changan, which will also announce a significant downturn in earnings, already has a joint venture with Ford, so it may have a slight insider's advantage.

Volvo presents an interesting potential acquisition for a Chinese automaker. Its cars receive high ratings for safety and quality -- two issues that have until now prevented Chinese auto firms from exporting to that holy grail of auto markets, the United States.

While Geely might be expected to have an advantage due to its successful record in 2008, we should not be terribly surprised if Shanghai or Changan, backed by their respective governments, manage to pull together stronger bids.

--------------------------
UPDATE: China Car Times offers more details on this story here.

Tuesday, January 27, 2009

Limits on SOE Executive Pay

The Ministry of Finance announced on Monday (which was New Year's Day in China, by the way) that SOEs in the finance sector would need to bring management salaries down to a "reasonable" level. Mirroring conditions in China as a whole, a significant income gap has opened up between those at the top and those at the bottom.

At first glance, a true capitalist would cringe at the notion that the market would not be allowed to determine compensation levels. After all, if the CEOs of Chinese banks are delivering earnings growth for their shareholders (the largest of whom is the state), why punish them by limiting their pay?

Well, one possible reason would seem to be that bank CEOs don't really have a lot of influence on earnings. Credit quality has improved since Zhu Rongji re-centralized lending authority and pushed through measures to clean up the banks in the late-90s -- early-00s.

Now, according to Victor Shih, the central government has ordered banks to lend, lend, lend without much regard for credit standards. Apparently Zhu's re-centralization has put the central government in a better position not only
to monitor credit quality, but also to destroy it if it sees fit.

All of which makes one wonder why some CEOs in China's financial sector have been taking home salaries north of 10 million RMB (US$1.4 million).

Even More Help for China's Automakers

In yet another sign of how much China's government values the viability of its auto industry, the central government announced yesterday even more measures to help automakers weather the recent downturn in sales and to further develop alternatively fueled vehicles.

In a previous post I noted that the State Council would be halving the sales tax on smaller cars, helping farmers to exchange inefficient vehicles for low-emission vehicles and contributing 10 billion RMB for the development of alternatively-fueled vehicles.

The next day, China's Central Bank announced a number of financial measures designed to support capital funding for auto companies and to support an increased availability of auto loans to consumers.

The governments of Shenzhen City and Guangdong Province also have announced measures to support a local private automaker, BYD.

Now the Finance Ministry is getting in on the act with a trial scheme to subsidize the purchases of clean energy vehicles in 13 cities. The idea is that the central government would cover the price differential between gasoline and alternatively-fueled vehicles used for public transportation, taxi, postal and urban sanitary services. There was no mention as to whether the subsidies would be restricted only to purchases of vehicles made by SOEs.

Taken together, these are some fairly substantial plans to ensure that, once the recession and financial crisis have passed, there will still be a number of Chinese auto firms around to compete.

There may also be some good ideas here for the U.S. government as it considers how consumers will be encouraged to buy the clean energy vehicles that the Big 3 will be forced to make.

Monday, January 26, 2009

Did anyone else hear an "outburst"?

I thought my newsreader was broken because I wasn't getting any Chinese newsfeeds this morning. Then I realized that the entire country is on holiday, and news simply doesn't happen during Spring Festival.

Unfortunately, that still leaves this whole Tim Geithner issue to pick at. And the Financial Times seems to be fanning the flames. (My previous posts on this topic are here and here. China Law Blog picks up on other views of this issue here.)

Let me preface this by saying that I love the Financial Times. Their global coverage of business and economics has few serious competitors. I wish I could say the same for their analysis of American politics.

In this morning's "Lex" column they write: "Mr. Geither's outburst may be more political, pinning blame elsewhere." (emphasis added)

Outburst? Seriously? Is this one of those differences between British and American English like the word "pants" which means "trousers" in America and "underwear" in the UK? (I once told a British friend that I needed to go home and change my pants, which resulted in his doubling over in laughter.)

Perhaps "outburst" in British English means "stated matter-of-factly". If not, I am leaning toward a suspicion that Lex is trying to stir up trouble between China and the U.S.

To quote Forrest Gump: That's all I have to say about that.

I hope to resume our regularly scheduled programming once news starts happening in China again.

Sunday, January 25, 2009

Saturday, January 24, 2009

Redux: Why Geithner's Words Don't Matter (Yet)

After much more weeping and gnashing of teeth in yesterday's press -- including an official reaction from China -- I think it's important to reiterate why Geithner's comments on the renminbi should be taken with a grain of salt.

First, a bit of (recent) history. Many economic observers seem to have forgotten the early days of the Clinton administration, perhaps because such history does not show up in their quantitative models. However, I am betting that the one person who really matters, Barack Obama, has already taken to heart some hard-learned lessons from the Clinton days.

Early in his administration, Bill Clinton attempted to link trade relations with improvements in China's human rights. China was given a deadline by which it would have to demonstrate tangible improvements or risk having its vital trade with the United States halted. To make a long story short, when push came to shove, Clinton ultimately had to back down from his threat. Beyond releasing a handful of dissidents from prison, the Chinese made no efforts to accommodate America on human rights.

President Clinton finally learned something that the Chinese already knew: our two economies were already becoming so intertwined, so interdependent, that neither side could afford the inevitable recession that would result in an interruption of that relationship. (Lampton's Same Bed Different Dreams and Mann's About Face both contain excellent in-depth descriptions of this episode.)

Fast-forward to the present. This week's Economist contains a terrific briefing entitled "Global Economic Imbalances" that sets out to explain the deeper underlying causes of the current financial crisis. It details just how much further intertwined national economies have become. These nice pictures help to illustrate the issue very well.






Michael Pettis, a finance professor at Beijing University, also explains the issue very clearly in terms of just the United States and China in this article at YaleGlobal Online.

So what does this have to do with Geithner's testimony? A lot.

In addition to my previous assertion that we should not place too much stock in the words of people who desperately wants jobs they do not yet have, I am counting on a few other realities to help tame the potential for upsetting the Sino-US relationship.

Barack Obama, regardless of what individuals may think of him as a potential leader, is one incredibly intelligent person. Without a doubt, the smart economists who are advising President Obama have made certain that he is aware of the interconnectedness of the Chinese and American economies. Furthermore, we can be certain that he is also well aware of the loss of credibility that resulted from Clinton's withdrawn threat.

Regardless of what may be said in confirmation hearings, and regardless of the inevitable angry words toward China that will emanate from the Pelosi-led Congress, Barack Obama and Tim Geithner will not countenance major economic sanctions toward China during a time when our cooperation is of utmost importance. To do so would lead to a trade war that would bring about an even longer and deeper world recession.

Of course, all of this assumes that President Obama wants to be reelected in 2012.

Friday, January 23, 2009

Don't Worry About Geithner's Words on China's Currency

The Financial Times appears to be freaking out over words contained in Tim Geithner's written responses to questions from the Senate Finance Committee, saying that they are bound to "anger China".
In a written response to questions from senators, Mr Geithner, whose nomination was supported on Thursday by a clear majority of the Senate’s finance committee, said: “President Obama – backed by the conclusions of a broad range of economists – believes that China is manipulating its currency.” Mr Obama would “use aggressively all the diplomatic avenues open to him to seek change in China’s currency practices”, he said.
What is meant by "manipulating"? If he means that China exerts control over how far the currency is allowed to float, he is absolutely right. Any economist who doesn't agree with that statement simply hasn't been paying attention.

Also note that Geithner says President Obama will use all diplomatic avenues to address the situation. Correct me if I'm wrong, but sanctions and trade protectionism (the presumed punishment for such "manipulation") are economic avenues, not diplomatic.

And if you're not buying that argument, I have another. Not only is Geithner not the Secretary of the Treasury yet, but he is (or at least was at the time) being criticized for not having paid taxes at some point in the past. The nominations of potential cabinet secretaries have been sunk for much less than that in the past. (Anyone remember Zoe Baird?) Geithner, of all people, knows he needs to say what the Senators want to hear if his nomination is to be confirmed.

My point here is that we should take the words of as-yet-unconfirmed cabinet secretaries only as seriously as we take campaign rhetoric. Geithner, like President Obama during his campaign, wants a job that he does not yet have. Appearing to be tough on China is always part of a good campaign strategy in the United States.

Once people win elections or confirmations, they then become responsible for doing a good job. Often the practicality of leading a country negates the necessity of following-through on campaign rhetoric.

Today's Wall Street Journal has a little more balanced account of Geithner's responses:
Yet while the yuan is an "important piece" of the economic dialogue with China, Mr. Geithner said the "immediate focus" has to be on spurring domestic demand in both China and the U.S.

"The immediate goal should be for us to convince China to adopt a more aggressive stimulus package as we do our part to try to pass a stimulus package here at home," Mr. Geithner wrote.

In fact he stressed that all of the U.S.'s trading partners would have to inject financial stimulus into their economies.

"If such plans fail to materialize, a slowdown in worldwide demand will ensue, exacerbating the downturn both here in the U.S. and abroad," Mr. Geithner said.


He's already giving himself a very good reason for not hounding China on its currency. Of course, that assumes China intends to play ball.

Thursday, January 22, 2009

How to Compete and Win with Unproven Technology

Last year when the shakeup in China's telecom sector was announced, the general consensus was that China Mobile got the short end of the stick as it was being forced to implement China's homegrown alphabet soup of a 3G mobile standard: TD-SCDMA.

Until that time, China Mobile, whose shares are listed in New York, was by far the dominant mobile player in China. As part of the shakeup, China Mobile was forced to buy China Tietong, a smaller fixed-line player, while China Unicom and Netcom were allowed to merge. The idea seemed pretty good for the industry as a whole because China ended up with three major telecom players, each with a slice of both mobile and fixed-line service.

However, many observers felt that the merged Unicom/Netcom (Unicom) and China Telecom (Telecom) both ended up in superior positions in terms of 3G technology because they would be getting licenses for 3G standards that were already in use outside of China. China Mobile's TD-SCDMA was brand-new, unproven technology that would have trouble catching on when competing with the WCDMA or CDMA2000 standards expected to be used by Unicom and Telecom. Or so everyone thought.

The Ministry of Industry and Information Technology announced yesterday that new policies would support TD-SCDMA. More bandwidth was assigned to China Mobile than to Unicom or Telecom for use with 3G services. According to an article in today's SCMP:

The measures announced yesterday fell into six areas - financial aid, project support, network construction, product research, commercialisation, and industry development, the ministry said.

The government will add TD-SCDMA to the official procurement list and give developers of the technology priority in tapping its existing funds. Another key measure is the possibility of discounts for telephone calls made through the TD-SCDMA network.

"This is an unexpected outcome as the market has previously anticipated [the ministry] might raise China Mobile's interconnection tariff in order to support the balanced growth of the industry," UOB Kay Hian analyst Victor Yip wrote in a research note yesterday.

"Now the announcement seems to indicate the [ministry] is using an asymmetric policy to help China Mobile on the development of TD-SCDMA network."


How to compete with unproven technology? It's actually quite easy when the deck gets stacked in your favor.

This actually makes a lot of sense from China's perspective because with the homegrown TD-SCDMA, no royalties flow outside of China to foreign patent-holders. However, it does seem to run contrary to the whole idea of creating a more level playing field as was envisioned with the shakeup in the first place.

I just hope my GSM phone still works when I get there in a few months.

Wednesday, January 21, 2009

An Ownership Conundrum for the State

Following the previous few days' posts here and here, today I just happened to be scouring the annual reports of Dongfeng Auto, trying to figure out who owns what.

Dongfeng Auto is one of only two Central SOEs in the auto business. It began life as "Second Auto Works" back in 1969, but at some point probably figured that if they were ever to become the largest, they would have to dump the name. (They claim to be the third largest behind First Auto Works and Shanghai Auto Works.)

The hard part about figuring out ownership of Chinese companies is that it is only possible when one or more of the entities is listed on a stock market. Otherwise, there really is no requirement for state-owned (or any non-listed company, for that matter) to divulge anything about the company.

Fortunately for us, Dongfeng has at least two listed entities. One, Dongfeng Motors Group Company (东风汽车集团股份有限公司) is listed in Hong Kong, and is represented by the green box below. The other, Dongfeng Auto Corp. (东风汽车股份有限公司) is listed in Shanghai, and is represented by the purple box at the bottom of the chain.

While I'm at it, I apologize for the rough nature of this sketch. I wasn't intending it for public consumption, but I later decided that it may be of interest to some readers. Also, this sketch is not intended to be a comprehensive picture of all entities in the Dongfeng group. My goal here was merely to lay out the chain of Central Government ownership which is represented by the colored boxes.

Photobucket

The interesting thing about this picture is that the central government, in this case, SASAC (the pink box at the top) is several layers away from the entity that actually manufactures cars: the purple box at the bottom.

If you do the math, the central government only controls roughly 20 percent of the real business (100% of 70% of 50% of 60.1%). Renalt/Nissan, on the other hand, controls about 30 percent of the real business (50% of 60.1%).

It seems to me that this is exactly the kind of situation that the central government is wanting to rectify. Auto firms have already been identified as among China's "pillar" industries, and the central government has already expressed its intention to consolidate its controlling ownership in these enterprises.

While I don't think the Central Government intends to order Dongfeng to abrogate its partnership with Renalt/Nissan, the minority shareholders in the two listed enterprises (小股东) may want to reconsider long-term ownership.



Tuesday, January 20, 2009

More on SASAC's "Not For Sale" Sign

Having fielded a handful of emails on this topic (covered in a previous post), and having discussed it with a Chinese friend who is knowledgeable on the topic, I think a few more details are in order.

Again, the central topic is that SASAC, the "owner" of the Central Government's enterprises, is preparing to release a list of SOE subsidiaries in which it intends to consolidate its ownership indefinitely. These subsidiaries are all two to three levels removed from the SOEs that are directly owned by SASAC, and they are all in what are considered to be the country's seven most important industries:
military, electricity generation and transmission, petroleum and petrochemical, telecommunications, coal, civil aviation and shipping.

The rough process by which these subsidiaries would make it onto the list is, first of all, to be owned by one of approximately 40 "mother enterprises" in these seven industries that are directly owned by the Central Government. Then, each of these subsidiaries whose assets and/or profits constitute more than 60 percent of the mother enterprise's assets and/or profits will be singled out for further scrutiny.

In other words, some of these "mother enterprises" are in fact no more than holding companies or shell companies whose sole purpose is to own one or more subsidiaries where the actual operations take place. The purpose behind SASAC's move is to strengthen its hold over, not just the holding companies, but also the subsidiaries where the money is made (or lost).

So what will SASAC do with these subsidiaries? There are a number of realistic possibilities:
  • They could be merged into the mother enterprises.
  • Those that have already been listed may be de-listed. (In other words, the State may choose to become a 100% shareholder.)
  • The state may simply to decide to increase its ownership percentage in these subs.
  • Also, even subsidiaries that constitute less than the 60 percent threshold may be merged with other subsidiaries to create a larger entity that would then be absorbed by the "mother enterprise".
What will SASAC do with the subsidiaries it does not want?
  • As alluded to above, some may be merged into the subsidiaries that the State does want.
  • Or, according to one SASAC insider, subs without prospects will be sold: "没有前途的企业则退股".
So does this mean that private firms are not welcome in those seven key industries?
  • Strangely enough, no. But it does mean that private firms in those industries will begin to find themselves completely overwhelmed by SOEs that are expected by the state to dominate the industry. Only those small firms that are willing to confine themselves to a niche will continue to exist outside of state control.
The article to which I refer also mentions a further set of "pillar" industries in which the State, while not intending to exercise direct control, will still attempt to strengthen its controlling position. These are machine tools, autos, electronic information, construction, steel, and non-ferrous metals.

According to a knowledgeable friend, even private firms in these "second-tier" industries will continually find themselves at a disadvantage vis-a-vis their state-owned counterparts.

A few takeaways here:
  • First, the 40 central state-owned firms (and their subsidiaries) that fall among the seven key industries account for 79 percent of SASAC's profits, so this is not an insignificant chunk of assets over which the State is increasing its control. This is a clear continuation of the "zhua da, fang xiao" policy begun in 1995.
  • Second, I don't think this bodes well for the shareholders of listed firms in the seven key industries, and maybe not in the six pillar industries either.
  • Third, (and this is good news, I think) it still leaves a lot of ground from which the state has all but announced that it intends to withdraw.

Monday, January 19, 2009

Rogers Puts Money Where Mouth Is...but not Family

Please forgive a little cynical sniping from the sidelines...

Jim Rogers, who at one time made a lot of money on Wall Street, has apparently abandoned his home country for a more promising locale. He's pouring his money into China because, "This is going to be the new centre of the world, not just the financial but the political world."

On current measures in the U.S. to deal with the crisis, Rogers says: "The idea that you can fix a period of excess borrowing and excess consumption by more borrowing and more consumption to me is just ludicrous."

I'm not trained as an economist, but I must admit that he has a point.

On the other hand, he has essentially nothing to say (at least in this short Reuters article) about the fact that China's entire model has been built on Americans continuing to buy their stuff.

The other thing that I just don't get is, if China is "the new centre of the world", then why did Rogers move his family to Singapore?

Sunday, January 18, 2009

SASAC to Hang "Not For Sale" Sign

A SASAC insider has reportedly told Jingji Guancha that, sometime during 2009, SASAC will publish a list of subsidiary enterprises that must indefinitely remain in the hands of central SOEs. (Jingji Guancha Wang, 19 Jan 2009)

Though the Central Government (via SASAC) as of today owns only 141 enterprises, many of the important operating assets of these enterprises are buried in subsidiaries two or three levels down. (These 141 enterprises directly owned by the Central Government control some 22,000 subsidiaries.*) In essence, the Central Government has decided (or is in the process of deciding) that there are subsidiaries in certain industries that they have no intention of selling in the foreseeable future.

The industries most likely to be covered by this "list" were actually named in a document released by SASAC in December of 2006: military, electricity generation and transmission, petroleum and petrochemical, telecommunications, coal, civil aviation and shipping.

Some analysts see this as an attempt by SASAC to extend the depth of its control from the "mother companies" (母企业) down into the subsidiaries (子企业). However, it is also possible that this list will remove a lot of suspense as to what the state intends to control in perpetuity.

What isn't clear at this point is what is to be done with the subsidiaries that don't make the list. Will they be privatized, or absorbed into those firms that do make the cut?


* Update/correction: While the Central Government owns enterprises that control 22,582 subsidiaries, SASAC's 141 SOEs only control 16,373 of that number. (2007 SASAC Yearbook, p. 585)

Friday, January 16, 2009

PBOC Steps in to Help Auto Industry

Yesterday, I noted that the market wasn't thrilled with the State Council's apparently hastily arranged package of support for the auto industry, and that surely more help must be forthcoming. Today, the Central Bank has also stepped in to lend a hand.

The PBOC, China's Central Bank, convened a meeting yesterday with members of the auto industry. The primary outcome of the meeting was for the bank to announce its support for increasing the channels of funding for the auto industry. (Caijing 16 Jan 2009)

Among the provisions announced were:
  • an increase in loans to auto firms
  • an increase in auto loans to consumers
  • support for an increased use of corporate bonds
  • promotion of auto loan securitization (packaging of loans for sale to investors)
  • further development of rental and insurance services
In short, the Central Bank wants to help the auto industry to build more long-term and stable sources of finance, and to find more ways to spread risk.

Securitization in general was approved as early as 2005, but until now, only ten of China's automakers have been specifically approved to securitize their customers' auto loans. Most automakers have had to rely on a combination of bank loans and retained earnings for funding. Securitization will help to free up capital for more useful purposes such as working capital or R&D.

This is especially important for those companies that are designing their owns cars rather than simply assembling cars for a joint-venture. The State Council has announced explicit support for helping to promote home-grown auto brands (自主品牌), but this requires a massive amount of R&D expense, a burden with which the Chinese-foreign joint ventures do not have to be concerned (because the R&D has already taken place in the U.S. or Japan or Korea or wherever).

Unfortunately, the announcement was lacking in some important details such how some of these measures of support would be carried out. (This is actually quite typical for such announcements: high-level folks announce the goal, and lower organizations are expected to deal with implementation.)

Also, there was no mention of whether this support is extended to private as well as state-owned firms.

Thursday, January 15, 2009

All Politics is Local in China Too

Well, the market was quite unimpressed with yesterday's announcement by the State Council of support for auto firms. This will probably result in yet another plan from the State Council a few months down the road, and/or local governments will have to come up with their own measures to support their local auto firms.

There was a time when local authorities would simply pick up the phone and order the local branch manager of one of China's state-owned banks to make loans to favored industries, but Zhu Rongji supposedly put an end to that by centralizing lending authority in the late 1990s.

Another measure that local governments have traditionally taken is to order other locally-owned or -regulated businesses to offer discounts to favored industries. For example, they may order the local power company to knock a few zeros off a certain firm's energy bill.

Unfortunately for local governments, now the central government isn't too keen on energy discounts either, as the NDRC and State Electricity Regulatory Commission jointly announced today. "NDRC price regulators ... expressed concerns those incentives would negate Beijing's previous policy to phase out inefficient and pollution-prone plants by raising their power prices..." (SCMP, 16 Jan 2008)

So what's a worried local government to do? Local leaders are faced with mandates from the top to tamp down social unrest -- this is built into their incentives -- and one of the best (i.e. cleanest) ways to do that is to ensure that everyone has a job. Even if the NDRC is successful in getting local governments to stop energy subsidies to their local industries (and that's a big IF), local leaders will simply find other ways to keep their factories humming and their citizens happily employed.

Getting to the top of China's political ladder must be well worth the aggravation of trying to implement conflicting policies from above.

Wednesday, January 14, 2009

Chinese Firms Bought Evil Derivatives Too?

Due to increasing discoveries of losses on derivative instruments (金融衍生品) among state-owned enterprises (SOEs), SASAC and the State Audit Administration are teaming up to conduct an investigation of the financial derivatives activities of large SOEs. (Caijing 14 Jan 2009)

  • China COSCO lost 4 billion RMB on a Freight Forward Agreement.
  • China Eastern Airlines lost 6.2 billion RMB on fuel futures.
  • China Air International lost 3.1 billion RMB on fuel futures.
  • China Railway lost 1.9 billion RMB on currency futures.
Suddenly there is concern that SOEs are using derivatives for purposes other than to mitigate an existing risk. Auditors will be looking for:
  • the extent of derivatives losses on SOE books
  • the impact of derivatives losses on last year's profits
  • the existence of wrongdoing and whether procedures were properly followed.
There was no word on whether those whose derivatives bets paid off would be rewarded.

State Council Wastes no Time Helping Automakers

In a recent post I noted that China's State Council was debating provisions to help the auto industry, and would probably get around to announcing the outcome after Spring Festival. Apparently they've been busy because the decision has been made already, and here are the results in a nutshell:

  • From 20 January 2009 until 31 December 2009, Passenger cars with a displacement of 1.6 liters and below will get a sales tax break -- a decrease from 10% to 5%.
  • The government will set aside 5 billion RMB to subsidize the purchases of 1.3 liter and below displacement vehicles by (and I'm translating here) "peasants who scrap their three-wheeled vehicles and low-speed delivery vehicles" in favor of these newer, low-emission vehicles.
  • Cancel "unreasonable rules that limit purchases of cars" (清理取消限购汽车的不合理规定). (No details given on which rules are "unreasonable".)
  • The government will spend 10 billion RMB over the next three years to support the development of "new resource vehicles" (新能源汽车) and components.
  • The government will continue to push for consolidation in both the assembly and parts industries.
I suppose they threw in the part about consolidation for good measure since the government has been begging for consolidation for years with no results so far. Again, until the central government is willing to do battle with local governments over this -- or at least provide some kind of an incentive -- I don't think we'll see many local governments willing to give up their prized car companies.

Sourced from articles in Jingji Guancha Wang and Caijing.

Why China Works (?)

I was alerted this morning by an article in Economic Observer Online to the existence of this terrific article in Newsweek. I think it gushes a little too much about China's apparent success, but if you can spare about 10 minutes out of your day, it is worth your time.

This is probably one of the best articulations I have seen of the puzzle that motivates my own research. Why is it that liberal, Western economies seem to tumble from crisis to crisis while China continues its steady upward march? Why do economic theories about the pernicious effects of government intervention in the economy not seem to apply in China? How can China's government both own businesses and provide the proper incentives for commercial success?

While I don't agree with everything said in the article (for example, their populist tendency to badmouth all financial derivatives), it sets up the current conundrum quite well.

Though, as the article points out, things seem to be going well in China -- at least from the article's 30,000-foot point-of-view -- it's important not to forget that China is still a society on edge. With falling exports and falling factory employment, the potential for unrest is increasing. Though China has achieved unprecedented levels of growth, I think a lot of people would question whether it is completely out of the woods yet.

I would be very interested to read anyone's opinion on this paradox.

__________________
Note: At some point in the future, the Newsweek link above may disappear. I have saved a pdf of the article here.

Tuesday, January 13, 2009

Three Models Emerging for Electric Car Makers

Electric/hybrid cars are getting a lot of attention in Detriot this week. Just forget for a moment that people stopped buying Priuses as they rolled off the assembly line during the last half of 2008. Also forget that, with lower gasoline prices in the US, it now takes 8 eight years to pay off the hybrid vs conventional gasoline price differential rather than the 3 years it would have taken with fuel at $4/gallon.

An article in today's LA Times notes that some companies, like GM and Toyota, either already have or are building their own battery plants. Other companies, like Ford, see no reason for branching into a new field and are instead outsourcing their battery needs.

So we have the emergence of two models here:
1. Carmakers that also make their own batteries.
2. Carmakers that outsource their batteries.

Add to that the BYD model:
3. Battery makers that also make their own cars.

Let a hundred models bloom, and let's see where this all leads...

Meanwhile, few Chinese are likely to cough up the equivalent of $22,000 for BYD's plug in hybrid which, on the outside, looks like a warmed-over Toyota Corolla from a few years back. Also, with gasoline as cheap as it is in the US, few Americans outside of Hollywood are going to spring $40,000 for the Chevy Volt when (if) it comes out next year.

The truth is that the market is not going to make alternatively powered vehicles a winning proposition for auto companies that are driven by shareholders to maximize returns. Somehow, the prices of conventional and alternative vehicles need to be equalized, and that can only happen by making it more expensive to drive a gasoline powered vehicle or less expensive to drive a battery-powered vehicle -- or some combination of the two.

China's State Council is already talking about lowering the cost of electric/hybrid vehicles. What will the new Obama administration do? The recent auto bailout forces US automakers to make these vehicles, but as nearly as I can tell (and I could be wrong), there are no provisions to encourage Americans to buy them.

Monday, January 12, 2009

The Central Govt's Power to Consolidate, or Not

The South China Morning Post is reporting that the State Council is considering measures "such as tax cuts and incentives, to promote consolidation in the slumping steel industry". ("Beijing to Discuss Steel Industry Incentives and Consolidation", 13 Jan 2009.) These measures are apparently separate from the previously announced four trillion RMB stimulus package.

Consolidation among steel industry firms is certainly desirable; China's steel industry currently suffers from over-capacity among dozens of firms. This news, however, is probably not anything new. China's government has been talking about consolidation for years -- among both the steel and auto industries. So why has nothing happened until now? Is it due to the central government's unwillingness or inability to force consolidation?

The evidence would seem to argue for the former.

There are plenty of examples in which the central government was able to force consolidation and/or reorganization. Recent moves with the telecom industry come to mind. Also, several years ago, the central government was successful in consolidating the civil aviation industry. Local governments all over China had their own airlines, and in one fell swoop, these local airlines (with the exception of Hainan Airlines) were divvied up among China's current Big Three SOE airlines. Regardless of the reason, it can be assumed that the central government simply decided it was time for consolidation and took steps to make it happen.

If they could force this kind of consolidation on the airline industry, then why not the steel industry, or the auto industry? Why only use incentives and suggestions? Are the reasons political or institutional?

I had a conversation this afternoon with a visiting scholar from Beijing who took a stab at a hypothesis: Not surprisingly, it has to do with the staying power of the Communist Party. The logic here (at the risk of oversimplifying) is that, planes falling out of the sky run a much greater risk of causing widespread social instability than do problems with the quality of mainland steel or autos.

Poor oversight of a fragmented airline industry could potentially lead to maintenance problems, and ultimately, to plane crashes. Such news would cause people to question the viability of the Party which has staked its legitimacy on social stability, not to mention economic growth and more nationalistic themes such as technological prowess (which could be called into question should planes start to fall).

The perceived potential for social instability necessitated actions to force the consolidation of the airline industry. The lack of such potential in the steel or auto industries means that the central government is only willing to spend enough political capital to give really strong suggestions to the local government owners of firms in these industries. Suggestions that, until now, most have chosen to ignore.

At least that's my friend's theory. Does it sound plausible? Is there any evidence that would confirm or refute this theory?

__________________

By the way, it is now possible
to anonymously post comments on this blog. Registration is no longer required. But I still reserve the right to delete spam posts or others that don't contribute to the conversation at hand.

China's "Bermuda Triangle" for Private Airlines

In 2005 China's first private airline, Okay Airlines (奥凯航空) began flying. Subsequently, another four private (民营) airlines also began flying in China.

On 06 December 2008, Okay took its final flight. It has since been trying to reorganize itself, but to no avail. This article asks whether the policy of permitting private airlines is being reversed.

Today, another article appeared announcing that Air China, the flagship SOE airline, will be buying 100 percent of private airline "East Star" (东星航空).

Naturally, the blame for the disappearance or absorption of these private airlines is blamed on the financial crisis, which has apparently dampened demand for flying in China. Even two of China's big three SOE airlines (China Southern and China Eastern) recently were the beneficiaries of three billion RMB in government money.

However, if Singapore's Temasek Fund had been allowed to take a stake in China Eastern in 2007, the government bailout probably would not have been necessary. Apparently, the impending takeover was blocked in a political maneuver by the former head of Air China who had just been promoted China's Civil Aviation Administration. China Air reportedly wanted China Eastern for itself. (This article by Barry Naugton in China Leadership monitor details some of the maneuverings.)

Economic theory tells us that state owned firms tend to drive private investment out of industries in which they compete, and China's civil aviation industry is a prime example. When times are tough, the government is always ready to step in and rescue its most important SOEs, if for no other reason than to prevent the unemployment that would be generated by a liquidation.

Private airlines, on the other hand, are generally left to fend for themselves. The market wisely decides not provide more capital to a business that has fallen on hard times. Barring a government bailout (such as Air China's purchase of East Star), there is no other choice but for private airlines to disappear.

All of which raises what I think is the most important question: Why do private investors even bother in the first place?

Also, why do we see this phenomenon more prominently in some of China's industries and not in others? For example, why do state-owned and private firms seem to compete so well together in the auto industry and not in the airline industry? Is it all a matter of industrial policy -- of governments picking and choosing exactly where private firms will, and will not, be allowed to compete? And if that's the case, then why even allow Okay Airlines to get launched in the first place?


More on BYD

Following up on yesterday's post, today's WSJ has a nice writeup on BYD, including some background on their founding CEO, Wang Chuanfu.

Curiously, they failed to mention that BYD got its auto expertise by acquiring an existing automaker. That's a crucial part of the story. Otherwise, how could a battery company, founded only in 1995, manage to enter the auto business?

A few questions for readers in China... Has anyone actually seen, or ridden in, the new F3DM? Can one walk into a dealership and buy one today, or is there a long wait?


Sunday, January 11, 2009

Apparently This Cat Catches Mice

In Friday's post I wrote
"Will we also see local governments willing to go to the mat for private firms? I think we will."
I wrote that, not knowing that today I would read this article in Nanfang Daily (dated 15 Dec 2008). Though it was published last month, I think it illustrates very well how important the auto industry is to China's government -- not just SOEs, but private firms as well.

BYD (比亚迪), a company about which I will certainly be writing more in the future, announced last month the introduction of their "dual mode" F3DM. "Dual mode" means that this sedan operates as both a plug-in electric car (like GM's old EV1, but with a longer range and better batteries) and as a hybrid (like Toyota's Prius). This is the first production plug-in hybrid in the world. Toyota, GM and others are working on plug-ins, but theirs will still not come to market until 2010 at the earliest.

I won't go too deeply in to why BYD was able to pull this off except to note that, before BYD was a car company, it was a battery company. Founded by an engineer in 1995, they made batteries for cellphones and laptops. Then in 2003 they bought a Xi'an-based state-owned car company and incorporated their two technologies.

With that bit of history out of the way, the article I am referencing here says that BYD, a privately-owned, Hong Kong-traded (HK1211) company has recently benefited richly from state support.

  • The City of Shenzhen (where BYD is HQ'd) and China Construction Bank signed an agreement to buy an unspecified number of F3DM cars from BYD.
  • The State Development Bank of China signed an agreement for development financial cooperation (sorry, it doesn't translate well: 开发性金融合作协议). From what I can tell, this is a long term loan for development purposes.
  • As if that weren't enough, Guangdong Province, home to the City of Shenzhen released a document in which they single out "Shenzhen BYD's electric car project" for state support. ("加快推动深圳比亚迪电动汽车等项目建设".)

"Will we also see local governments willing to go to the mat for private firms?"

We already have.



_______________________

Update: John Garnaut of the Sydney Morning Herald brought to my attention this article from the New York Times that highlights a lot of the cool electric/hybrid technology to be unveiled at this month's Detroit Auto Show.

Friday, January 9, 2009

China's Advantage in the Coming Auto Wars?

An interesting article in the January 12, 2009 issue of Business Week highlights overcapacity in the global auto industry. "Having indulged in a global orgy of factory-building in recent years, the industry has the capacity to make an astounding 94 million vehicles each year. That's about 34 million too many based on current sales, according to researcher CSM Worldwide, or the output of about 100 plants."

A graphic (stats reproduced in table below) shows actual production and excess capacity by region. Notice that China is the only region whose actual production is less than one-half of total capacity. (Note: Data are in millions of units, based on estimates from CSM Worldwide.)

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The article goes on to say that
Much as the crash of 1929 reordered the U.S. auto industry, a sudden dearth of buyers will do the same in the People's Republic. Industry watchers expect local companies to absorb much of the pain as the weakest players close and large state-owned companies gobble up the stronger ones.
Early in the 20th century, the U.S. auto industry looked similar to today's Chinese auto industry in that there were at any given time anywhere from 40 to 60 serious players in the market, along with hundreds of wannabes. As BW notes, the Great Depression managed to sweep aside many of the weaker players; however, after the depression, the U.S. was still left with about a dozen or so contenders that gradually fell by the wayside during the 1950s and '60s, finally leaving us with the Big Three we know today. Anyone remember Nash? Packard? Studebaker? Or AMC which was swallowed up by Chrysler in the 1980s?

The difference of course, as BW points out, is that most of China's major players are state-owned. This was not the case in the U.S. (Although one might argue that, given the huge wartime contracts thrown their way during WWII, the U.S. automakers may as well have been state-owned.)

However, an important aspect of China's industry that BW has not picked up on is the degree of local state ownership. China's central government has been talking for years about overcapacity and the need for consolidation, but the central government only owns two auto firms (First Auto Works and Dongfeng). The rest are either private or owned by local governments -- in fact, almost all of the rest are local state-owned enterprises. Aside from a fairly recent merger between Shanghai Auto and Nanjing Auto, much of the called-for consolidation simply hasn't happened.

So why hasn't the central government simply forced some of the smaller players together? Because they can't. Local governments in China prize their local industries -- especially their car companies. And they have become quite adept at playing off one central government faction against another when the need arises. This isn't to say that consolidation will never happen, but it will only come through a long and painful process.

The question that I have is regarding the roles of private auto firms in China. If the entire industry were privately-held and therefore subject to market pressures, we would expect to see a shake-out similar to what the U.S. experienced in the 1920s and '30s. But with only the handful of private firms subject to market pressures, will they be the first to go? That would be a shame because Geely and BYD (two private firms) have arguably among the brightest prospects of Chinese auto firms.

On the other hand, Geely and BYD, though private, are undoubtedly valued by their respective local governments in Hangzhou and Shenzhen for their contributions to their local economies. Will we also see local governments willing to go to the mat for private firms? I think we will.

All of which brings us back to square one: what is to be done about global overcapacity in the auto industry? Well, the eventual economic recovery should help somewhat, but beyond that, something's gotta give. Unless we spiral into autarky, not every country can have an auto industry. Will China's state ownership of auto firms give it a leg up in the future fight for global auto market share?

Wednesday, January 7, 2009

Provincial Govt to Give Business People a Break

We've seen a lot of stories of how factories have been closing in Guangdong Province. In fact, with this whole global crisis thing, conditions for businesses in Guangdong have become quite stressful.

Fortunately, the Guangdong Procurator's Office has business peoples' backs. According to a story in today's
SCMP:

The provincial prosecutors' office announced on Tuesday that to "guarantee the stable development of the economy", law and order authorities, such as the Public Security Bureau, might not detain or arrest legal representatives of businesses, daily operations chiefs, and technical staff who are suspected of "general crimes".

According to a statement posted on its website, the prosecutors' office urged all lower-level branches to follow new guidelines to help businesses in difficulty, saying the goal was to advance Guangdong's economic development.

Perhaps if some business people are allowed to sneak out of restaurants without paying, or view a little pornography on the internet, they will make better business decisions...

While it's nice that authorities understand the connection between economic growth and the "freedom" of entrepreneurs, maybe their energies would be better focused on encouraging more (legal) channels for funding of entrepreneurial ventures. Or how about just lowering taxes?

Central SOEs to be Held to a Higher Standard in 2010

(And they really mean it this time.)

SASAC's Assistant Director in charge of performance assessment announced that SASAC is preparing to look harder at SOE performance beginning in 2010. They had been planning to implement tougher measures in 2009, but apparently the financial crisis, any number of natural disasters, the Olympics (feel free to throw in any other excuse you can think of) have necessitated a relaxation of the rules.

But they really are planning to judge SOEs based on "economic value added" (EVA) starting next year. Honest, they really are serious this time.

All cynicism aside, EVA is a pretty rigorous financial calculation based on the idea that a business must cover both its operating costs and its capital costs. It is calculated by subtracting the opportunity cost of capital from a firm's net operating profit after tax.

Part of the reason for choosing this calculation is a concern that SOEs have traditionally engaged in unproductive investment without regard to the cost of capital. According to aggregate statistics from China's Statistical Yearbook, there is a pretty significant gap between private and state-owned industrial firms in terms of asset productivity. (These stats compare only state-owned enterprises with private enterprises. These stats for state-controlled enterprises were not available.)

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Part of the reason for this is that a lot of these SOEs are probably still saddled with old, unproductive assets. Another reason is that the leaders of these SOEs have often been motivated, not by profitability, but by size. Traditionally, anything they could do to make their respective enterprises larger before moving on to their next political appointment was considered to be a good thing.

SASAC has been expressing its concern about this over-investment for years, and according to the article, they plan to establish a threshold above which investment must get approval from SASAC. Furthermore, the EVA measure, which some enterprises have reportedly adopted voluntarily, will become a part of the annual evaluation.

However, I can imagine a few difficulties as SASAC attempts to implement these measures. I cannot imagine how they will begin to calculate the cost of capital for these firms given that SASAC's 142 SOEs collectively control about 22,000 subsidiaries (see SASAC 2007 Annual Yearbook in your local university East Asian Library). SASAC lacks the small army necessary to oversee this process.

Also, they will need to decide on some sort of benchmarks against which to measure performance. But against what kind of firm would you benchmark a sprawling state-owned industrial firm? Other state-owned firms?

Finally, SASAC will need to put some teeth in its rules and mete out punishment if it expects these standards to be followed. However, I'm not certain whether SASAC even has the power to enforce such standards. The leaders of these SOEs, while some may be recommended by SASAC, are generally appointed by the Party with approvals from other relevant organizations.

It sounds like a nice idea though.


Tuesday, January 6, 2009

Proposal to Support China's Auto Industry

The NDRC and State Council, with help from a host of other concerned ministries and organizations, are working on a plan to boost China's auto industry. Ideas being discussed include either reducing, or completely eliminating sales tax on small or low-emission autos, and helping auto firms with credit and financing. There is also discussion of a rule that government organizations must "buy Chinese" -- not merely cars made in China, but those designed in China (自主品牌).

Unlike US government help which is designed merely to keep the three US automakers afloat, the stated purpose of China's plan is to maintain at least 10 percent growth in its domestic industry which has about 50 different players. (Obviously, some consolidation is in order; plans for this have been under discussion for some time.)

I'll be interested to see the final proposal which is supposed to be approved sometime after Spring Festival. While the tax breaks are a no-brainer, the help with financing being proposed is probably dominating discussion at the State Council. Are we to expect more state-directed lending, or possibly an easier path to stock market listings? What would be done with the extra funds? Would they be used for expansion (not something needed while demand is low), R&D (great, but it wouldn't significantly boost the economy in the short-run), mergers and acquisitions (again, great, but not necessarily a good short-term boost)?

My best guess would be none of the above. Rather, the idea would probably be to provide working capital loans to help some of the weaker players avoid bankruptcy (and unemployment). This would alleviate some short-term pain, but, as with massive debt being accumulated in the US bailout, there would be a longer-term price to pay.

The tax breaks, however, are smart move. Car sales have been down in recent months due to decreased demand from Chinese consumers. Getting them to spend some of their massive savings on cars will not only be a boost to China's domestic economy, but also take some pressure off of exports as a major driver of China's economy.

But where will they park all those cars?

Monday, January 5, 2009

Privatization of Central SASAC Assets

I saw a story in today's South China Morning Post saying that Jiangsu Shagang, China's largest private steelmaker (and second largest overall, I think ... behind Baogang) is looking for an outside investor or possibly an overseas listing. (I won't bother posting a link to SCMP stories since they disappear after about a week.)

Anyway, this reminded me of a conversation I had last month with a journalist friend of mine who is based in Bejing. We were discussing the apparent trend away from privatization, and the consolidation of state ownership over China's most important industries. We pretty much agreed that Li Rongrong, head of SASAC, rather than gradually privatizing SASAC assets, appears to be moving full steam ahead with plans for long-term state ownership.

Not long after this conversation, I came across this article in the 21st Century Business Herald that seemed at first to refute what my friend and I had discussed.

According to the story, the aforementioned Jiangsu Shagang (hereafter "Shagang") are apparently buying the shares of Zhangtong Gongsi, a listed firm (currently "ST" status*) whose controlling stockholder is Gaoxin Investment Group (中国高新投资集团公司), a Central SASAC wholly-owned enterprise (中国高新为国务院国有资产监督管理委员会下属的国有独资企业). (Those interested may search for that Chinese phrase in the pdf file on this page to see the explanation of controlling ownership.)

There are a couple of interesting observations here. First, Shagang, because it is private, has been struggling to raise capital until now, but by buying Zhangtong (its "ST" status notwithstanding) it now gets a back-door listing. In other words, rather than going through the major bureaucratic hassle of filing for its own listing (and risk getting shot down), Shagang gets a listing simply by buying another listed company and injecting its assets. Frankly, I'm surprised that the authorities are allowing a private firm to get listed at this time, especially through a back-door listing.

Second, and on the other hand, I guess I'm not surprised that an ST company owned by a Central SASAC firm is being cut loose since Li Rongrong has made it clear numerous times before that SASAC only intends to keep firms that are among the top three in their respective industries. The general managers of these SASAC firms are probably under pressure to dump under-performing assets -- even if that means giving them to the private sector. On yet another hand, this may, in a roundabout way, support the trend away from privatization my journalist friend and I had discussed, in that only the junk assets are being privatized, which ultimately results in a stronger public sector and a weaker private sector.


*Note: "ST" stands for "special treatment". It is appended to the ticker symbols for all Chinese firms that have lost money for two or more years in a row, and/or that have negative equity. It's sort of a warning to unsophisticated investors that this company may not be a good investment.