China’s Reform

Forces of Movement and Forces of Order


Forces of movement

In every organization, including the Chinese Communist Party, there are forces of movement and forces of order.  The forces of movement have moved into ascendancy in China and this was signaled by establishment of the special economic zone in Shanghai and the program emerging from recent Third Plenary Session.  However, the uncertainty over implementation kept domestic and foreign investors cautious.

December 4rth’s announcement by the People’s Bank of China will help reassure investors and the pace of implementation may be more aggressive than anticipated.  Financial reforms will be rolled out in the next three months and “most” of the reforms will be implemented within a year.  Moreover, these reforms may be duplicated in other special economic zones.

That said, it is still unclear whether “most” reforms include liberalization of capital flows.  For example, individuals employed in the zone are supposed to be allowed to buy foreign assets easier.  It is to allow foreign companies operating in the zone to buy Chinese assets.  This could dramatically alter Chinese capital flows, if allowed to the fullest extent. 

It is also true that of the various institutional stakeholders in China, the PBOC is typically among the strongest advocates of liberalization, though its overall influence is debatable.   Nevertheless, it matches the signal we picked up from our recent discussions with Chinese officials.  The tone of much of the off-the-record comments reflects the awareness that the forces of order have subverted and/or blocked reforms.  At the same time, these officials seemed unusually confident the forces of reform have the upper hand.

Forces of order

Of course, the forces of order are not defeated and have to be co-opted.   The quid pro quo may be over politics and security, which the forces of reform will have to respect vigorously, which may be in part, what the escalation of tensions over the disputed islands reflects.  Nor are Chinese officials, including the forces of reform, willing to discuss openly the contradiction between the modernizing economy and the continued rise of the middle class on one hand, and the arcane and inflexible political system on the other.

The forces of movement are aware of the track record.  Of the 124 emerging market countries that sustained 5% or more growth for a 10-year period since 1980, 52% were representative governments and 48% were authoritarian governments. The type of political regime is a poor predictor of the ability to sustain growth. 

Renminbi transactions

Both the forces of movement and order are celebrating the recent news from SWIFT, that the Renminbi has surpassed the Euro in global trade finance in November 2013, with an 8.66% share of letters of credit and collection (euro share 6.64%).  The US dollar share is 84.96%.  At the start of 2012, the RMB’s share was a little less than 2%.  An estimated 20% of China’s trade is now invoiced in RMB compared with 1 % four years ago.  Some industry forecasts suggest it can reach 33% in the coming couple of years.

SWIFT said the RMB was the 12th most used currency for transactions in October 20123 on its global payments system.  Its growth rate of 1.5% on the month was less than the 4.6% overall growth.  This means that the RMB’s market share slipped to 0.84% from 0.86%.   According to BIS figures, daily RMB turnover averaged $120 bln in April and nearly 4-fold increase since 2010 and places in into the ninth position overall.

The Deputy Governor of the PBOC said on November 20 that it is no longer in the national interest to continue accumulating foreign exchange reserves, which stood at a  little above $3.6 trillion at the end of Q3 2103.  However, this was not a policy indication as China appears to be still accumulating reserves.  Moreover, while some pundits read this as a blow to the US, this has been the US Treasury position for a long time.

Bitcoin ban

Just as some a couple of bank analysts suggested that central bank may use the bitcoin for reserves and that fair value as higher than prevailing prices, China banned its banks from trading the digital currency.  Baidu,  China’s biggest internet portal reversed itself and indicated it would no longer facilitate the use of bitcoins.  This announcement is perfectly consistent with the reformist agenda.  There are no Bitcoin instruments, like notes or bonds.  The Bitcoin is not backed by gold, silver or commodities.   The apparent anonymity lends itself to money laundering and illegal capital movement.  Just as the forces of movement embrace greater capital market liberalization, they have to vigorously clamp down on extra-legal forms.

The message was driven home by the fact that the decision to ban banks from trading Bitcoins was made jointly by five different government entities, including the PBOC, the Ministry of Industry and Information Technology, the China Banking Regulatory Commission, China Securities Regulatory Commission and China Insurance Regulatory Commission.  Going forward virtual currency trading platforms will have to register with telecommunication authorities.   

China embraces Russian ruble

Separately, China has embraced another currency:  The Russian ruble.   In the border city of Suifenhe in the Heilongjian Province, China has recognized the ruble and is willing to allow it to circulate freely.  We note that Russians are allowed to visit Suifenhe without visas.

China is unlikely to do this unilaterally.  Russia should be expected to shortly announce allowing the renminbi to trade freely in some border city.  The reciprocity should, over time, generate a true market based bilateral exchange rate.

Although Nixon-Kissinger are credited with playing the China-card to squeeze the Soviet Union during the Cold War, there is arguably greater scope for cooperation between China and Russia than the other BRICs.   China needs oil and gas and Russia has plenty.   With Europe’s slow growth and aging population and fundamental antagonism,Russia has interest in developing an Asian market for its energy products.  Bilateral trade is forecast to reach $100 bln in the next couple of years. 

On a different front, the Japanese government is on a bit of a diplomatic offensive as it seeks to bolster support in its confrontation with China.   It not only is seeking tighter military ties with the US and Philippines, but it also is offering to guarantee Samurai bonds sold by Mongolia, a resource rich neighbor of China. Specifically a state-owned bank (Japanese Bank for International Cooperation, JBIC)) will guarantee the bonds sold by the Development Bank of Mongolia, to which Moody’s assigns junk status (B1).  

Chinese bond yields surge

Lastly, we note that privately Chinese officials appear to be increasingly concerned about the surge in bond yields since mid-year.  China’s 10-year bond yield has risen about 120 bp since early July to almost 4.8% at the end of November.   Like Japanese government bonds, though for different reasons, the vast majority of Chinese bonds are owned by domestic entities.

Domestic insurers, pension funds and commercial banks alone hold about 75% of the government’s debt.    We suggest three forces that have driven Chinese bond yields higher:  increased supply, the rise in global yields and the rise in headline inflation from 2.1% in May to 3.2% in Oct.

Marc Chandler