AAP

Volvo Cars, the Swedish subsidiary of Chinese carmaker Geely, has reported a slight increase in its 2013 sales thanks to a spectacular growth in China.

The Asian country became Volvo's first market at the end of last year, during which the company sold 427,840 cars, 1.4 per cent more than in 2012.

"After six consecutive months of growing sales we can report a great full-year performance exceeding last year's results," Volvo Cars Marketing, Sales and Customer Service executive Alain Visser said on Thursday.

"Our China team has delivered fantastic growth and we will continue to expand our presence there."

The figures vary sharply from country to country.

In the United States, still Volvo Cars' strongest market for the entire 2013, sales were down by 10 per cent compared to 2012.

In China, the 45.6 per cent growth recorded in 2013 was distorted by an underestimation of sales in 2011 and an overestimation in 2012, detected by Volvo in the beginning of last year.

Last year, Volvo opened its second and third Chinese factories with the support of the China Development Bank.

In Sweden, its third largest market, Volvo Cars increased its market share to 20 per cent, with sales up by 0.8 per cent.

The company, which intended to return to operating at break even in 2013 after repeated losses since the second quarter of 2011, did not provide any profit figures.

By a staff reporter, with Dow Jones Newswires and AAP

China's trade surplus contracted more than expected in December, according to official data.

In December, China's trade surplus was $US25.64 billion, down from $US33.8 billion in November, the General Administration of Customs announced on Friday.

Bloomberg analysts had expected a trade surplus of $32.15 billion in the month.

Exports rose 4.3 per cent on year in December, down from November's 12.7 per cent rise and below the median forecast for a 4.5 per cent expansion.

Imports rose 8.3 per cent on year, up from a 5.3 per cent rise in November and beating the economists' median forecast for a 5 per cent increase.

Meanwhile, the country's annual trade surplus reached $US259.75 billion ($A292.96 billion) in 2013, up 12.8 per cent from the previous year.

Exports rose 7.9 per cent in the year, to $US2.21 trillion ($A2.49 trillion), while imports increased 7.3 per cent, to $US1.95 trillion.

The country's total trade in goods for last year came to $US4.16 trillion, an increase of 7.6 per cent, just below the government's target of eight per cent.

The European Union was China's biggest trading partner, Customs said, followed by the United States, the Association of Southeast Asian Nations (ASEAN), Hong Kong and Japan.

Between them, the traditional markets of the EU, US and Japan accounted for 33.5 per cent of China's trade, down 1.7 percentage points, indicating that emerging markets' share of business was growing.

Chinese and South Korean companies are jostling for access to new Australian resources projects to the benefit of local companies, according to The Australian.

Among those seen to profit from the competition is ASX-listed copper play Rex Minerals Ltd, which has seen Korean conglomerate Hyundai challenge the China Nonferrous Metal Industry (NFC) for the engineering and construction contractor rights to Rex's Hillside copper project in South Australia.

"NFC were first movers on this. Hyundai came to us later in the piece and we have been very, very impressed with the amount of people that they have mobilised on to the project and the amount of progress they have made to get to this stage," Rex managing director Mark Parry told The Australian.

"Copper is very important to the Korean industry, and they want to make sure that they are having their share of the world pie.”

Rex is hoping to begin construction on the project this year.

Dow Jones
 
Li Ka-shing plans to raise up to US$3.6 billion in a Hong Kong initial public offering this month of his Hong Kong electricity assets.

HK Electric Investments, which owns power plants and electricity-distribution networks in the city, is selling 4.43 billion units in an indicative price range of HK$5.45-HK$6.30 each, it said in a statement late on Sunday.

HK Electric will be listed as an investment trust – playing to investor demand for steady, high dividends in a low-interest-rate environment. The trust, being carved from Mr. Li's Power Assets Holdings Ltd. (0006.HK), will provide a yield of 6.26%-7.24%. That is more than existing business trusts listed in Hong Kong – like telecom trust HKT Trust controlled by Mr. Li's son Richard which is trading at 5.5%. The U.S. 10-year Treasury bond is trading at 3% yield.

China state-owned electric utilities State Grid Corporation of China agreed to buy 18% of HK Electric Investments after the IPO while Oman Investment Fund, a sovereign wealth fund of the Oman government, agreed to subscribe 0.7%-0.8% of the total number of unites issued. HK Electric is slated to list on Jan 29, it said.

By listing HK Electric Mr. Li will be able to raise money from an asset that is low growth and facing increasing government regulation. The government caps the rate of return for the city's electricity operators at 9.99% – down from 15% five years ago. The rate of return pegs the maximum profit the city's electricity companies can make to the value of their fixed assets.

East Asia Forum

Australia is enjoying its 22nd year of economic growth without recession – an experience that is unprecedented in any other developed country. For the first decade of expansion, growth was based on extraordinary increases in productivity, attributable to productivity-raising reforms from 1983. In the early years of this century, reform and productivity growth slowed sharply and then stopped. For a few years, increases in incomes and expansion of output came from a housing and consumption boom, funded by wholesale borrowing overseas by the commercial banks.

Unlike other English speaking countries and Spain, Australia avoided recession with the end of the housing and consumption boom (earlier in Australia than elsewhere). This was largely the result of a China resources boom. The boom emerged when the exceptional metals and energy intensity of Chinese growth in response to Keynesian expansion through the Asian financial crisis and again in response to the global financial crisis took markets by surprise, and lifted prices of iron ore and coal continuously and immensely from 2003 until the Great Crash late in the September quarter of 2008.

China’s fiscal and monetary expansion put iron ore and coal prices back on a strongly rising trajectory in the second half of 2009, and new heights were reached in 2010 and 2011. The high prices for coal and iron ore flowed quickly into State and especially Commonwealth government revenue and was mostly spent as it was received – raising the Australian real exchange rate to unusual and by 2013 unprecedented levels. The high commodity prices induced unprecedentedly high levels of resources investment after the recovery of the Chinese economy from the Great Crash of 2008, adding to the expansionary and cost-increasing impacts.

The China resources boom created salad days of economic policy, in which incomes could grow even more rapidly than community expectations. The expansionary effect of the resources boom – taking expenditure induced by high terms of trade, resource investment and resource production together – reached its peak in the September quarter of 2011, when the terms of trade began a decline that continues today.

The terms of trade fell partly because Chinese growth fell by about one quarter within a new model of economic growth. A bigger influence was the new model of growth, which caused energy and metals and especially thermal coal to be used less intensively. Huge increases in coal and iron ore supplies are also putting downward pressure on prices and will be increasingly important in future.

The declining impact of the China resources boom ushered in the dog days of economic policy from late 2011, when government revenue and private incomes growth sagged well below expectations and employment grew less rapidly than the adult population.

The maintenance of high employment and reasonable output growth without external payments problems requires the restoration of investment and output in trade-exposed industries beyond resources. And yet the real exchange rate by early 2013 was at levels that rendered uncompetitive virtually all internationally traded economic activity outside the great mines. A substantial reduction in Australian cost levels relative to other countries is required – a large depreciation of the real exchange rate – to maintain employment and economic growth.

The more that productivity growth can be increased the better. Helpful policy measures include the removal of artificial sources of economic distance between Australia and its rapidly growing Asian neighbours to allow larger gains from trade – removal of remaining protection and industry assistance at the border as the real exchange rate falls, and investment in transport and communications infrastructure.

While China’s new model of economic growth ends the extraordinary growth of export opportunities for iron ore and coal that characterised the first 11 years of this century, new patterns of growth in China and elsewhere in Asia are rapidly expanding opportunities in other industries in which Australia has comparative advantage – education, tourism and other services, high quality foodstuffs, specialised manufactures based on innovation. But in contrast to iron ore, coal and natural gas, Australia does not have overwhelming natural advantages over other suppliers of these products. It must compete with the rest of world on price and quality – especially with developed country suppliers with hugely depreciated real exchange rates in the aftermath of the Great Crash.

Even with the return of productivity growth to the world-beating levels of the 1990s, maintenance of output and employment growth would require a large reduction in the nominal value of the dollar, accompanied by income restraint to convert this into a real currency depreciation.

A new economic reform era is required. That requires social cohesion around acceptance that all elements in society must share in restraint as well as commitment to productivity-raising structural change. Achievement of this outcome is blocked by changes in the political culture of Australia since the reform era. Now, uninhibited pursuit of private interests has become much more important in policy discussion and influence.

The new Australian government will succeed in building the political culture that is necessary to deal with the problem only if it is effective in persuading the community of the importance of reform, and in confronting the Great Australian Complacency of the early 21st Century. This will be hard, as the government will have to change the 21st century tendency for private interests to outweigh the public interest in policy discussion and choice. Harder still, the new government will have to disappoint its strongest supporters along the way to leading Australia into a new reform era.

This article was originally published at East Asia Forum. Reproduced with permission.

AAP

Chinese state-owned oil giant Sinopec will pay compensation over a pipeline explosion at its facility in the city of Qingdao that killed dozens of people and caused losses of more than $US100 million ($A111.49 million).

Sinopec is listed in Hong Kong and in a filing to the stock exchange there, said on Monday an official Chinese government investigation determined that "direct economic loss" from the accident totalled $US124.3 million.

The company said it "will pay its share of the compensation", although it did not say how much that would be, or what proportion of it would go directly to victims of the disaster, which killed 62 people and injured 136.

Sinopec said in the statement Sunday that its pledged compensation would come mostly from company insurance policies, adding that its "production, operation and financial position are currently stable".

Citing the probe by China's State Administration of Work Safety, it said the direct cause of the explosion was vapours from oil leaking from an underground pipeline, which were ignited by sparks from a hydraulic hammer.

The investigation also found that Sinopec and its subsidiaries' failure to ensure safe operations contributed to the accident, as did local authorities' failure to properly conduct safety inspections and identify risks, Sinopec's statement said.

The huge blast ripped roads apart, turned cars over and sent thick black smoke billowing over the city.

The explosion happened seven hours after an oil leak was first spotted, and questions remain as to why local residents were not ordered to evacuate in the intervening period.

According to state media 15 people, including unspecified numbers of Sinopec employees and Qingdao city staff, have been detained in connection with the explosion.

Sinopec issued an apology for the incident but denied that it was slow to respond.

AAP

French cosmetics giant L'Oreal says it has received the official greenlight for its $US843 million ($A939.85 million) bid to acquire the Hong Kong-listed facial care company Magic Holdings International.

The bid of $HK6.30 per share is worth a total of $HK6.53 billion ($A930 million) and was approved by China's commerce ministry, the companies said in a joint statement.

Magic's MG brand is one of the leaders in China's fast-growing cosmetic facial mask market.

Present in China since 1997, L'Oreal has 3,500 employees in the country where it operates two plants and a research centre.

Last week, L'Oreal said it was halting the sale of its Garnier brand in China to focus on its L'Oreal Paris and Maybelline New York mass market brands, which have enjoyed better sales.

Western companies believe that the beauty and personal health products market in China, which accounted for more than a quarter of luxury goods sales there, still has enormous potential.

However, the sector has recently felt the chilling effect of a Chinese government clampdown on corruption, which often takes the form of gifts of luxury goods.

The listed arm of Chinese resource giant Chinalco – the largest shareholder in Rio Tinto – has been forced to sell some of its assets to stay in the black for the 2013 financial year, avoiding the fate of being treated as a pariah on the Chinese stock exchange.

Under Chinese listing rules, a company will be placed under special watch if its net profit is in the red for two consecutive years. ST, which stands for special treatment, will be added to the company’s name at the stock exchange.

Having posted a record loss of $1.44 billion for the 2012 financial year, Chinalco was desperate to be in the black this year to avoid that public humiliation.

The company was regarded as China’s national champion to take on Western resources giants. In 2008, Beijing anointed it to raid the share registry of Rio Tinto to block the potential merger between BHP and Rio.

However, the wounded national champion was forced to sell assets to its unlisted parent company to artificially inflate its bottom line. In the first half of 2013, it sold nearly 10 billion yuan of assets, but it was not enough.

The company was also forced to sell its iron ore asset in the final quarter last year for a cash infusion of $2.3 billion in order to turn a small profit of $180 million. 

Its last-minute auction saved it from joining an inglorious list of loss-making state-owned giants listed on China’s stock exchanges, including China Metallurgical Group Corporation, which is the principal contractor for building CITIC Pacific’s much-delayed Sino Iron project (China's shock and ore at the Australian way, January 9).

The worst performing centrally-owned company is COSCO, the country’s largest shipping company, which lost 20 billion yuan last year. Its Australian division is one of the few profitable subsidiaries in the world, mainly due to rental income from its office building in Sydney.

Chinalco executives have reportedly signed a written undertaking with the State Council (China’s cabinet) to return the company to profitability and some of the most senior executives have forfeited salaries, according to 21^st Century Business Herald, a Chinese-language newspaper.

Chinalco’s troubles highlight one of the toughest challenges for the country’s policymakers: how to turn around underperforming state-owned enterprises that receive disproportionate resources from Beijing.

Of the 63 listed companies under credit watch, 17 are large state-owned enterprises, according to Caixin, one of China’s leading independent business publications. Seven state-owned giants sold off 30 billion yuan in assets to boost their bottom line.

Though Chinalco blames its financial woes on external factors such as slowing economy, decreasing price for aluminium products and weak consumer sentiment, the truth is state enterprises are a protected species that don’t thrive on competition and still suffer from bureaucratic mismanagement.

In contrast, the privately-owned Shandong Weiqiao, which also manufactures aluminium products, has been enjoying record levels of profitability, despite tough market conditions. Its gross profit was around 30 per cent in 2012, according to company reports.

Qiu Lin, an industry analyst, compares Chinalco’s quasi-bureaucracy to Weiqiao’s streamlined management structure. Chinalco employs about 90,000 people,10,000 of whom are administrative staffs. The ratio of production staff to management is about eight to one.

At Weiqiao, the company employs 16,700 production workers, 3,950 technicians and 334 managers. The ratio is about 62 to one. Chinalco, a supposedly modern listed company, is still run like a government bureaucracy.

The state-owned sector is also plagued with corruption issues. Chinalco’s former senior vice president Li Dongguang is under investigation for alleged corruption. Many senior executives from PetroChina and China Mobile – two of the largest fortune 500 companies in the world – have also been arrested recently for disciplinary infractions, a codeword for corruption.

One of the most disappointing features of China’s otherwise bold reform blueprint unveiled at the third plenum of the Eighteenth Party Congress is on reforming the state-owned sector. It is not only inefficient but also choking a dynamic private sector of precious resources for further expansion.

AAP

A proposed waterway to rival the Panama Canal could make Nicaragua the richest country in Central America, a project official has been quoted as saying.

President Daniel Ortega recently approved the $US40-billion ($A43.30 billion) undertaking, granting the concession to little-known Hong Kong-based company HK Nicaragua Canal Development Investment Co, known as HKND Group.

Under the deal, the company led by Chinese tycoon Wang Jing gets 50 years of exclusive rights to build and operate the canal in exchange for Nicaragua receiving a minority share of the profits.

Now its poorest nation, "Nicaragua will become by far the richest country in Central America - and that will affect the entire region," the La Paz daily Pagina Siete on Sunday quoted HKND spokesman Ronald MacLean Abaroa as saying.

MacLean Abaroa, a Bolivian former World Bank official, is a former mayor of La Paz and now serves as an adviser to HKND.

"Investment in this project is three to four times the GDP of Nicaragua, there will be an effect of full employment and prosperity," he was quoted as saying.

Environmentalists have warned that the project could spark an environmental disaster that threatens drinking water supplies and fragile ecosystems.

MacLean Abaroa has said in the past that the company was considering four possible routes for the waterway, and all would necessarily go across Lake Nicaragua.

In the lake lies an island with an active volcano and some 300 small islands that serve as breeding grounds for the American crocodile (Crocodylus acutus), the largest reptile living in Central America and the Caribbean.

In Sunday's remarks, MacLean Abaroa said the waterway project could generate resources to deal with environmental problems such as the cleaning up of Lake Nicaragua and deforestation caused by endemic poverty and civil war.

The canal plan includes building ports, an airport, pipeline and a railway. A free trade zone is also set to be created.

The waterway is expected to be wider and deeper than the 82-kilometre Panama Canal.

Work should begin in May 2014 after a feasibility study is completed.

The Panama Canal handles five per cent of world trade annually, and has hosted more than one million vessels since it was inaugurated in 1914.

Dow Jones


China plans to establish a national system for tracking real-estate ownership and sales transactions, a key step in its effort to tame a property sector that threatens to price many Chinese out of the housing market.

A nationwide real-estate registration system could pave the way for levying a broad property tax in China for the first time. It could also help Beijing crack down on government officials and others who buy and own multiple properties despite restrictions on ownership.

"This is a tough task," said Xu Deming, vice minister of land and resources, at a work meeting on Saturday, according to the ministry's website. China has to carry this out to safeguard the interests of the public and to ensure sustainable economic growth, Mr. Xu said.

He didn't give details on whether such registrations would include the ownership of commercial property in addition to residential property. Such a system would make it easier for the authorities to detect and tax multiple property ownership.

Currently there are many local registries and systems that aren't linked, making it difficult to determine who owns what.

In November, the State Council, the country's cabinet, said real-estate registration processes that had been supervised by nine government departments would be combined into a single system overseen by the Ministry of Land and Resources.

Officials see property taxes as a sustainable solution to control speculation and keep the gap between rich and poor from widening.

It is now in place on a trial basis in Shanghai and Chongqing, but policy makers said they would expand it to more cities.

Average housing prices in 100 cities rose 11.5% in December from a year earlier, according to private data provider China Real Estate Index System. Housing prices in Beijing and Shanghai rose 28.3% and 15.6%, respectively.

Analysts said a property tax could address the issue of empty apartments kept off the rental market. Still, they say the thorny issue of privacy has hindered the progress of such efforts.

In recent years, court cases of individuals owning multiple properties have also driven calls for more transparency. In September, Gong Aiai, nicknamed "Sister House" in China, was sentenced to three years in prison for forging identification documents that allowed her to purchase 44 properties.

At the same weekend meeting, Jiang Daming, China's minister of land and resources, said farmland and the production of food must not be reduced while carrying out land reforms.

The official Xinhua news agency said authorities would restrict the purchase of rural land by rural residents, citing Mr. Jiang.

At a key policy meeting in November, Communist Party leaders said they wanted to make it easier for farmers to transfer their land.

"Rural land reform still faces strong opposition at the current stage" said research firm NSBO Beijing. "We do not expect to see large changes for the land system in the short term."

Dow Jones


China plans to establish a national system for tracking real-estate ownership and sales transactions, a key step in its effort to tame a property sector that threatens to price many Chinese out of the housing market.

A nationwide real-estate registration system could pave the way for levying a broad property tax in China for the first time. It could also help Beijing crack down on government officials and others who buy and own multiple properties despite restrictions on ownership.

"This is a tough task," said Xu Deming, vice minister of land and resources, at a work meeting on Saturday, according to the ministry's website. China has to carry this out to safeguard the interests of the public and to ensure sustainable economic growth, Mr. Xu said.

He didn't give details on whether such registrations would include the ownership of commercial property in addition to residential property. Such a system would make it easier for the authorities to detect and tax multiple property ownership.

Currently there are many local registries and systems that aren't linked, making it difficult to determine who owns what.

In November, the State Council, the country's cabinet, said real-estate registration processes that had been supervised by nine government departments would be combined into a single system overseen by the Ministry of Land and Resources.

Officials see property taxes as a sustainable solution to control speculation and keep the gap between rich and poor from widening.

It is now in place on a trial basis in Shanghai and Chongqing, but policy makers said they would expand it to more cities.

Average housing prices in 100 cities rose 11.5% in December from a year earlier, according to private data provider China Real Estate Index System. Housing prices in Beijing and Shanghai rose 28.3% and 15.6%, respectively.

Analysts said a property tax could address the issue of empty apartments kept off the rental market. Still, they say the thorny issue of privacy has hindered the progress of such efforts.

In recent years, court cases of individuals owning multiple properties have also driven calls for more transparency. In September, Gong Aiai, nicknamed "Sister House" in China, was sentenced to three years in prison for forging identification documents that allowed her to purchase 44 properties.

At the same weekend meeting, Jiang Daming, China's minister of land and resources, said farmland and the production of food must not be reduced while carrying out land reforms.

The official Xinhua news agency said authorities would restrict the purchase of rural land by rural residents, citing Mr. Jiang.

At a key policy meeting in November, Communist Party leaders said they wanted to make it easier for farmers to transfer their land.

"Rural land reform still faces strong opposition at the current stage" said research firm NSBO Beijing. "We do not expect to see large changes for the land system in the short term."

East Asia Forum

The Australian minerals boom appears to have peaked, as commodity prices eased back after 2011 and investment has begun to taper.

Currently there are 37 mineral resource projects in Australia, worth around A$33 billion in total, which have funding committed. But there are a further 165 mineral resource projects in the publicly announced and feasibility stages, which are yet to finalise their financing. These projects are worth around A$174.5 – 202.5 billion in total.

Australia can no longer rely on its traditional luck; rather the quality of policy and openness to the best international management will determine how the mining sector will now fare going forward.

China has significant ongoing needs for mineral resources which are not available at low cost domestically. As Australia moves from the investment phase of the mineral boom to the production and export phase, there will be reduced labour costs and the Australian dollar should fall sharply. These circumstances are likely to reduce the costs of investing in Australia, especially for Chinese investors because the RMB rose 2.3 per cent against the US dollar in 2013. Indeed, as China is the largest new source of foreign direct investment globally, Chinese investment in the minerals and other sectors in Australia remains most prospective.

Yet Chinese investors have been seared by their experience in investing in Australia. The failure of the Rio Tinto-Chinalco tie-up and the massive cost over-runs of CITIC Pacific’s Sino Iron project – from around US$2.5 billion to US$8 billion – have sent a cautionary message to Chinese investors. These developments also revealed the complex connection between the economics and politics of international investment in Australia. The spill-over from these two big investment failures has been substantial. The delays and cost blow-outs associated with the CITIC Project precipitated the suspension of all Chinese magnetite investments in Western Australia as of 2011.

Meanwhile, Chinese investors are also learning the stark reality of being a first-mover in high-risk investment environments, in Africa and elsewhere. Corruption, unstable institutional frameworks and increasing anti-China sentiment have plagued projects in places like Guinea and Liberia. These marginal projects could provide a longer-term alternative to Australian minerals, but in the medium-term, few are likely to deliver a great deal.

Recent changes in Chinese corporate governance systems should in fact make Australia a more attractive investment location. China’s 2012 foreign investment guidelines demand higher degrees of due diligence and risk management on all overseas projects by major SOEs and also require that executives be held ‘accountable’ for foreign investments that result in significant losses to the state.

To capitalise on Australia’s foreign investment opportunities, and to ensure that the bad luck of the commodity price downturn is not compounded by bad policy choices, the new Australian government will need to demonstrate to potential international investors, from China and beyond, that it has learned lessons from the previous government’s failures. It needs to convince the public, as well as the coalition party room, that foreign investment is indeed welcome in Australia.

The signals from its performance in the first few months do not bode well.

When Australian Treasurer, Joe Hockey, decided to block the sale of Grain Corp grain distribution business to American company Archer Daniels Midland, he noted that the Foreign Investment Review Board (FIRB), when considering Australia’s ‘national interest’, should ‘specifically have regard to the impact the decision on this proposal would have on broader Australian support for foreign investment and the foreign investment regime into the future’.

This creates a dangerous precedent. Foreign investment is complex and stirs sentiments among a range of different domestic stakeholders. The Australian public, like that in the vast majority of countries, is reticent by nature toward foreign investment and has been since American investment became important during earlier the post-war period.

To mitigate this tendency towards national insularity over foreign investment, FIRB is charged with consulting other Australian agencies (governing tax, competition and other matters) in considering the complexity of investment proposals and providing objective advice to the Treasurer to ensure Australia’s ‘national interests’ are protected. This institutional structure was established precisely to de-politicise the foreign investment process. Treasurer Hockey’s public messages about investment undermines FIRB’s mission.

The China-Australia FTA negotiations will be the next test for the new Australian government; it will require thoughtful management of powerful and competing stakeholders in China and Australia. The Chinese will insist on increased FIRB thresholds for their private and state-owned enterprise investors. But increasing that threshold will go directly against views that were articulated by Prime Minister Abbott as opposition leader – that ‘it would rarely be in Australia’s national interest to allow a foreign government or its agencies to control an Australian business’ and that ‘the thresholds for the FIRB to assess foreign acquisitions are too high for the agricultural sector’.

If managed properly, Australia’s minerals investment boom has much life left in it yet; and given that value of trade with China is equivalent to nearly A$15,000 to every Australian household, the continuation of its growth is most clearly in Australia’s national interest.

This article was originally published at East Asia Forum. Reproduced with permission

Rumours that the economic leadership under Premier Le Keqiang sees liberalisation of the Chinese renminbi as a top priority are on the march again, if the viewpoints of prominent Chinese economists and international bankers are to be trusted. Yes, we have heard these before and various ‘liberalisation’ measures have been somewhat underwhelming and involve only allowing the RMB to trade within a 1 per cent band of the prescribed exchange rate vis-à-vis the American dollar dominated ‘basket of currencies’ that the Chinese Central Bank pegs the RMB against.

Should we be more optimistic about the prospects for liberalisation after so many false dawns? Most in the financial world will say ‘yes’ because allowing free exchange and market-determined rates appears to make good economic and commercial sense. This author says that genuine liberalisation is not imminent because the conditions that have prevented liberalisation have not changed.

What’s the case for allowing a freely traded RMB whose rate is determined by the market? For a start, an appreciating RMB (it would almost certainly rise against major currencies if traded freely) would make imports cheaper for the Chinese people. China imports about half of its consumer goods, and only has vast trade surpluses with advanced economies in North America and the European Union. Allowing the RMB to be freely exchanged will create a much larger market for the currency outside China, and beyond its use merely for bilateral trade with China.

This could open up options for a more fruitful use of its foreign exchange reserves – estimated at US$3.66 trillion – that go beyond buying low yielding American government backed bonds. Importantly, liberalising the RMB is an essential step towards developing a wider and deeper corporate bond market in the country since it would encourage international buyers to purchase such bonds in a currency that was freely traded.

Of course, China cannot meaningfully liberalise its currency without liberalising its capital market, which is currently tightly restricted and controlled. There would be poor demand for the RMB if money under the country’s capital account could not easily enter and leave the country. Beijing would also have to liberalise its interest rates in order to prevent huge imbalances being created from the dangerous combination of a liberalised currency and open capital account alongside a fixed interest rate regime.

Economists, who have long attributed many of China’s imbalances to too much state intervention in capital, cost of money and exchange rates, would embrace such a move – another seemingly economically rational prescription. So if the economic reasons appear strong, why doesn’t Beijing allow it?

The first reason is potential instability. If the currency-peg was dismantled and capital controls lifted, Beijing fears domestic capital flight. Organisations like the IMF estimate that this could amount to 2-4 per cent of GDP, while more pessimistic experts such as MIT’s Victor Shih believe that this could amount to US$3 trillion in savings leaving the country. Whatever the accurate figure would be, the IMF estimate seems understated as various studies suggest that Chinese citizens already move an amount equivalent to 2-3 per cent of GDP out of the country even with a closed capital account, for example, through dummy companies in Hong Kong supposedly engaged in trade or through the purchase of expensive assets (such as real estate) for their children studying abroad.

But the greater problem may be speculative capital coming in, which the IMF and others believe would amount to more than 10 per cent of GDP. During the 1997 Asian Financial Crisis when massive amounts of capital first flowed in and then out of the Southeast Asian countries, China was largely unaffected as it was not tapped into global capital markets. The experience has convinced Beijing that it does not want to render its economy vulnerable to the whims of external speculators. Since the RMB has been repressed for so long, currency speculators will pour into capital into China in the hope of making a killing on a rapid RMB appreciation following currency and capital account liberalisation. Such money will leave the country, just as quickly as it enters at the first sign of trouble with the Chinese economy – and there are many such signs.

Then there is the matter of the impact of a rising RMB for China’s export manufacturing sector. Various studies show that a 10 per cent rise in the RMB against the dollar would lead to a 5-10 percent decrease in foreign direct investment entering the country. Remember that around 80 per cent of all FDI is destined for the export manufacturing sector. China is one part – albeit a central part – of a regional manufacturing production chain that encompasses Northeast and Southeast Asia. Many of these countries are competing with each other to attract FDI in order to host a part of the manufacturing process – making products mainly destined for the US and EU. These sectors employ around 50 million people in China directly, and another 100 million indirectly, and create the best jobs in the country. Beijing and the southeast provinces which host these manufacturing firms would not want to jeopardize such a setup.

Then there is the issue of the country’s huge foreign exchange reserves. The trillions of dollars are often described as some kind of economic ‘war chest’ for China. It is no such thing. The reserves largely arise out of a combination of its trade surpluses in the current account with the US and EU, and its fixed currency regime. This takes some explaining.

This is what happens when a Chinese-based manufacturer sells a plasma TV to an American consumer. Let’s say the price of the TV is US$100. The American consumer pays his money to the importer, who subsequently transfers the agreed amount to the Chinese manufacturing firm – let’s make it US$50. The Chinese Central Bank takes possession of the US$50, and issues an RMB equivalent ‘I owe you’ to the bank of the Chinese manufacturer, upon which the RMB equivalent appears in the local bank account of the Chinese manufacturer.

This means that the People’s Bank of China has to hold on to the foreign currency and ‘park’ its money outside China in a foreign currency-denominated asset. The People’s Bank of China generally buys US government backed bonds because it is the only place big and safe enough to ‘park’ that amount of hard currency. It just is not feasible to put it all in euro or Japanese yen-denominated bonds.

All this means that there are liabilities against China’s foreign currency reserves, namely the IOUs to its domestic banks holding money for the accounts of the country’s exporters. Beijing cannot afford to ‘park’ its foreign exchange reserves in too many higher risk assets because it needs the money to be there – hence the grudging support for the American government bond market despite such low returns.

If the RMB were to appreciate against the dollar, then the amount of foreign exchange reserves required to honour the People’s Bank of China’s IOUs given to China’s retail banks would increase proportionately. In other words, a 10 per cent appreciation in the RMB against the dollar could well mean a 10 per cent increase in the amount of American dollar-denominated foreign exchange assets needed by the People’s Bank of China to cover its liabilities. In the event of rapid RMB appreciation, the People’s Bank of China could well be forced to quickly issue its own bonds on the international market to meet its IOU liabilities.

There are other reasons why Beijing will be slow to liberalise its currency. But it’s enough to say that these imbalances preventing currency liberalisation are getting worse, rather than better meaning that liberalisation will administer quite a bit of acute pain before any structural gain becomes apparent.

The bottom line: China’s fear of liberalisation is a sign of its immense economic vulnerabilities and not strength. This applies whether it is the currency, capital account or interest rates that we are speaking about.

Dr John Lee is the Michael Hintze Fellow and adjunct associate professor at the Centre for International Security Studies, Sydney University. He is also a non-resident senior scholar at the Hudson Institute in Washington DC and a director of the Kokoda Foundation in Canberra.