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    China's state-owned enterprises and private firms are preparing to escalate investments in Australia's mining sector to take advantage of low commodity prices before they recover, according to The Australian.

    The firms are targeting distressed miners, who have been hit hard by falling commodity prices. The newspaper reported that fund managers, bankers and transactional lawyers have noted an uptick in activity.

    "Our prediction is that some time in the next six to 12 months, China's new leadership will ramp up the economy again," private equity fund manager Jason Chang told The Australian.

    "As with all changes of leadership in China, it takes six to 12 months to settle in. And we expect – and our partners in China are of the same view – that now is the time to position ourselves for growth that is going to come in about 12 months."

    Macquarie Group's West Australian chairman Mark Barnaba, also a director at Fortescue Metals Group, said the steep sell-off in mining company shares was “certainly presenting a wonderful set of opportunities”, according to The Australian.  

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    State-owned, private firms see buying opportunity amid share sell-off.
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    China is considering dramatic moves towards making the renminbi freely tradeable within several years, previously unreported comments from a central bank conference in March show, according to The Financial Times.

    “China could accomplish basic or partial renminbi capital account convertibility in a few years,” State Administration of Foreign Exchange director-general Guan Tao told the conference, according to the FT. “In another couple of years, China could announce full capital account convertibility of the renminbi.”

    But  foreign advisers told the conference, organised by the the People's Bank of China and the International Monetary Fund, they were surprised at how enthusiastic Chinese officials were in pursuing capital account opening and the reforms could put China’s financial system at risk if introduced too rapidly. 

    “Premature capital account liberalisation risks accidents and crisis," IMF deputy director of Asia Markus Rodlauer said, according to the FT. 

    "Therefore China will be served well by continuing its careful approach."

    Liberalisation of the currency would allow businesses, investors and individuals to trade the renminbi across China’s borders with no significant barriers. 

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    Conference notes shows central bank could partially open capital account 'in a few years'.
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    Graph for The heady rise of China's shadow banking
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    It is widely recognized that China has a very sizeable informal financial sector, which refers to financial intermediaries that are not registered with any  regulatory agencies and therefore are not regulated. This informal sector is often lumped together with  the wealth management products offered by regulated banks and trusts and referred to as the “shadow banking” sector, because they accept deposit-like  funding and provide credit outside the traditional,  and more highly regulated, banking model.

    Technically, these financial intermediaries are often in violation of Chinese law. But local governments, knowing the existence of these financial  intermediaries, usually allow them to continue operating unless there is evidence that they may have  done harm to the local economy.

    The composition  and size of the Chinese informal financial sector, according to the IMF, is illustrated below: 

    Graph for The heady rise of China's shadow banking

    Several reasons have been proposed by leading academic and business journals to explain the existence of a sizable informal financial sector. The first reason is the local government’s borrowing behaviour. Local governments have become the main competitor with local firms for bank loans.  According to a recent report by the PBOC, one third of the outstanding loans in China were made  to the local governments. Over the last several years, about 30 per cent to 40 per cent of total loans went into  government infrastructure projects. This massive  borrowing on the local government level crowded  out private borrowing.

    The second reason is the structure of the Chinese banking industry. As described above, several large banks dominate the banking industry in China. Large Chinese banks tend to lend to large firms. In other countries, such as the US, small local banks and other savings and loans companies fill the gap left by large banks. Also, large banks in those countries develop other financial instruments targeted at small private firms. This is not the case in China’s formal sector.

    The third reason is the underdevelopment of the corporate bond market. This has made it very difficult for local private firms to issue corporate bonds to raise money. The fourth reason is the IPO regulatory frame work. As discussed above, the approval system poses further difficulties for local firms with no connections with the government to go public and  raise money.

    Fifth, the periods of negative real deposit rates, due to spurts of high inflation, while not the source of the shadow banking sector, certainly exacerbated its growth. Between February 2007 and October 2008, and from February 2010 to October 2011, the real one-year interest rate on deposits in Chinese banks was negative. During these periods, there was a consequent growth in the informal financial sector, as this sector avoids the government-mandated ceiling on deposit interest rates. The higher rate available to savers helps draw a lot of wealth into the informal sector, especially during these inflationary spells. To sum up, local private firms have very limited access to bank loans, the bond market and the stock market. Therefore they are almost forced to acquire funds from informal channels.

    What is the situation of the informal financial sector in China? There is no official data or studies on the informal financial sector on a national level. The related area of wealth management products has been singled  out as especially concerning by Xiao Gang, the chairman of the Bank of China. He has estimated  there to be over 20,000 of these WMPs, reaching a  total value of 12.14 trillion RMD by 2012. Xiao  has characterized this ‘shadow banking’ sector as  “a potential source of systemic financial risk,”  whose model is “fundamentally a Ponzi scheme.”

    A more conservative estimate places the value of  these WMPs at only 7.1 trillion RMB, while other estimates agree that the value of these wealth management products is not much greater than 14 per cent of China’s GDP. This is still striking, given that they were only just above 4 per cent of GDP in 2010. The rapid growth of this shadow banking sector can be attributed to the period of negative real interest rates on bank deposits during the majority of 2010 and 2011.

    Other informal financial flows, such as private lending, are even more difficult to account for, with analysts roughly estimating the later to amount to some 4 trillion RMB per year. Overall, the informal ‘shadow’ banking sector is estimated to account for just over 20 per cent of total bank assets (in 2012), an increase of about 33 per cent since 2010.

    One way of evaluating the current situation of the Chinese informal financial sector is by taking a look at Wenzhou, which is one of the places that the informal financial sector has thrived over the  past few years. Wenzhou is a city in Zhejiang Province, one of the most developed provinces along the east coast of  China. Wenzhou is famous for its industrial output and at the beginning of the reform era generated a  group of high net worth individuals.

    It is reported that the GDP of Wenzhou reached RMB 243 billion in 2010, with per capita GDP being RMB 40 thousand, compared to a national average of RMB 30 thousand. About 300,000 small private firms produce more than 90 per cent of the local output, with  about 70 per cent of them relying heavily on exports.

    The informal financial sector went through two stages in Wenzhou. The first stage started in around 1995 and lasted until the global financial crisis. In this stage, the rapid development of the Chinese economy and, most importantly, export-driven economic growth, generated a large group of wealthy individuals in this area. The informal financial sector in this period mainly served as  underground asset management firms providing  alternative investment opportunities.

    For example, it is claimed that about RMB 200 billion flew into the real estate market in Beijing and Shanghai, causing a boom in real estate prices. The informal financial sector was also accused of causing large swings in cotton prices, meat prices and many other commodity prices.  The second stage started after the financial crisis and continues now. Since the Chinese economy has slowed down and the global financial crisis, combined with the ensuing euro crisis, has reduced foreign demand, many local firms have experienced a drying up of liquidity.

    The local informal financial sector provided short-term liquidity for the local firms during this period. The liquidity provision was mainly done through very short- term but high-yield loans. For example a loan could be as short as three to five days, and the annualised yield could reach 70 per cent. It is estimated that the magnitude of the informal financial sector in Wenzhou reached RMB 700 billion.

    The downturn of global trade as a result of the global financial crisis also caused a large scale default of local firms. Some owners of private firms, who had significant debt within the shadow banking system, went abroad to avoid debt collectors.  This, in turn, affected the fragile local underground financial system, triggering defaults that harmed their investors.  

    In 2011, the local court sentenced one of the CEOs of the underground financial system to death, convicting her of “illegally gathering investors’ money”. This case was brought to national attention by some very prestigious economists, who insisted that “illegally gathering investors’ money” should  either not be a violation of the law or should not  receive such a severe sanction.

    Prime Minister Wen Jiabao himself also asked the court to “recon sider carefully the accusation and the final verdict”.  In the end the Supreme Court repealed the death sentence. This case is widely seen as providing an impetus for further financial reform in Wenzhou. 

    This article is an extract from the Brookings Institute's John L Thornton China Center paper The Chinese Financial System: An Introduction and Overview, published July 1. 

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    Post-GFC settings have shifted the role of shadow lending in China’s economy, facilitating a spike in the sector’s value to 14 per cent of GDP or more, from around 4 per cent in 2010.
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    Chinese President Xi Jinping

    China’s President Xi Jinping and Premier Li Keqiang’s credibility would seriously suffer if the world’s second-largest economy does not grow at least to their 7.5 per cent target this year, says Li-Gang Liu, chief economist on China for ANZ.

    Liu predicts a 7.6 per cent economic growth for China in 2013. “If the government does not meet its target it will have a credibility problem,” he says. “Financial markets will begin to doubt whether an economic forecast number is credible or not.”

    The former World Bank and Asian Development Bank economist expects China to announce a detailed urbanisation plan for 2000 cities. The further development of these urban areas will help bolster the economy, Liu says. The investment rate for China is running at a growth rate of 20-21 per cent a year, he says. That is helping to directly bolster the economy annually by 3-4 percentage pints.

    The surge in China’s seven-day repurchase rate to a record 10.8 per cent on June 20 was not a “credit squeeze” but a “panic", says Liu. The supply of money, as measured by M2, rose 15.7 per cent in the first five months of this year, indicating there is enough liquidity in the financial system, he says.

    “Last month was a confidence issue and a policy mistake,” says Liu. “The PBOC (People’s Bank of China) did not inject enough liquidity. A central bank should stabilise short-term interest rates. They have not played their monetary role well.”

    ANZ expects iron inventories at Chinese steelmakers to fall but steel inventories to rise. That means there will be less demand for iron ore in the second-half of 2013, says Liu. But as long as China maintains investment growth of about 20 per cent a year then it has to produce enough steel for infrastructure and construction projects.

    ANZ expects the Chinese iron ore spot price in the six months to December 31 to be $US115 a tonne. The spot price for iron ore n the north-east Chinese port city of Tianjin yesterday rose $US1.50, or 1.2 per cent, to $US122 a tonne, its fifth consecutive day of gains, according to Bloomberg data.

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    ANZ’s China economist says the communist nation's president will help ensure economic growth remains robust.
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    Minerals Council of Australia (MCA) chairman Andrew Michelmore has warned that Australia's attractiveness as an investment destination for Chinese investors is on the wane, according to The Australian.

    Mr Michelmore, who took his position at the MCA last week and also serves as chief executive of the Melbourne-managed, Hong Kong-listed and Chinese state-controlled MMG, warned that Chinese firms are cool to the sales pitch that Australia is ripe with distressed mining asset values attractive to foreign investors.

    He added that anyone hoping for a repeat of the Chinese investment rush into Australia following the global financial crisis is likely to be disappointed.


    “It was almost indiscriminate back then. I think now it will be much more value driven,” Mr Michelmore told The Australian.

    “The Chinese are serious about Australia but we can't take it for granted.

    “We have to be serious about creating the right environment.

    “We can get a win-win situation. That's what we've lost. Real or not, that's how it is perceived at the moment.”

    He added that Canada is beating Australia as the most attractive destination for foreign resources investors.


    “Canada is out there beating themselves on the chest and thanking Australia for all the uncertainty here,” Mr Michelmore said, according to The Australian

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    New MCA chair says Canada is winning Chinese foreign investors' attention.
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    Graph for The investment test that has Beijing trailing
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    In a recent trip to several countries in South East Asia, many academics, think-tankers, journalists and even officials offered the opinion that China would soon dominate the region economically – eventually forcing countries to change their strategic orientation away from Washington and ever closer towards Beijing. Some Australian strategists proffer the same opinion, the most prominent being Professor Hugh White in his widely read book, Power Shift: Australia’s future between Washington and Beijing.

    At the heart of these arguments is the observation that Chinese economic growth and importance in the region will surely pull countries into its sphere of influence, even if they go kicking and screaming. Trade is often cited as evidence of this China-dominated economic power shift away from the West. In reality, and although significant, trade numbers are less important than is often made out. The key is to look at investment flows in Asia. And if we do, it becomes clear that China is far from the dominant economic force now and into the future that many people assume to be the case.

    The China trade story is well known. Trade between China and major regional countries has been growing rapidly over the past two decades. China is already the largest trading partner for Japan, South Korea, Vietnam, Indonesia, India and Australia. It is the largest trading partner with the 10 ASEAN nations considered as a whole.

    In predicting the strategic future why put more emphasis on foreign direct investment or FDI (defined as equity ownership of 10 per cent or more in a foreign business), even if trade remains important? To explain, consider the following scenario.

    You go to the same butcher every day to buy meat for your family. Lately, you've also been buying your meat for the restaurant you own from the same butcher, making you a major customer and the proprietor very happy.

    But in the midst of a promising relationship, you have an argument with the town mayor, who bans you from entering the shopping strip where the butchery is located.  

    There are few winners from the mayor’s rash decision. From your point of view, this is enormously inconvenient since you'll have to now order your family and restaurant meat from a neighbouring town, leading to increased costs for your restaurant business and a delay in getting your domestic requirements. From the proprietor’s point of view, the loss of significant business will hurt his bottom line and he'll have to work harder to increase sales elsewhere.

    Now imagine that you're an investor in the butchery. A breakdown in your relationship with the mayor – and a resulting ban against you coming anywhere near the butchery – is much more serious. You can no longer oversee the running of the business, let alone work in it. If things take a turn for the worse, it'll be difficult to sell your stake in the business. If the mayor decides to seize your equity in the business, you lose a major asset. It's in your overriding interest to do whatever it takes to make peace with and appease the mayor. At the very least, you'll be reluctant to invest again in that town until a new mayor is in office.

    In essence, trade is a series of generally recurring but stand-alone transactions that is of benefit to both parties. Once the transaction is completed, the relationship potentially ends. If Country A needs less of our stuff, we quickly move on and build relationships with Country B – recognising that there are normally transaction costs with shifting suppliers or identifying new buyers. But trade is ultimately much more indiscriminate and fluid.

    The relationship between governments on the basis of trade is also much more indiscriminate. Sure, Canberra wants a good relationship with Beijing in order to facilitate a smooth trading relationship for Australian firms. But if Australian firms move on and identify new opportunities in, say, India, Indonesia or Vietnam, Australian diplomacy will follow suit. At the end of the day, Canberra doesn't care whether Rio Tinto receives the bulk of its revenues from China or from some other rising giant in the future – as long as it gets its share of taxation revenue. 

    The FDI relationship – in the eyes of both governments and firms – is very different. From the firm’s point of view, FDI is an investment of considerable capital, manpower and the firm’s brand and reputation in a foreign jurisdiction and political-economic system for a substantial period of time, meaning that it is a far better indicator of economic integration and intimacy than trade. Getting out prematurely will invariably entail a significant sunk cost and loss of the firm’s and management’s reputation. Any private or government-owned firm – generally in step with their own government’s advice – needs to be confident about the economic opportunities available in that country. It's also a vote of confidence in the current and future stability, fairness and trustworthiness of that political-economy, and that the firm’s equity, interests and promised commercial access will be protected by the host government.   

    Moreover, well over two-thirds of trade between China and other major countries is intra-firm processing trade – that is, importing raw material and parts into China for assembly or further processing, and then shipping these products out again. Around three-quarters of the final destination of products stamped ‘Made in China’ is America or the European Union.

    This is important in this context because it means that China has simply become a major part of a regional production chain for the Western consumer – rather than a domestic consumption market that can compete with the industrialised Western world. China’s emergence as an export manufacturing hub is great for manufacturing multi-national corporations seeking efficiency gains. But it also means that there is intense competition for manufacturing jobs between China and economies such as Vietnam, Thailand, the Philippines, Indonesia and Malaysia.   

    Moreover, much of Asia, aside from advanced economies such as Japan, needs foreign capital to develop rapidly – which is why FDI matters at least as much as trade. Note that a massive influx of Chinese capital and aid for ‘nation building’ infrastructure projects – more so than trade – is the main reason Cambodia believes it has no choice but to enter Beijing’s political sphere of influence. But host governments in the more important maritime Asian economies are reluctant to allow foreign equity (whether it be private or sovereign-owned) into key sectors of their economy unless there's a pre-established diplomatic relationship and political trust between the two governments – as well as adequate harmonisation of regulatory, taxation, legal and other standards.

    Incidentally, this is Huawei’s problem in Australia, and the reason why Swedish company Ericsson is far more welcome than Huawei despite our trade relationship with the Chinese.

    Let’s look at some comparative figures of FDI in the economies of key players in Asia.

    Let’s begin with Japan. In 2012, the cumulative FDI into Japan was over $US206 billion. The US accounted for almost $US62 billion, EU over $US95 billion, and Singapore $US15.4 billion. Cumulative Chinese FDI was only $US552 million or less than 0.26 per cent of all FDI in Japan.

    A similar story can be told for a so-called strategic ‘swing states’ such as Thailand and Indonesia. Cumulative Chinese FDI into Thailand is under $US2 billion. This compares to over $US46 billion by Japan, $US26 billion by the EU, $US24 billion by Singapore, and $US13 billion by the US. In Indonesia, Japan accounted for about 28 per cent of FDI in 2010, US 4.3 per cent, and the rest of ASEAN as a whole 44.4 per cent. China accounted for only 2.7 per cent.     

    The same can be said for Chinese FDI in Australia despite all the attention it receives. The US, UK and Japan account for the top three positions in cumulative FDI into Australia at 24 per cent, 14 per cent and 11 per cent respectively. The Netherlands, Switzerland, Singapore, British Virgin Islands, Canada and Germany follow. China is 10th at about 3 per cent of FDI stock in Australia.

    These figures bring more accurate perspective in countering runaway talk about a China-dominated Asian economic century. It also proves that trade – especially of the processing kind – is not the be all and end all, and that major regional economies have abundant alternatives to Chinese capital.

    So to the economists and strategists out there: plan for an Asian Century if you must, but don’t assume that it will be a Chinese dominated one.

    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.

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    China may be a potent force in world trade but it lags on foreign investment – a far better indicator of economic integration and intimacy.
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    China’s inflation rate is picking up and this should be viewed as good news for Australia.

    Higher Chinese inflation implies a number of things – either the economy is growing at a solid pace and price pressures are building, or there are rising prices in the cost of doing business. Which of these explanations carries the most weight at the moment in China will be sorted out when more information becomes available, but it is safe to say that stronger growth and rising domestic prices are good news for a commodity exporter like Australia.

    The Chinese CPI showed inflation lifting to an annual rate of 2.7 per cent in June. This is up from 2 per cent at the start of 2013 and is the second highest reading in the last 12 months. While the annual inflation lift was centred on higher food prices, the disinflation that has been seen in China in 2012 has been replaced by a gentle broadly based acceleration in inflation.

    The inflation data has seen the consensus view further scale back expectations of any further easing in policy, even though GDP in China is forecast to slow to a 23-year low of 7.5 per cent in 2013.

    Amid all this, it needs to be remembered that China is restructuring towards a ‘new normal’. Gone are the days where GDP growth of 10 per cent and more was the norm. Those double-digit growth rates were doable when the economy was one-fifth the size it is now and incomes were rising from what were subsistence levels. But with economy now in the middle phase of industrialisation, GDP growth nearer 7 per cent is more likely than not to be what is achievable and sustainable for years to come.

    Indeed, in 2011 the Chinese government announced a target for 7 per cent growth on average in its five-year plan for 2011-2015, a point that many economists and China economy watchers tend to ignore as they see growth rates cooling towards that pace. It was meant to be.

    At the time of the new five-year plan, the government said, "We must maintain a proper level of economic growth in order to provide necessary conditions for creating jobs and improving people's wellbeing and to create a stable environment for changing the growth model and restructure the economy. We must ensure that economic growth is in accord with the potential economic growth rate".

    In other words, there was a realisation that the potential rate of economic growth would inevitably be reduced as the economy matured. There were signs of overheating recently with property prices rising at bubble like rates and a construction boom that has seemingly left an uncomfortable glut of empty buildings around the country.

    Importantly, 7 per cent GDP growth in China now when its annual output is around $US8.25 trillion contributes a lot more to global growth and demand for commodities and services than 20 years ago, where a 10 or even 12 per cent GDP growth rate occurred when annual output in China was around $US1 trillion.

    In addition to the lift in Chinese inflation, there are some tentative signs of a lift in commodity prices. Admittedly, these higher prices are from a low base and it is clearly the case that the conflict in Egypt accounts for most of the rise in oil prices. That said, the broad based commodity price indices are up around 4 per cent in the last week.

    Are these commodity prices a further sign of solid global growth and inflation risks? It is possible, but still too early to be sure.

    Having an influence on commodity prices and the global inflation outlook is the steady improvement in the US economy. It now seems squarely on track to grow above 3 per cent next year, which would be the first time in seven years that such a growth rate has been achieved.

    It needs to be remembered, given the hype about China, that the US is still the largest economy in the world, accounting for almost one-quarter of total global output and is almost double the size of China. The US growing at 3 per cent instead of 1.5 per cent is akin to China growing at 9 per cent versus 6.5 per cent.

    It really does matter.

    All of this suggests that a rise in Chinese inflation, a clear lift in the growth momentum of the US economy and just a hint that commodity prices are edging higher is the sort of good news that will help underscore a lift in optimism in Australia in the months ahead.

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    China's GDP was always meant to fall back to more sustainable levels but its rising inflation, coupled with a US growth spurt, spells good news for Australia.
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    Graph for Markets: Stocks back in style

    After much wailing and gnashing of teeth, is the S&P/ASX200 Index in the midst of a minor rally? Since June 25 the index has gained 4.9 per cent after falling 11 per cent between May 20 and June 25. Concerns about the ending of monetary stimulus in the US and increasing evidence the Chinese economy is slowing have been trumped by expectations of easier monetary conditions at home. Combined with a weaker currency – the Australian dollar has dropped 13 per cent since April 11 – that may help underpin economic growth.

    Certainly business could use some help as yesterday’s National Australia Bank survey showed. Business conditions, as measured by hiring, sales and profits, fell to -8, a four-year low. Yet like many statistics that are digested by the market, the NAB survey prompted not gloom but optimism.

    UBS interest rate analyst Andrew Lilley says the market reckons there is a 60 per cent chance of a rate cut at the next Reserve Bank of Australia’s monetary policy committee meeting next month. Even Citigroup’s Paul Brennan, who doesn’t think there will be any change in the level of the cash rate this year from 2.75 per cent, admits yesterday’s NAB survey has “increased the risk of a rate cut”.

    The turmoil in bond markets caused by rising yields has caused many to flee from fixed-income assets. Could they be dipping their toes back into Australian stocks? It may be so. Their targets could be miners where predictions of a prolonged period of low commodity prices has yet to eventuate – or perhaps has already been factored in by some. Citigroup may have cut its forecast for China's economic growth to 7.4 per cent this year and 7.1 per cent next year but steel mills in the world’s second-largest economy and Australia’s biggest trading partner seem to continue to want iron ore.

    The spot price for iron ore imported through the northeast Chinese city of Tianjin has gained 12 per cent since May 31 when it was at $US110.40 a tonne, according to Bloomberg data. Yesterday the price rose $US1.80, or 1.5 per cent, to $US123.70 per tonne. Even gold is staging a revival. The spot price of gold is up 4.2 per cent since June 27 when it was at $US1200.65 an ounce, according to Bloomberg. At 0818 AEST the spot price of gold was $US1251.25 an ounce.

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    The ASX seems to be in the midst of a rally that may gain traction on expectations of a rate cut.
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    By a staff reporter, with AAP

    China's trade surplus widened less than expected in June, according to official statistics.

    In June, China's trade surplus came in at $US27.12 billion ($A29.85 billion), after a May result of $US20.43 billion.

    Bloomberg analysts forecast a trade surplus of $US27.8 billion.

    Exports in the month decreased by 3.1 per cent, against expectations of a 3.7 per cent rise.

    Imports shrank by 0.7 per cent, well below expectations of a six per cent increase.

    Customs spokesman Zheng Yuesheng says China's foreign trade is "facing grave challenges".

    The main cause was "prolonged sluggish foreign demand", followed by rising export prices in foreign currency terms, labour costs, and a deteriorating trade environment due to rising trade disputes, he said.

    But the trade surplus for the first six months of 2013 was substantially higher than the same period last year, the statistics showed, up 58.5 per cent to $US107.95 billion.

    First half exports rose 10.4 per cent to $US1.05 trillion and imports increased 6.7 per cent to $US944.87 billion.

    Mr Zheng said the factors bedevilling China's trade situation are likely to linger over the short term.

    "Trade still faces a complicated and volatile situation in the second half of the year and there are a lot of difficulties and challenges," he said.

    Alarm bells have rung over the health of China's rebound from a prolonged downtrend as trade and manufacturing conditions have worsened this year.

    China's economy grew 7.8 per cent in 2012, its worst performance in 13 years, on the back of slack demand for exports and weakness at home.

    The first three months of the year saw expansion of just 7.7 per cent, disappointing analysts who had expected growth to accelerate after showing strength at the end of 2012.

    The government has set a growth target for 2013 of 7.5 per cent, the same as last year's, as it looks to retool its economic model from exports to domestic consumption.

    Beijing is due to announce gross domestic product (GDP) figures for the second quarter on Monday.

    China's June trade figures came after the International Monetary Fund (IMF) on Tuesday cut its global economic growth forecast, citing new downside risks in key emerging-market economies and a deeper recession in the eurozone.

    The IMF projected the world economy to expand 3.1 per cent in 2013, down from its April estimate of 3.3 per cent.

    China and other emerging economic powers now face new risks, it warned, "including the possibility of a longer growth slowdown".

    On Tuesday, the government announced that China's inflation accelerated to 2.7 per cent in June, but analysts cautioned that demand remained weak and second-quarter economic growth may have slowed further.

    The year-on-year figure for the consumer price index - a main gauge of inflation - was up from 2.1 per cent in May, the National Bureau of Statistics (NBS) said.

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    Data shows surplus widens; imports, exports fall unexpectedly.
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    AAP

    Auto sales in China, the world's largest car market, increased by 11.2 per cent year-on-year in June, an industry group says.

    A total of 1.75 million vehicles were sold nationwide last month, marginally lower than 1.76 million in May, data from the China Association of Automobile Manufacturers showed.

    In the first half of the year, car sales rose 12.3 per cent year-on-year to 10.78 million, it said.

    China's auto sales rose only 4.3 per cent annually to 19.31 million in 2012, hit by limits on vehicle licence plate numbers imposed by some cities to ease traffic congestion and tackle pollution.

    China's economic rise has been accompanied by a surge in demand for vehicles, including luxury ones, as the country's increasing wealth gives consumers more money to spend.

    China became the world's largest auto market in 2009. Of the more than 19 million vehicles sold last year, 15.5 million were passenger cars.

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    World's largest auto market continues to see robust sales.
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    AAP

    US Vice President Joe Biden has called on China to end its "outright theft" through hacking as he opens two days of annual talks between the world's two largest economies.

    "We both will benefit from an open, secure, reliable Internet. Outright theft that we are experiencing must be viewed as out of bounds and needs to stop," Biden said, while also calling for cooperation with the rising Asian power.

    The United States accuses China of waging a vast hacking campaign against its government and companies, with a recent study saying that the theft of trade secrets was costing corporate America hundreds of billions of dollars a year.

    Beijing has hit back that it too is a victim of hacking, charges that gained ammunition when US intelligence leaker Edward Snowden said that US spies had broken into the Asian power's Internet routing network.

    Biden voiced hope that the annual Strategic and Economic Dialogue would build trust between the United States and China, saying: "Our relationship is and will continue to be a mix of competition and cooperation."

    The talks involve senior officials including Secretary of State John Kerry, whose attendance had been in doubt after his wife was hospitalized with seizure-like symptoms.

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    Graph for China's rocky road to financial freedom

    Lowy Interpreter

    The spike in China's short-term interest rates over the past month sent a shiver through world financial markets, in the same way that Fed Chairman Bernanke's statements on quantitative easing startled financial markets a month earlier. In both cases the market over-reacted, reflecting a misunderstanding of what was happening. But at the same time the liquidity glitch was a trigger for legitimate concerns about the wider Chinese financial sector.

    The short-term interest rate in China, as in almost all countries, is under the control of the central bank (the People's Bank of China, or PBoC). In countries with mature financial sectors, this interest rate is the key instrument of monetary policy: when the central bank wants to tighten policy, it raises this short-term rate, discouraging borrowing.

    In the case of China, this key interest rate, which has been around 2-4 per cent in recent times, rose to well over 20 per cent. What policy message was being sent by such a disconcertingly large shift? Or if, for some reason, it wasn't a reflection of policy intent, what had gone wrong? Was it China's Lehman moment, a sign that the pent-up imbalances in the financial sector had finally tripped, spilling out the suppressed problems of accumulated bad debts and an unregulated shadow banking sector?

    In a fully-evolved financial system, a short-term interest spike like this would suggest a serious operational error on the part of the central bank. It is a primary responsibility of central banks to supply enough liquidity to allow banks to provide the public with whatever currency they want to hold and to leave the banks with a comfortable amount of liquidity to meet their reserve requirements and carry out inter-bank transactions. Operational hitches are no excuse: it is especially easy to adjust liquidity in the Chinese system, via a reduction in required reserve levels.

    It looks like there were a few glitches in the PBoC's liquidity management.

    Circumstances (a public holiday, foreign exchange transactions) left liquidity tight. The PBoC seems to have been ready to use this tightness as a signalling device for its desire to firm policy, in the face of rapid growth in bank credit. This would never be a preferred method of signalling an intentional tightening in most central banks as it leads to confusion and misinterpretation. If credit or economic activity is growing too fast, an announced interest rate rise is more effective. If, on the other hand, the underlying problem is excessive non-performing loans, or the shadow banking sector is expanding too quickly, this is a matter for the prudential authorities, not a case for an interest rate increase which could trigger bank failures.

    Monetary policy control in China, however, is still evolving.

    The PBoC is not independent, nor is there a well-defined decision process. The PBoC may have taken the opportunistic path to shift the effective stance of policy in the desired direction. But the messy signal delivered demonstrates the collateral cost of such opportunistic ad hocery.

    Liquidity has now been rebalanced and the situation has returned more-or-less to normality. The residual messages are that the PBoC would like the policy stance to be tighter, with credit growing more slowly. More fundamentally, the PBoC would like to see banks' non-performing loans dealt with and the shadow banking sector brought under control.

    While these structural issues are serious, the threat of a Lehman-like meltdown or a repeat of the 1997-8 Asian crisis seems remote, to say the least. The big five banks that dominate the financial sector are all predominantly government owned. China's macro position has no similarities with that of Asia in 1997: China is not vulnerable to the capital flow reversals that were central in the 1997 crisis.

    The problem of the shadow banking sector reflects the stage of development of the financial sector. When banks are closely regulated, financial intermediation shifts outside the regulated sector, beyond the control of the authorities. As usual, politics impinges: regional governments exercise informal pressure to obtain unregulated funding, using some of this to build infrastructure, not all of which is viable.

    The PBoC has signalled, however crudely, its intention to slow the growth of credit. It will be a bigger step to get on top of the shadow banking sector, and the resolution of bad debts will leave official debt higher. It's hard to be sure about Chinese financial data or to find relevant comparators. The ratio of credit to GDP is around twice that in the US, but this reflects the nature of the Chinese financial sector, where banks play a much larger role than in the US.

    Clearing up the financial system might be expensive and a credit squeeze might crimp growth, but reform is underway and the degree of control which the authorities have over the economy makes a financial collapse unlikely. One of their instruments might provoke a pang of envy from Western central bankers: the PBoC has issued a directive to the domestic press to avoid malicious hype and to strengthen positive reporting.

    All this is playing out in an economy undergoing structural change to reduce its dependence on capital expenditure, especially infrastructure, replacing this with faster consumption growth. The liquidity glitch is not important in itself, but is another reminder that the road of financial reform is bumpy and the pace of travel is not fully under control.

    Originally published by The Lowy Institute publication The Interpreter. Republished with permission.

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  • 07/11/13--12:02: NAB eyes China food business
  • National Australia Bank (NAB) has launched an initiative intended to help farmers access China's booming growth by forming a relationship with China's largest agricultural group, according to The Australian.

    NAB has signed a memorandum of understanding with China's state-owned China National Agricultural Development Group Corporation (CNADC), which has economic and trade ties with more than 80 countries and the equivalent of $A2.6 billion in assets.

    NAB's head of business bank and Asian operations, Joseph Healy, called the deal an “important milestone” to build bilateral trade.

    “For Australia's agricultural sector, our abundance of productive land and high food quality makes us an ideal strategic partner for China's growing food, beverage and agricultural needs,” Mr Healy said, according to The Australian.

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    Bank deal with CNADC seen helping farmers access Chinese markets.
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    A leading China analyst has warned that the Chinese economy could be in for a hard landing that risks triggering a global recession, according to The Australian Financial Review.

    Peking University professor Yiping Huang warned at an ANU China Update 2013 conference in Canberra that the Chinese government must address structural imbalances if it is to avoid an economic slump.

    Mr Huang pointed specifically to the country's transition from an export-led economy to one based on domestic consumption.

    “The days of 10 per cent growth are over and we are looking at a growth potential now of between six and eight per cent,” Mr Huang said, according to the AFR.

    “Transition of the growth model is already under way and could lead to slower growth, higher inflation pressure, improved income distribution, more balanced economic structure and more volatile economic cycles.

    “We might actually see some kind of harder landing than people had in mind, and if that happens, given the close links between Chinese growth and economic growth in the region and growth in the rest of the world, we might actually see the first China-induced global recession.”

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    Leading analyst warns Chinese economy could be in for hard landing.
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    ANZ Banking Group Ltd deputy chief executive Graham Hodges has called for Asian countries to play a larger role in establishing global financial rules to ensure the region has a greater say in banking regulations, according to The Australian Financial Review.

    The change would better protect the region from problems in the United States and Europe, both of which have a disproportionate influence on global regulations, he argued.

    “A driving influence behind this regulation has been the experience of the United States and Europe,” Mr Hodges wrote in a paper published this month by the Lowy Institute for International Policy, according to the AFR.

    “While consistency in the implementation of strengthened standards is important and regulatory arbitrage should be avoided, it is important that the challenges and pressures confronting other financial systems are appropriately recognised.”

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    Bank exec argues Asia should have stronger voice on regulation.
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    AAP, with a staff reporter

    China's finance minister Lou Jiwei signalled the world's second biggest economy was likely to grow at a slower pace than previously forecast.

    Mr Lou said a 6.5 per cent Chinese growth pace wouldn't be a "big problem", as he forecast a seven per cent average expansion in 2013.

    The level he quoted in Washington, on the sidelines of a US-China summit, is lower than the Chinese government's 2013 target of 7.5 per cent, given in March.

    Commonwealth Bank currency strategist Joseph Capurso said the comments follow the downgrade of International Monetary Fund forecasts.

    "The IMF ... many other private sector economists have downgraded their China forecasts, so it's not a lot of new news," he said.

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    Finance Minister signals economy likely to grow at slower pace than expected in 2013.
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    Graph for China's conflicted money for nothing
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    FT.com

    Over the past six months, analysts working for Argyle Street Management have been fanning out across China to visit local bank branches. Argyle, a Hong Kong-based hedge fund, wanted to know more about some of the products these banks were selling to their clients – in particular high-yielding wealth management products.

    It quickly became apparent that these products were very popular with the banks’ clients and it was easy to see why. They paid yields above 7 per cent, far more than the meagre amount offered on deposits. Less apparent was what these clients were actually investing in, or under what terms.

    Some involved loaning money to buy land for property developments, despite banks not being allowed to lend money for land acquisition. Others involved investing in the pet projects of local governments, such as building roads in remote border areas or the debt of water pipelines. In many cases, the loans being offered to potential investors had virtually no conditions to protect the lenders, while the collateral – if there was any – often consisted of unnamed items or personal guarantees.

    “Hordes of retail investors are attracted by the 7 per cent yield,” one analyst reported to his boss after a visit to local bank branches in Shenzhen last month. “Many WMPs were fully subscribed within hours.”

    A week before, the same analyst came across another wealth management product promising a 12 per cent yield without a word on the actual underlying investment project. “Investors don’t care about the underlying project,” he noted. “They think everything is backed by the government. One salesman told me that as long as the Communist party remains in power, these products are safe.”

    Welcome to China’s shadow banking system, a booming sector whose size was recently estimated by a Chinese banking regulator at Rmb8.2tn ($1.3 trillion). But many analysts say the figure is much higher, with Deutsche Bank estimating that shadow banking accounts for 40 per cent of gross domestic product – or 21 trillion renminbi.

    Charlene Chu, a senior analyst at Fitch Ratings, estimates that one-third of all outstanding credit at the end of last year was held in “non-loan channels”, where information on asset quality and borrowers is extremely thin.

    Hedge funds have not had much luck in mainland China, where strict rules make it difficult for investors to build negative stakes. But to many hedge funds, China’s shadow banking system looked like an unmissable opportunity to make money. Some compare the investment products the shadow banks create to the subprime debt that led to the meltdown in the US mortgage market and triggered the global financial crisis.

    After much digging, investors at Argyle and other local hedge funds concluded that there would be a cascade of defaults on the projects behind these wealth management products – and that the banks would be forced to compensate clients in the name of social stability, wiping out their equity capital in the process.

    These hedge funds are putting money behind that conviction by shorting the shares of some of the weaker banks, which are listed in Hong Kong. Their strategy recalls the way some hedge funds bet that the US mortgage boom would end badly.

    “These wealth management products are CDOs with Chinese characteristics,” says Kin Chan, founder of Argyle, referring to collateralised debt obligations, the sort of complicated financial products that ended so disastrously in the US. “If the projects go wrong, they will become the liability of the banks.”

    As China struggles to reconcile the tension between its tightly controlled official banking system and those determined to circumvent their controls, hedge funds have become powerful, if unlikely, players. In a way, they are challenging the regulators. But they have also been the biggest beneficiaries of the People’s Bank of China’s efforts to reassert discipline over the country’s credit growth.

    When the central bank took action in June, by letting rates rise in the market through which banks provide funds to each other, the negative bets of these hedge funds paid off handsomely. For a while at least, the interests of the two groups came together.

    Today, much of the debt flowing from the banks to borrowers in China no longer involves simply taking depositors’ money and lending it to creditworthy applicants in a transparent process. Instead, it flows off the banks’ balance sheets via intermediaries, such as trust companies, to borrowers who would otherwise have difficulty obtaining the money. They charge rates that are often far higher than those officially sanctioned.

    That is not always a bad thing. The shadow banks also provide flexibility to an inflexible financial system. Regulated interest rates mean that banks are reluctant to lend to private companies and new businesses that lack adequate collateral and cash flow, because they cannot charge enough for the risk to such untried borrowers.

    Low payments on deposits mean households do not earn enough on their savings. Many wealth management products resemble money market funds in the US rewarding savings with rates that can be far higher than those paid on deposits, depending on how risky these products are.

    Still, many analysts agree with Chu’s conclusion that shadow banking activity is worrying. It represents a sort of window dressing, a way to conceal troubled loans. Because many of these products have a far shorter life than the projects they are meant to finance, there is always the possibility that the project will not be refinanced when the time comes. The existence of the shadow banks also complicates monetary policy, making controls on the growth of credit – already twice GDP – far less effective.

    Given the lack of disclosure, transparency and meaningful collateral, it appears to the analysts at Argyle and other hedge funds that the collapse of many of these products will leave the banks on the hook.

    That does not pose a huge risk for the large state-owned banks. But second-tier banks listed in Hong Kong or in mainland China, including China Merchants, China Minsheng Banking and tiny Huaxia, are vulnerable. That opinion is shared by Chu, who notes that these smaller banks have less ability to absorb losses and more of their balance sheets are tied up with shadowlike activities.

    Early this year, many hedge funds began putting on bearish positions by shorting the shares of these banks. Clearwater Capital, a fund that has historically invested in distressed debt, began buying credit default swap protection on China and other credit indices as a proxy for the illiquid banks. The fee to borrow shares was surprisingly low, brokers say. So while Chinese share prices generally have fallen this year, those of these banks fell even more. The sector has reported a 30 per cent decline, underperforming the Hang Seng index by 14 per cent.

    That made the debt market nervous, sending the cost of buying credit insurance in the credit default swap market higher. Meanwhile, because these second-tier banks lack the nationwide deposit-gathering branches of the state-owned behemoths, their borrowing costs began to rise as well.

    Then, other Asian banks began to cut back the credit facilities they made available to the second-tier Chinese banks, increasing pressure on them. It was a stark illustration of the way such bearish hedge fund bets can feed on themselves and become self-fulfilling prophecies. In sounding the alarm, these funds have added to the risk factors for China in the struggle to tame a system showing the strain of preserving artificially cheap capital for privileged borrowers and artificially poor returns for most savers.

    “Investors began to become cautious about supplying capital to these banks,” says Liu Ligang, chief economist for China at ANZ. “All foreign banks are reviewing their Chinese counterparties’ credit risk.” The chief executive of one big Asian bank adds that he has cut back his credit lines to these Chinese banks. “If the bank isn’t one of the top five, anything can happen,” he said.

    China Minsheng Banking has proved to be the most popular in this reverse popularity contest. Of all the banks covered by JPMorgan, it had the fastest growth in its interbank assets, as well as the highest weighting of interbank liabilities to total interest bearing liabilities, according to a June 25 report.

    Until recently, few hedge funds could have anticipated the extent to which the PBoC’s policy moves would transform their good trades into great trades. After all, many hedge funds have been bearish about China for a long time without making money. The stock market has not gone anywhere in 10 years but because so many mutual funds are obliged to invest in China – and investing in the country inevitably means investing in its banks – going short has been perilous.

    For the past few months, officials at the PBoC and the Chinese Banking Regulatory Commission have been voicing concern over the excessive growth of credit in the economy. In May, they backed up their words with actions and began cracking down on the use of false trade invoices. Monetary conditions tightened, although not enough to raise alarms.

    But money supply and credit growth continued at a pace that exceeded the regulators’ desired target.

    . . .

    By the third week of June, when bank liquidity came under pressure as a result of tax and other technical factors, the central bank had still done nothing to help cash-strapped banks as it has in the past. Interest rates in the interbank market soared to almost 14 per cent from an earlier 3 per cent rate.

    “Until then, everyone had looked on the People’s Bank of China as the sugar daddy,” says the head of China for one of the European banks. “And then suddenly they weren’t there.”

    The stock market dropped more than 5 per cent in a single day, while individual bank shares dropped even more. In the wake of PBoC inaction, China’s bank shares moved to an all-time low, trading at less than their book value, according to Morgan Stanley. “Some banks are not doing a good job in liquidity management,” warned Shang Fulin, head of the CBRC. “They should pay attention.”

    Alarmed, the central bank caved. “The PBoC engineered a liquidity squeeze because they wanted to teach the banks a lesson,” says Liu of ANZ. “But then they were forced to extinguish the fire. They didn’t want a Lehman. They had to backtrack.”

    On June 25, China Minsheng Banking, which had fallen 30 per cent in three months, held a conference call to reassure investors that its liquidity and asset quality were stable.

    At the same time, some hedge funds quietly took off their shorts. “It may go on for longer but I have already made so much money,” says the head of one regional fund, adding that holders of shares were calling in their shares to engineer a short squeeze.

    Others, however, have kept their negative bets on, sure that there is worse to come.

    Rating agencies: Bearer of unpalatable truths

    On June 18, Fitch, the rating agency, held its annual global banking conference at the Four Seasons Hotel in Hong Kong. The presentations included the standard outlooks for banks in Asia-Pacific, Canada, Europe and the US. But most people were there to hear Charlene Chu, a diminutive analyst with the demeanour of a student, give a presentation on Chinese banks: ‘Why Shadow Banks Are a Concern’.

    “Systemic risk is rising,” Chu warned her well-heeled audience, focusing on the mid-tier banks given that “their credit exposure is high, off-balance-sheet activity substantial, loss absorption capacity modest and liquidity thinning”. Since joining Fitch in Beijing in 2006 after a five-year stint at the Federal Reserve Bank of New York, and degrees from Yale, Chu has attracted a huge following among hedge funds looking for insight into China’s banking system.

    While many investors draw far more dire conclusions than does Chu, she has been embraced because she was one of the first to sound the alarm about the issues that plague China’s financial system.

    “The banking industry risk remains one of the largest vulnerabilities,” she wrote in her first report for the rating agency seven years ago. “Key weaknesses include widespread corruption and ineffectual corporate governance, underdeveloped risk management and internal control systems, weak accounting and legal frameworks, and poor [albeit gradually improving] profitability, asset quality and capital.”

    She was among the earliest analysts to write about the wealth management products that are among the most contentious issues facing China. Analysts are debating whether these are as toxic as some of the structured products in the US six years ago.

    Chu’s sobering views have given Fitch an uncharacteristic visibility. Not all China watchers agree with her and some quibble over her calculations but in a world where most analysts have been seen as cheerleaders all too often, her sober assessments cannot be dismissed easily.

    Copyright the Financial Times 2013.

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    AAP

    China's economic growth dropped to 7.5 per cent in the second quarter of this year, analysts predicted in an AFP survey ahead of fresh data, projecting a further slowdown in the world's second-largest economy.

    The median figure from a poll of 10 economists is a further deceleration from the already slower 7.7 per cent recorded in the first three months, as concerns mount over the Asian powerhouse.

    "One point for sure is that the second-quarter growth will definitely be lower than the first," said Yao Wei, economist at Societe Generale in Hong Kong, citing weakness in manufacturing as a result of poor domestic and foreign demand.

    "Generally if manufacturing growth declines, macro-economic growth will slow down as well," she said.

    China has also been buffeted recently by worries over its financial system, which suffered instability last month when the interest rates banks charge each other surged to record highs, reflecting Beijing's reluctance to loosen monetary policy.

    The country's new leaders so far seem to have taken a more laissez-faire approach to the slowing economy, a development that in years past would have been met with monetary easing and large-scale pump-priming.

    They have proclaimed a long-term goal of rebalancing the economy, and since coming to power as Communist Party chief in November and then state president in March, Xi Jinping has placed less emphasis on the traditional growth drivers of exports and investment, and more on consumer spending.

    "The new policymakers have focused more on reforms rather than short-term stimulus since taking office, so in the short run the downward risk is increasing," said Ma Xiaoping, a Beijing-based economist at British bank HSBC.

    "Reform measures are beneficial in the medium-to-long term, but they may not provide some stimulus in the short term," she said.

    Late last month, Xi was quoted prominently in state media as saying officials can no longer expect kudos just for achieving growth targets.

    "We should never judge a cadre simply by the growth of gross domestic product," Xi told a party meeting, the official Xinhua news agency reported.

    Premier Li Keqiang, whose brief is the economy, emphasised on Tuesday in comments posted on the government's website the importance of pursuing reforms - but also spoke of the importance of stabilising growth.

    The remarks prompted a stock market rise on Thursday on hopes they could signal the introduction of some stimulus measures.

    The government has set a growth target for 2013 of 7.5 per cent, the same as last year's. Such objectives are usually made conservatively and thus usually exceeded.

    Comments by Chinese Finance Minister Lou Jiwei, however, raised questions about whether that figure can be achieved this time.

    "Our expected GDP growth rate this year is seven per cent," Lou told reporters on the sidelines of an annual strategic and economic dialogue between China and the United States in Washington on Thursday.

    "Of course, it won't be a big problem for us if we achieve growth of seven per cent or 6.5 per cent."

    China's economy grew 7.7 per cent in the first quarter, a result that disappointed economists who had expected a more vigorous 2013 after last year's 7.8 per cent performance, the worst annual result in 13 years.

    Nomura International economist Zhang Zhiwei said Li's comments "may indicate that he is feeling under more pressure as the economic data continue to weaken".

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    Analysts predict upcoming data will show Q2 growth slowed to 7.5%.
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    By a staff reporter

    The Australian dollar remains weaker as the Chinese economy suffers a second consecutive growth slowdown.

    At 1200 AEST, the local unit was buying 91.06 US cents, off its morning lows but still down from Friday's 91.67 cents.

    The currency lifted slightly after the release of data showing China's economy grew by 7.5 per cent in the year to the end of June.

    That was in in line with market forecasts.

    Growth in the world's largest economy has slowed for the second consecutive quarter, after growing at an annual pace of 7.7 per cent in the March quarter.

    Easy Forex senior dealer Francisco Solar says traders are still nervous about the impact of weaker Chinese growth on Australia's economy.

    "If China sneezes, Australia catches a cold," he said.

    "A slowdown in that part of the world is the last thing that we want, considering the amount of exports that we send to that part of the world, especially resources exports."

    The Australian dollar was dented at the weekend after Chinese finance minister Lou Jiwei's comments about 7.5 per cent growth were wrongly reported by China's official Xinhua News Agency, which quoted him saying that rate could be seven per cent.

    Meanwhile, Australian bonds were slightly firmer at noon.

    At 1200 AEST the September 10-year bond futures contract was trading at 96.260 (implying a yield of 3.740 per cent), up from 96.250 (3.750) on Friday.

    The September three-year bond futures contract was at 97.310 (2.690 per cent), up from 97.300 (2.700 per cent).

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    Local currency remains lower as China's GDP read meets expectations.
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    One of the oddities in the discussion about China’s economic growth rate is the way in which its slowing is interpreted despite the fact that the explicit and stated objective of its new leadership is a slowing and re-orientation of growth.

    The 7.5 per cent GDP growth China says was generated in the second quarter shows that the new government headed by President Xi Jinping is getting what it wished for – a lower and less export and investment-dependent growth rate.

    While, if the trend of slipping growth is maintained, China would produce its lowest economic growth rate in more than two decades, China’s leadership appears to be unfazed.

    It wants, indeed needs, to transition the economy from the old model of investment and exports to one with a better balance of consumption. It is acutely aware that there has been significant unproductive investment and there are quite severe credit quality and allocation issues within its financial system as a result of the heady double-digit growth rates over the past decades.

    It would also recognise that with Europe in recession, the US economy growing only weakly, the renmimbi appreciating and its cost advantages reducing as its living standards increase, reliance on the export-driven growth model isn’t sustainable.

    Since the financial crisis in 2008 – which China responded to with a massive stimulus program oriented towards infrastructure investment – China’s GDP has significantly more than doubled, from around $US3.5 trillion to more than $US8 trillion.

    That level of growth over such a relatively short timeframe would inevitably have created imbalances and excesses – and a lot of leverage against poor quality assets – and it is clear the new regime have decided they have to implement structural reform to reduce the level of risk and leverage within their economy.

    The official growth target for this year is 7.5 per cent but it would appear the new regime is less fixated with targets than its predecessors and may be prepared to see it slip a little lower if it is apparent the desired redirection of the economy is occurring without any threat to social and political cohesion. Unemployment levels will be closely watched.

    Ultimately, however, if China decides it needs to give its economy a bit of a kick along it has both the financial firepower and the control over the levers of its economy to do so.

    The leadership will be reluctant to do so before bringing their domestic financial system and its misallocations of capital and credit under control but it remains an obvious option for putting a floor under the rate of growth if the attempt at a controlled slowdown looks like overshooting.

    It used to be taken as an article of faith under the previous leadership that China would never allow its growth rate to slide below 8 per cent a year, which was seen as the rate at which the economy needed to grow to manage the large-scale and accelerating urbanisation of its population that has occurred over recent decades.

    It would appear that the new leadership is quite prepared to live with something with a '7' in front of it and might even tolerate something lower for short periods if it can contain social tensions while pursuing its quite ambitious attempts at reform.

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