East Asia Forum

Credit has been the subject of much scrutiny in China, where there have been broad concerns about rising non-performing loans and wasteful lending to state-owned enterprises.

While major government-owned banks steal the most headlines, it’s also important to understand how credit operates at the grassroots levels. Unsurprisingly, that system has risks and inefficiencies of its own.

Rural Credit Cooperatives (RCCs) are China’s main official banking institutions servicing borrowers outside of cities. The lack of alternative savings institutions and investment channels has made RCCs very popular savings options in rural China, where often the only other option is to keep household savings under the mattress. The banks are then officially charged with lending those funds to support agricultural development among farm households.

Despite this official mandate, most of these funds do not find their way into enterprising farmers’ pockets. Throughout the 1980s and 1990s, about half of all RCC loans went to township and village enterprises (TVEs), which are small or medium-sized enterprises located in and managed by township and village governments. This bias toward government enterprises did not yield positive returns for the cooperatives. Indeed, before they were restructured in 2003, about half of China’s 40,000 RCCs were technically bankrupt or had negative net worth. On one estimate, the rate of bad loans to TVEs was as high as 80 per cent in the late 1990s.

In developing countries, it’s not uncommon for rural banking institutions to direct a disproportionate amount of their loans to large rather than small borrowers. But there are unique political and economic reasons for this phenomenon in China.

Although officially banking institutions, RCCs have been forced to walk a line between China’s fiscal and banking systems, which serve inherently different economic and social objectives. The fiscal system plays a redistributive role: it collects taxes from the ‘haves’ and redistributes the revenue in the form of social services to the ‘have-nots’, at least in theory. In contrast, the banking system has an intermediary purpose: banking institutions pool capital from savers and allocate it to borrowers, with the price of loans reflecting the risk profiles of the borrowers.

RCCs mingle two systems by using savings to serve a fiscal role. This can bring huge inefficiencies in capital allocations. Loans often end up in the hands of politically well-connected borrowers who have little incentive to repay them.

Local interference in credit allocations is an unintended consequence of the Communist Party cadre evaluation system and the fiscal system. Cadre evaluation prioritises local economic growth and improvement of fiscal revenue. This forms the basis of local officials’ promotion and career performance. Local governments are additionally responsible for financing around 70 per cent of government expenditures, significantly more than in most countries. These include the bulk of government social services. But local governments also face a systemic imbalance between the expenditures they are expected to make and the means they are given to generate revenues. To meet the central government’s demands, local officials siphon resources from formal credit institutions to finance local industrial development for the purpose of raising revenue.

Like all local bureaucratic agencies in China (RCCs aren’t government agencies, strictly speaking, but they have had a long history of being subject to local government control), the cooperatives are subject to a dual accountability system, one part of which is political. Under the system, managers in township cooperatives report to county cooperative unions, but they were also accountable to township party secretaries. Similarly, county cooperative unions were also answerable to county party bosses.

Until the late 1990s, local party secretaries had veto power over use of personnel and financial resources held by the cooperatives. RCC managers formerly were appointed, evaluated and promoted by local party secretaries. This system explains the bias in lending patterns toward local government-related firms and projects across all locales, even though the cooperatives’ mandate was to serve the agricultural and rural community.

As part of the 2003–05 reform package, the central bank provided RMB165.6 billion conditional debt-for-bills swaps and RMB830 million earmarked central bank loans to help RCCs clean up their debt burdens and toxic loans. Together, the bailout accounted for about 10 per cent of RCCs’ loan portfolio in 2003.

The bailout raises the ‘moral hazard’ that RCCs will expect to be bailed out again because they have managed to get away with bad financial decisions in the past. The central government’s financial rescue amounts to an indirect bailout of local authorities, and this has also allowed local governments to shirk their financial responsibility.

As local government debt mounts, the actions of RCCs and other rural financial institutions are a key part of this growing risk. If reforms are not enacted to promote lending for purely economic grounds, the inefficiency of lending for political reasons will eventually become unsustainable.

Lynette Ong is an associate professor of political science at the University of Toronto.

This article was originally published in East Asia Forum and has been republished with permission.

Fitch Ratings Chinese analayst Charlene Chu has warned China that increased lending could stifle the success of future stimulus measures, following a downgrade of the Asian nation's growth forecasts last week, The Australian Financial Review reports.

According to the newspaper, Ms Chu said Chinese policymakers would be confronted with a sharp challenge as the swelling use of credit blunts its stimulatory impact and the nation's pace of growth slows.

"Now we’re at a point where the numbers are very large – credit to GDP [gross domestic product] is 200 per cent and the numerator is still growing twice as fast as the denominator – and growth is consistently disappointing on the downside," she said.

"It’s possible that we’ve hit some kind of saturation point with credit, and using it as a lever to stimulate the economy may not be as effective as in the past."

China is urging its banks to control risks from credit expansion and says liquidity in its financial system is at a "reasonable level", amid growing fears of a cash crunch, according to Bloomberg. 

“At present, the overall liquidity in China’s banking system is at a reasonable level, but due to many changing factors in the financial markets and also because of the mid-year point, the requirements for commercial banks in liquidity management have become higher,” the People’s Bank of China said in a statement dated June 17 and published on its website today in Beijing, the newswire said. 

The government's comments are the most direct since the country's benchmark money-market rates soared to record highs last week.  

VoxEU.org

The Chinese central bank has recently dropped hints that it will quicken the pace of interest-rate reforms towards a market-determined regime. Both inside and outside the country, this has raised hopes of improving efficiency and reducing China’s ‘excessive’ savings and current account surplus.

The hopes about efficiency are reasonable, but this reform alone will not achieve the intended goal, and some complementary reforms outside the central bank’s controls must take place in concert. The hopes for a much-reduced current-account surplus are fundamentally misplaced and will be dashed.

What does it take to improve resource allocation?

The current interest rate regime places a ceiling on the deposit-interest rate, implicitly imposing a tax on savers, but puts a floor on the lending rate. The biggest beneficiaries of this scheme are large state-controlled banks, since the gap between the two interest rates gives them a fat profit margin. The biggest losers are savers who suffer from the implicit tax and firms (especially private sector firms) which face a higher cost of capital than necessary.

This reform will likely result in a lower (real) lending rate, and a higher (real) deposit rate (the actual nominal-interest rates will also depend on the country’s prevailing inflation expectation). It appears logical to think that the reform should necessarily lead to a better allocation of resources.

However, in the absence of further reforms on state-owned enterprises, the interest-rate liberalisation could exacerbate rather than reduce inefficiency. Specifically, state-owned enterprises often overinvest, because their senior management is rewarded for scale and size instead of purely for the pursuit of profit. If the interest-rate liberalisation reduces the cost of capital, their urge for scale could result in more overinvestment. This problem is aggravated by the fact that many state-owned enterprises do not pay a market price for using natural resources and do not pay the full social cost of compromising the environment.

In short, reforming state-owned enterprises and imposing adequate social costs of using environmental and natural resources are necessary complementary reforms needed to achieve efficiency improvement. One challenge is that these reforms are outside the purview of the central bank.

Will the reform drastically reduce China’s current-account surplus?

A popular theory in some Washington-based thinktanks is that the current interest-rate regime is the key culprit behind China’s high savings rate and current-account surplus. The supposed logic is that the low real interest rate on bank deposits has caused people to raise their savings rate to compensate for the lost interest income. This has then led to a current-account surplus. By this theory, the interest-rate reform would drastically reduce China’s current-account surplus.

This theory is false both logically and empirically. Logically, a lower interest rate produces two effects, with opposite signs. On the one hand, because the reward for savings is lower, people would save less. On the other hand, because interest income is lower, people feel poorer and may choose to consume less and save more. While the net effect appears ambiguous, both experimental evidence and statistical analysis of people’s actual savings choices overwhelmingly suggest that the first effect dominates. That is, a lower interest rate leads to less savings. Otherwise, the ultra-low interest rate in the US would have produced a savings boom. This means that the Chinese save a lot in spite of a low interest rate, not because of it. The interest-rate reform per se may very well raise China’s savings rate and current-account surplus.

The Chinese current-account surplus is not a mystery, for two notable reasons. The first is China’s accession to the WTO in late 2001, which, by itself, tends to reduce the domestic return to capital, generating incentives for the country to park a greater portion of its wealth in foreign assets during a transitional period of about six to seven years. My research with Jiandong Ju and Kang Shi suggests that this has contributed one-third of the surplus we observe.

The second factor is a rising ratio of marrying-age young men to young women since 2002. This imbalance has caused young men, and especially their parents, to raise their savings rate in order to compete better in the marriage market. The same force has also contributed to a rise in the corporate savings because more parents with an unmarried son and more young men themselves have chosen to be entrepreneurs. Given the difficulty in getting a bank loan, new entrepreneurs and small firms must rely on self-savings to finance their operation and expansion. Together with Xiaobo Zhang and Qingyuan Du, I estimate that this force has accounted for another one third of the current-account surplus.

To be sure, other factors also matter. But each perhaps plays a smaller role than commonly assumed. Collectively, they account for the remaining one third of the surplus.

Because the gradual reforms associated with the WTO accession have been completed, the part of the surplus due to this factor is naturally winding down. In contrast, because the sex ratio imbalance is going to rise over the next decade, the part of the surplus due to this factor is not going away any time soon.

In sum, while the interest-rate reform may carry many benefits, reducing the country’s current-account surplus is not one of them.

Shang-Jin Wei is professor of finance and economics, and of Chinese Business and Economy, at Columbia University's Graduate School of Business.

Originally published on www.VoxEU.org. Reproduced with permission.

AAP

China's central bank has promised to help out banks that run into cash shortfalls in an effort to calm fears the country faces a credit crisis.

The central bank said on Tuesday it would provide "liquidity support" if needed after a shortage of money in credit markets caused interest that banks pay to borrow from each other to spike last week.

The bank said it already had provided money to some institutions but gave no details.

The spike in interbank lending rates caused Chinese share prices to plunge on Monday on fears the country faced a credit crisis that might disrupt the economy.

Over the past five years, it has been the faltering advanced Western economies creating heartache for global markets, and fast-growing developing giants in Asia seemingly coming to the rescue. This time, it has been China’s credit crunch that has got Australian and global markets spooked. Although it seems to have been somewhat alleviated for the time being, pundits are divided on whether it signals the painful beginning of a fruitful reform process, or whether China’s much-touted authoritarian model is losing its touch. The perhaps unsatisfactory answer is that it is a bit of both.

So should it be a glass-half-empty or half-full viewpoint? My position would be this: despite the presence of some very competent technocrats in Beijing, history shows that the experience of large and complex economies trying to manufacture a slowdown in lending after periods of credit excess rarely ends well for them.

First of all, let’s recap what happened. In early June, data for May indicated a slowdown in construction and manufacturing, while exports posted their lowest growth at 1 per cent over a year. This was reflected in the imports of major metals such as copper and alumina falling at double digit rates, while energy usage such as coal also dropped sharply. In April, housing sales declined sharply. Figures for April revealed that new homes sales in Beijing fell over 57 per cent compared to the month before, while sales in pre-owned homes fell 88.1 per cent compared to the month before.

The standard analysis that China could miss its growth target of 7.5 per cent for the year by a few basis points was disappointing but hardly cause for concern. In reality, growth has been far lower. Even Premier Li Keqiang once admitted a few years back that official growth numbers were ‘man-made’ (read ‘made up’) and could not be believed. Historical forensic analysis consistently shows that the most reliable indicator has been electricity usage, with 85 per cent accuracy in indicating actual growth rates for the country once economists and accountants pour over old and revised data. Worryingly, electricity usage in May grew at around 2.9 per cent.

In the past, such slowdowns would cause Beijing to instruct its banks to further loosen credit, as occurred from 2009-2010 when the outstanding loan books of Chinese banks expanded by 58 per cent in a mere two years. For admirers of ‘capitalism with Chinese characteristics’, this was the advantage that authoritarian China had over Western economies: the capacity for immediate and decisive action.

This time, central authorities did not respond in the same way. President Xi Jinping demanded that the central and lending banks attack the ‘four winds’ of ‘formalism, bureaucracy, hedonism and extravagance.’ (Translations from Mandarin Chinese to English can sound somewhat obscure and antic.) Although President Xi’s exhortation applied to corruption within the Chinese Communist Party, it also refers to reining in excess credit which has ballooned from 120 per cent of GDP five years ago to 200 per cent currently.

Central authorities were sending a message to the country’s banks: over-rapid credit expansion would not be tolerated. Although it has the cash to do so, central authorities instructed the central bank to refrain from injecting cheap capital into the commercial banking system. The seven-day repo rate (repossession or repo rate is the interest of capital charged by the Central Bank to commercial banks) jumped from 2.78 per cent in mid-May to over 10 per cent in mid-June. The overnight repo rate ended on 25 per cent on June 20 having reached 30 per cent at one stage, effectively freezing this avenue of funds for banks. Subsequently, interbank lending rates (what commercial banks lend to each other) breached 13 per cent in mid-June in the highest ever recorded levels. Starved of cash, several banks also defaulted on their interbank obligations, creating a mini-panic amongst the country’s banks. There were fears that this could be China’s Lehman Brothers moment.           

The central bank finally relented, allowing the seven-day repo rate to fall back into single digits, even though it remains more than double what it was in May. Fears of a catastrophic ‘credit crunch’ have subsided for the moment but the brakes on credit growth have been clearly applied.

The curious thing about all this is that, ostensibly, it was an engineered liquidity crunch. Why did Beijing do it, and what happens from here on?

Beijing is concerned about two related things. The first is the explosion in credit growth, especially since 2009, resulting in a surge of unneeded and wasteful fixed investment. I have written about this several times in previous columns. (For example, see China grasps for a growth alternative, September 3, 2012.) As another indicator of investment inefficiency or capital factor productivity, every $100 lent now generates only $17 in GDP, falling from $29 in 2012 and $83 in 2007.

The second and related problem is the shadow banking system. So-called ‘shadow’ lenders get money by borrowing it from traditional banks, and also raising it from wealthy individuals wanting a higher return on their capital. These lenders then issue loans that would not suit the traditional risk profile for normal commercial and retail bank lending – at substantially higher rates. Financial vehicles to facilitate such lending include trusts, insurance firms, leasing companies and pawnbrokers. Given the decade of easy money, almost every type of corporate entity is involved in setting up these vehicles: from large and small banks, SOEs, large private corporates and local governments.

It is no wonder that central authorities want to crack down on this kind of activity. According to JP Morgan Chase estimates, the debt issued by the country’s shadow banking sector has grown from about $US2.9 trillion in 2010, to $US4.3 trillion in 2011, to about $US5.7 trillion in 2012. The common argument that Chinese financial system is not a heavily leveraged one clearly only looks at standard ‘vanilla’ loans.

Beijing has tried to clamp down on the high-risk shadow banking sector, considering it a systemic risk to the whole financial system and economy, though directives on allowable risk profiles for loans. The problem is that these alternative investment vehicles mentioned above are set up precisely to circumvent such directives and conceal risky lending from regulatory authorities, meaning that Beijing has had little success. In a desperate move, the engineered credit crunch is a blunt policy instrument that is designed to limit the amount of excess funds available that can be (mis)directed to the shadow lending sectors.

This is why some have applauded the move and see it as further sign that enlightened technocrats that rule the roost in the CCP. Of course, this viewpoint ignores the fact that the CCP’s refusal to liberalise interest rates and allow them to rise and fall according to market signals, is largely behind the problem in the first place. Remember also that ‘capitalism with Chinese characteristics’ encourages lending to inefficient SOEs rather than far more enterprising private firms, leading to deterioration in loan quality that is masked up by temporary technical fixes such as forced rollover of maturing loans and increasing new loan volume, in order to lower the official proportion of non-performing-loans on the books.

But even as a short-medium term technical fix, the risks of suddenly tightening liquidity are considerable.

For a start, many private firms starved of formal finance are forced to resort to the shadow banking system. The private sector in China is not just more efficient but is also more innovative than SOEs. Around four-fifths of all patented innovations in the country are from private firms, despite the domestic disadvantages they face. Killing shadow banking will kill off many private firms, and entrench the dominance of SOEs in many sectors even more.

Then there is the matter of the speculative high-end residential housing sector. On the one hand, buying and selling housing based purely on expectations of high capital growth that is completely divorced from rental yield return always ends in tears. But housing assets at inflated prices are widely used as collateral for further debt. Returns from residential construction projects are relied upon by local governments as a fiscal revenue raising measure, and to pay back outstanding loans. In 2011-12, an estimated $US1.7 trillion of maturing loans to local government financial vehicles were forcibly rolled over by the central government so that these local government owned entities would not be in default – and this was before the current credit crunch.

Turning off credit will lead to defaults, and the unbelievable NPL ratio of around 1 per cent of outstanding loans will be exposed as an illusion. Illusions are unhealthy and ultimately unsustainable in any financial system. But there is rarely a good time to expose them – especially when so much growth has occurred on the back of it.  

The point is that pricking asset bubbles and reining in credit after a period of excessive growth can lead to unintended consequences, however necessary it is to do from a macroeconomic point of view. In doing so, Japan suffered two decades of stagnation and America is only just tentatively recovering. The difference is that systems in industrialised economies can survive long periods of economic stagnation without great social and political turmoil.

China’s technocrats in the central government need to tread carefully. Some might still believe that authoritarian China has its advantages. But if there is a sustained period of economic stagnation, social and political resilience is not one of them.          

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.

West Australian Premier Colin Barnett is reportedly nearing a deal with the China Development Bank that would inject several billion dollars into the state's resources and agriculture sectors, according to The Australian.

Mr Barnett is believed to have discussed with CDB vice-chairman Yuan Li a plan that would see the development bank finance more Chinese-backed projects in WA.

More than 80 per cent of Chinese investment in Australia is in WA, which in part prompted Mr Barnett to negotiate a stand-alone deal distinct from the federal government.

Former resources minister Martin Ferguson had last year said he believed the federal government and states should present a united front to China, The Australian added.

Stratfor.com

The People's Bank of China released a statement June 24, though it was dated June 17, addressing the liquidity shortage that caused interbank lending rates to spike during most of June. The central bank claimed that the banking system's general liquidity level remained "reasonable" but that changes in financial markets and the need to tidy up books at the end of the first half of the year led to higher requirements, causing the liquidity squeeze.

The statement went on to warn commercial banks to better prepare to meet tax payments and reserve requirements. It also warned them to manage credit expansion at a time when the government intends to maintain "prudent" monetary policy and "steady and moderate" monetary and credit growth. Last, it warned against letting deposits fall too low.

The central bank has been heavily scrutinised amid the recent disturbances in interbank markets because the banks, as well as many investors and commentators, have called attention to its hesitancy to inject liquidity into the system to reduce the shortages. When the central bank finally took action last week by acting as lender of last resort past normal working hours and by providing special loans to particularly troubled lenders, interbank rates subsided from last week's record highs. The June 24 statement will reinforce the view that policy will remain tight and interbank rates elevated, but that banks will calm down somewhat in July as the scramble to meet half-year deadlines ends and as a number of central bank bills mature, sending cash back into the system. The People's Bank also says it will play a "stabilising" role.

But even if interbank rates fall during and after July, the showdown between the central bank and the rest of the banking system points to bigger risks and challenges.

Rumours surfaced in the Chinese media last week that the central bank provided emergency assistance worth "less than" 400 billion yuan (about $65 billion) to two of the Big Four state-owned commercial banks: Bank of China and Industrial and Commercial Bank of China. If accurate, these rumors show that the cash shortage is by no means limited to medium-sized lenders like Everbright Bank, whose Shanghai branch defaulted on a six billion yuan loan on June 6. The Big Four form the backbone of China's financial system. A bailout for two of them illustrates the central bank's willingness and ability to intervene to prevent widespread contagion. However, it also suggests that the entire system is severely strained.

Moreover, focusing on matters within the central bank's control, such as liquidity injection, directs attention away from smaller signs across the country over the past year that businesses in various sectors, along with the shadow loans tied to investment projects, have been failing:

– October 2012: Jiayue Co, a leading real estate company in Zhanjiang, Guangdong province, and dozens of connected firms went bankrupt, leaving about 6.1 billion yuan in debts unpaid.

– October 2012: Chenyang Rural Credit Cooperative in Sheyang County, Jiangsu province, suffered a rush on deposits after a credit guarantee company was shut down for illegal lending. The Sheyang County government forced the company to sell 25 million yuan in assets to pay depositors.

– December 2012: Citic Trust Co, an division of China Citic Group, delayed payment on one of its trust products after a steelmaker, Three Gorges Quantong, missed a 74.6 million yuan payment. Eventually the city government in Yichang, Hubei province, paid one billion yuan to support Quantong, which is now said to owe seven billion yuan to several banks because of a failed wealth management product.

– January 2013: Huaxia Bank in Shanghai failed to make an interest payment on a 140 million yuan wealth management product, according to a high-profile report by Caixin. The chief borrower collapsed after embezzling the funds lent, but the company that guaranteed the product, Zhongfa Investment Guarantee, paid back investors.

– Various other defaults on loans or wealth management products have occurred. Jilin Trust defaulted on a 150 million yuan trust product, as did unnamed companies in Ordos, Inner Mongolia, where excessive housing construction has led to overcapacity. China Communication Bank also saw the failure of a wealth management product.

– Reports in Chinese media suggest that privileged state-owned enterprises have increasingly begun defaulting on payments owed to small- and medium-sized companies, which have little recourse.

From these incidents – and several other rumoured events, including the most recent troubles among large banks – it appears that the rapid and vast expansion of shadow lending is unraveling, at least to some extent, under the pressure of China's economic slowdown and rebalancing reforms. The highest risk areas are joint-stock banks and other banks most exposed to wealth management products (13 trillion yuan total) and trust products (more than five trillion yuan total), plus the credit guarantee companies and banks that remain liable when such products fail and the hierarchy of local governments that are forced to bail out failed companies and banks. Ultimately, these risks even threaten the central government, since large banks can be affected and local governments themselves, which are often struggling with debt levels well above 100 per cent of revenues, may prove incapable of handling local crises.

The central government has extensive resources and plenty of room to lower reserve requirements or take other actions to ease policy. It could moderate its recent attempts to crack down on high-risk financial products and illegal capital inflows, though it will not want to backtrack unless circumstances force it to do so. Nevertheless, the emergence of problems among core institutions raises substantial fears that the sheer magnitude of China's credit boom since 2009 has produced systemic risks that could spiral out of control for even the best prepared and best equipped governments. Even in a less precarious scenario, the new pressure on banks to reduce risky lending, shore up their reserves and plan for the longer term will translate into less credit for the non-financial economy. Already Chinese reports suggest that small- and medium-sized banks have begun to scale back some preferential low interest rates for buyers of real estate, portending a broader impact. 

The State Council, which controls the central bank and is responsible for the government's general drive to tighten controls on the economy for the purposes of reform, will be challenged by the risk that a combination of its actions and weakening international growth could spoil too many investment projects, causing more defaults on unconventional loans tied to underlying assets of unclear value. Thus, even if interbank rates fall back to more normal levels in July or August, the gradual enervation of China's financial system could well continue, greatly complicating the new administration's bold reform efforts by necessitating more financial intervention.

Republished with permission of STRATFOR.

AAP

Prime Minister Kevin Rudd has urged China to conclude negotiations on a free trade agreement with Australia.

Mr Rudd says Australia's relationship with China is in good working order.

But he's likened the pace of progress on the free trade agreement to a "lame camel" trying to cross the Sahara desert.

"Let's conclude the free trade agreement," he told reporters in Canberra on Friday.

AAP

China's central bank says it will "adjust" liquidity to ensure stability after a week-long squeeze that has rattled financial markets.

The assurance from Zhou Xiaochuan, governor of the People's Bank of China (PBoC), on Friday helped Chinese share prices perk up after a recent sell-off that rippled across Asia and and around the world.

Anxiety about tightening credit has been spreading into the broader economy with some Chinese companies reportedly running short of cash to settle suppliers' bills.

But addressing a financial forum in Shanghai, Zhou said: "The PBoC will use all sorts of instruments and measures to adjust the overall liquidity level, so as to ensure the overall stability of the market."

For roughly three weeks, funds have been in short supply on China's interbank market, and the interest rates banks charge to lend to each other have surged to record highs.

The PBoC was said to be worried about a speculative boom in credit fuelled by low rates, but on Tuesday confirmed it had already offered liquidity "support" to banks and pledged to provide more if needed.

That statement marked an apparent change of course after the central bank earlier ruled out providing fresh funds and ordered banks to put their financial houses in order.

The comments on Tuesday came after Chinese stocks had closed at lows unseen since the global financial crisis in 2009.

Friday's new assurances helped the benchmark Shanghai Composite Index overcome opening losses to rise 0.78 per cent by midday.

But analysts said the PBoC would have to take more radical action for the market to rise more.

"Zhou's speech is in line with the central bank's earlier statement and the expectations of the market, so the impact is limited," Haitong Securities analyst Zhang Qi said.

Zhou remained confident about China's growth, though he acknowledged the economy had slowed.

"The Chinese economy, basically speaking, has kept stable growth," the central bank chief said.

"The growth rate has slowed down a little bit, but the growth rate is still in a reasonable range," he said, but gave no specific figure.

China has set its economic growth target at 7.5 per cent for 2013.

FT.com

History does not repeat itself but it sometimes rhymes. The fact that Barack Obama’s first real presidential trip to Africa coincides with the closing moments of Nelson Mandela’s life could never have been scripted. It is an eerily moving moment. America’s first black president enters the stage just as South Africa’s first black president is taking a bow. No one should doubt Obama when he describes the great freedom fighter as his “personal hero”.

And yet Africans could be forgiven for wondering how long Obama’s renewed interest in Africa will last. Having spent a total of 20 hours on the continent in his first term – on a 2009 stopover in Ghana – Obama’s six-day tour is meant to underline a new phase in US-Africa relations. The age of foreign aid is passing, say US officials. Seven out of ten of the world’s fastest growing economies are in Africa. Yet it is China - and increasingly Turkey, India and Brazil – that is reaping the new investment opportunities. Now is Obama’s chance to put that to rights.

Obama’s style of doing business, and particularly his diplomacy, does not lend much confidence that his interest will be sustained. With the exception of China, where his engagement has been intensive, Obama’s standard approach is to touch down, give a great speech, proclaim lofty goals, then move on. Such fleetingness might be expected of US presidents, who have real and potential Middle Eastern wars to manage, and a thousand other headaches. That is why they should create clear strategies for others to execute. Alas, there is no clear Obama strategy for Africa. Nor, for that matter, for the Middle East.

Does it matter? Yes. Geopolitics is about the long game. Both Bill Clinton, who pushed through the Africa Growth and Opportunity Act, which gave African exporters duty-free access to the US market, and George W Bush, who set up Pepfar, which has helped save the lives of hundreds of thousands of African victims of HIV-Aids, put in place modest but durable programs to engage and assist Africa.  Obama has inherited both. But he has nothing equivalent to show on his own account.

The backdrop could hardly be more auspicious. It is during Obama’s term in office that Africa has begun to break through as the next big emerging market frontier. Yet it is a fair bet that 90 per cent of the time Obama has so far spent on Africa has been swallowed by US counter-terrorism operations, which now range from the Sahel through the Magreb to the Horn of Africa. Last week, the US announced that it was opening a predator drone base in Niger. In parts of Mali, Yemen and Somalia, the US drone is becoming almost as familiar as it is in Pakistan’s tribal areas. According to the Pew Research Centre, 81 per cent of Senegalese approve of the US – a strikingly positive number given that Senegal is an overwhelmingly Muslim country. The US needs to be careful not to “Pakistanise” its engagement with the top third of the African continent. Drones are no substitute for engagement.

Second, China is playing a long game. There have been reports of growing African – and, for that matter, Latin American and central Asian – resentment at China’s mercantilist ways. Some accuse Beijing of neo-colonialism, since it is extracting raw materials and then exporting finished goods back to their source. All of which may be fair, but China is no fly-by-night operator. According to the UN Conference on Trade and Development, Chinese investment in African manufacturing almost equals its investments in commodities. China-Africa trade has shot up more than tenfold since 2000 to just under $170 billion in 2012 – twice the level of US-Africa trade. It has more than 150 commercial attaches in sub-Saharan Africa, against just six for the US.

During Obama’s first term, Hu Jintao, then China’s president, visited Africa seven times. Within weeks of taking over from Hu in March, Xi Xingping went on a three-nation tour of Africa (two of which, Tanzania and South Africa, Obama is also visiting). Officials at the multilateral lending institutions talk about Africa’s increasing readiness to junk their advice and take China’s less preachy money instead. Last year Obama had an opportunity to help relegitimise the World Bank in Africa by appointing Ngozi Okonjo-Iweala, Nigeria’s finance minister and a Bretton Woods veteran, as its president. Obama did not feel the time was ripe to relinquish America’s hold on that position. It implies no disrespect to Jim Yong Kim, the Korean-American who was given the job, to say it was a missed opportunity.

The Middle East aside, Obama’s second term is about executing his “pivot to Asia”. But as Vali Nasr, the former state department aide to the late Richard Holbrooke, has pointed out, China itself is pivoting to pretty much everywhere else in the world, including Africa.

Whether America’s goal is to contain or to engage China, the playing field is global. Neither drones nor quadrennial visits will be a substitute for the unglamorous business of constructing long-term relationships. Obama has made a belated start on the African continent. Let us hope it marks a new approach to Africa that will be linked to Obama’s larger Asia strategy. Call it joined up diplomacy. With almost four years left in office, he has time to put it to effect.

Copyright The Financial Times Limited 2013.

By a staff reporter

Manufacturing activity in China slowed in June, according to a pair of leading surveys.

The nation's official purchasing managers' index for June printed at 50.1, a fall from a read of 50.8 in the previous month.

A reading above 50 on the index indicates expansion, while below 50 indicates contraction.

Bloomberg analysts was expecting a slight fall on the previous month to print at 50.1

A second read on manufacturing in China, the HSBC manufacturing PMI, printed at nine-month low of 48.2.

The print follows a read of 49.2 in May and misses Bloomberg analysts' expectations of 49.1.

HSBC chief economist for China, Hongbin Qu said falling orders and rising inventories had added pressure to Chinese manufacturers in June.

"And the recent cash crunch in the interbank market is likely to slow expansion of off-balance sheet lending, further exacerbating funding conditions for SMEs," he said. 

"As Beijing refrains from using stimulus, the ongoing growth slowdown is likely to continue in the coming months."

AAP

New Trade Minister Richard Marles says Australia should provide more than just resources to China as the mining boom comes to an end.

Mr Marles, who was promoted to Prime Minister Kevin Rudd's cabinet today, said the rising middle class in China presented huge opportunities for Australia.

He said Australia should look beyond the minerals trade.

"Right now our trade to a place like China is dominated by resources, and it's been an important part of the mining boom," Mr Marles told ABC Radio.

"Going forward, it's going to be much more about providing goods and services for that growing middle class."

Mr Marles resigned from his role as parliamentary secretary for Pacific Island Affairs in March after publicly backing the shortlived attempt to return Mr Rudd to the leadership.

The S&P/ASX200 Index fell as much as 1.8 per cent after two gauges of Chinese manufacturing dropped in June, signaling that Australia’s biggest trading partner’s manufacturing sector may be contracting.

At 1438 AEST the index was down 75.791, or 1.6 per cent, to 4726.80, after falling as low as 4714.80. China’s official Purchasing Managers’ Index dropped to 50.1, the lowest level in four months. HSBC’s purchasing managers index was 48.2, the weakest since September. Readings below 50 signal an economic contraction. That may mean less demand for Australian minerals such as iron ore and coal, essential ingredients for Chinese steel mills.

At 1438 AEST shares in BHP, the world’s biggest mining company, had dropped 32 cents, or 1 per cent, to $31.05. Rio Tinto, the world’s biggest iron ore miner, had fallen 52 cents, or 1 per cent, to $51.85. Iron ore miner Fortescue was down 5 cents, or 16 per cent, to $2.99.

Utility shares were among the index’s biggest declines. The utility sub index was down 2.5 per cent at 1446 AEST. Origin Energy slipped 37 cents, or 2.9 per cent, to $12.20 after it agreed to pay $659 million for coal and hydroelectricity power generator Eraring Energy. Origin rival AGL decreased 39 cents, or 2.7 per cent, to $14.09.

Financial stocks fell. The sub index for such shares was down 1.9 per cent at 1451 AEST, perhaps on gloomier forecasts for the economy and the risk which that may pose for creditors repaying their debt, particularly in the mining and manufacturing sectors. National Australia Bank dropped 67 cents, or 2.3 per cent, to $29.01. Westpac fell 81 cents, or 2.8 per cent, to $28.07.

Supermarket retailer at 1452 AEST Woolworths slid 58 cents, or 1.8 per cent, to $32.23. The stock has gained 21 per cent in the last 12 months compared with the 14 per cent increase in the index during the same period.

Infrastructure Australia is set to release a seven-point plan to reform more than $100 billion in federal infrastructure spending intended to make Australia more competitive in Asia, according to The Australian.

The report, set to be released Tuesday, calls on the federal government to create a single national infrastructure fund to oversee investments such as the National Broadband Network, clean energy programs and other federal nation-building spending.

“Australia cannot afford to invest in the wrong projects,” the report says, according to The Australian.

“Without bold reforms today, Australia will miss opportunities tomorrow, because we are too slow, too budget constrained, or simply not ready.”

The report urges governments to address infrastructure bottlenecks and to privatise assets to unlock funds that could be used to address the infrastructure gap.

Infrastructure Australia argued its reforms could ensure annual economic growth of more than three per cent and lift national productivity by more than two per cent.

By a staff reporter

Infrastructure Australia (IA) has recommended the establishment of a single national infrastructure as the top priority for Australian governments looking to capitalise on the predicted growth of Asian economies.

The group released its National Infrastructure Plan, which is tabled to the Council of Australian Governments (COAG) and outlined five major recommendations.

The report suggests moving from grant funding of infrastructure to a system that encourages private investment; selling or long-term leasing of government infrastructure assets and re-investing the proceeds in new infrastructure; and a wider application of user pays funding arrangements.

IA chairman Sir Rod Eddington said the aim of the plan was to provide governments and the community with a clear set of actions to take advantage of the opportunities offered by the growth of the Asian economies over the next half century. 

"If adopted and pursued with vigour, these reforms will ensure that Australia secures the infrastructure it needs.

"There are challenges in pursuing these reforms. The community is wary of change. Too often, governments have been reluctant to make the case for such change."

The incoming Australian government is likely to inherit the best economic conditions for a generation: the lowest ever interest rates, a falling exchange rate and a recovering global economy, led by the United States.
 
The key risk is that Chinese growth falls short because of the credit crunch going on there.
 
But on balance this looks like being the best election to win since the 2001 Tampa and 9/11 election, when the economy hardly figured in the campaign.
 
A dozen years later, the boats are still coming and still driving politics, even though both sides are dead against them, but once again it’s “the economy, stupid”, to quote that memorable phrase from Bill Clinton’s 1992 campaign manager James Carville.

As I pointed out last month (The problem is debt, not the election, June 12) domestic demand has been contracting and some analysts have raised the probability of recession, but with rates at all-time lows and likely to be cut again, and the Australian dollar down another 4 per cent since then, conditions are improving daily. It’s now all about the US economy.
 
If the ALP loses this year it can count itself very unlucky indeed: the Rudd/Gillard/Rudd government will have exactly encompassed the second biggest crash and world recession in history followed by the slowest, most difficult recovery.
 
Compare that with John Howard, who, after winning that 2001 election, governed during one of the great economic booms in history, escaping into satisfied retirement 24 days after the stock market peaked.
 
Julia Gillard, in fact, was doubly unlucky because a key part of America’s recovery from the bust that its own credit excesses had caused was the debasement of its currency. When the 2010 election was held on August 21, the Australian dollar exchange rate was US89.38 cents, on its way to parity by the end of that year and $US1.10 by mid 2011.
 
So by coincidence, Gillard’s leadership more or less exactly encompassed the period of Aussie dollar strength, caused entirely by US dollar weakness. The good news is that it allowed 2 percentage points to come off the official cash rate because of low inflation, but that didn’t help Australia’s first female prime minister.
 
The US dollar and US long-term interest rates are now rising as America prepares to end the extraordinary monetary stimulus that has been required to stabilise its economy.
 
The Australian dollar is now closely following the US 10-year bond yield, inversely, which is in turn following US payrolls. So notwithstanding yesterday’s brief blip lower and then back again after the Reserve Bank’s statement came out reaffirming its easing bias, the level of the Australian currency is being determined entirely by the US economy.
 
Meanwhile global inflation has actually collapsed, not increased with all the money printing, as expected – average G7 CPI growth is down to 1.2 per cent. That means the cash rate in Australia can be cut again in the months ahead, most likely after the election.
 
The level of US payrolls is not only setting the level of the Australian dollar, but it has also been the key influence on global stock markets since 2009. So this week’s release will have a big bearing on the direction of share prices, as well as the Aussie dollar.
 
But in general the US economy is gradually improving, which is why there is so much talk about exiting, or “tapering” the Fed’s quantitative easing. As a result, the US dollar is likely to keep rising, and the Australian dollar to keep falling to below US90 cents.
 
The Japanese and European economies likewise appear to have bottomed, especially Japan, where “Abenomics” have got off to a roaring start. European unemployment remains dismal but some of the forward looking indicators suggest a turnaround may be coming.
 
China is in for a period of slow growth as the new government sets about controlling the rampant credit growth and housing bubble caused by its own version of the shadow banking that brought down the United States in 2008, and reforming the economy in general.
 
There seems little doubt that Chinese growth will fall below 7 per cent, but whether it gets to the 3 per cent that some are predicting is another matter. More likely the world’s second biggest economy will continue to grow by very large dollar amounts but diminishing percentages because GDP is now so big.
 
All in all, it’ll be a good election to win and a bad one to lose. With China slowing, we may not see a boom like the one John Howard enjoyed, but with the cash rate likely to start at 2.5 per cent and the dollar probably back at US88 cents, the Australian economy will prosper … and, of course, the boats will therefore keep coming

By a staff reporter

Activity in China's non-manufacturing sector continues to grow, but at a slower pace, according to official figures.

China's non-manufacturing purchasing managers' index for June printed at 53.9, a slight fall from May's 54.3.

A reading above 50 indicates expansion in the sector, while below 50 points to contraction.

A second PMI read is due out of China at 1145 AEST, the HSBC services PMI.

FT.com

The new Chinese leadership is trying to manage one of the most difficult of economic manoeuvres: slowing down a flying economy. Recently, difficulties have become more apparent, with the attempt of the authorities to bring ‘shadow banking’ under control. Yet this is part of a bigger picture: the risk that a slowing economy might even crash. Indeed, the expressed desire of China’s new government to rely on market mechanisms raises the risks.

In a recent note, David Levy of the Jerome Levy Forecasting Center has asked the crucial question: what is China’s stall speed? The general view is that it is straightforward for China to move from 10 per cent to, say, 6 per cent growth over the coming decade. The implicit assumption is that “a rapidly expanding economy is like a speeding train; let up on the throttle and it slows down. It continues to roll along the track as before, just not as rapidly.” He argues, instead, that China is more like a jumbo jet: “In recent years, a couple of engines have not been working well, and the pilot is now loath to keep straining the remaining good engines. He is allowing the plane to slow down, but if it slows too much, it will fall below stall speed and drop out of the sky.”

Thus, after 2008, net exports ceased to be a driving force for the economy. Investment took up the slack, particularly in 2009. That led to a further jump in the share of spending on investment in gross domestic product, from an already extraordinarily high 42 per cent in 2007 to an absolutely amazing 48 per cent in 2010. The jet fuel driving this investment engine was an explosive growth of credit: loans rose at an annual rate of close to 30 per cent during 2009. The policy was highly successful. But, with booming net exports a thing of the past, the Chinese authorities now also wish to reduce the reliance on credit-fuelled investment. The engine that the Chinese economy now has left is consumption, private and public.

In fact, figures for quarterly contributions to the growth of demand suggest that the desired slowdown has gone impressively smoothly, so far. But the challenges of a move to annual growth of 6 per cent remain huge.

First, investment in inventories must fall sharply, since its level depends on the growth of an economy, not on the level of activity. Think about it: in a stagnant economy, inventory accumulation would normally be zero. Again, other things equal, an economy growing at 6 per cent would need 60 per cent of the investment in inventories of one growing at 10 per cent. The immediate impact of this adjustment would be a sharp decline in investment in inventories, before their growth resumed at 6 per cent a year, from the now lower level. Moreover, businesses might well fail to anticipate the economy’s slowdown altogether, particularly after years of far higher economic growth. They would find themselves burdened with rapidly rising inventories and would then be obliged to slash inventories, and so levels of output, even further.

Second, investment in fixed capital must also fall sharply. Investment might have to fall by 40 per cent: all other things equal, in China that would imply a 20 per cent decline in GDP, which would evidently entail a deep (and unexpected) recession. Those responsible for investment might well fail to adjust quickly, because they expected the 10 per cent annual rate of growth to return. That would support the economy for a while, but at the expense of soaring excess capacity. As in the case of inventories, that would then cause a still bigger investment fall.

Third, an investment-induced reduction in demand and activity is also likely to have a large downward impact on profits. That would impair corporate solvency and lower investment still further. Finally, a decline in the rate of economic growth, particularly one preceded by a very large credit boom, might have unexpectedly grim effects on the state of balance sheets. China’s private sector is already relatively highly indebted. Such debt should be manageable, provided the economy continues to grow at 10 per cent a year. In such a dynamic economy, the timing of new projects hardly matters. But, in a more slowly growing economy, the jump in bad debts might prove huge.

The World Bank’s latest Global Economic Prospects argues that “ongoing rebalancing efforts remain a priority as does engineering a gradual decline in its unsustainably high investment rate”. But, “should investments prove unprofitable, the servicing of existing loans could become problematic – potentially sparking a sharp uptick in non-performing loans”. Even if the government rescued the financial sector, those responsible for lending would surely become more cautious. The growth of off-balance sheet finance, to which the authorities have recently reacted, seems certain to make this even harder to manage.

None of this is to argue that China cannot continue its catch-up growth, in the medium to longer term. The point is, instead, that the structure of an economy growing at 6 per cent will, inevitably, be quite different from that of one growing at 10 per cent. One must not think of such an adjustment as proportional. On the contrary, the economy that would emerge might have consumption at, say, 65 per cent of GDP and investment at just 35 per cent. So consumption would have to grow substantially faster than GDP, while investment would grow far more slowly. This would mean a different distribution of income: substantially higher shares of household disposable incomes and lower shares of profits in GDP. It would also necessitate a different structure of production, with relatively fast growth of services and relatively slow growth of manufacturing.

The new Chinese government is, in effect, now engaged in the task of redesigning the jumbo jet, as it comes into land, with half of the engines working poorly. The market is most unlikely to deliver such a huge change smoothly. The sole reason I find to trust the landing will work as hoped is that the authorities have handled so many arduous tasks in the past. But it is going to be very tricky. In order to sustain demand, the government might find itself compelled to do some things – run very large fiscal deficits, for example – that its new leaders neither want nor now expect. At least, forewarned is forearmed.

Copyright The Financial Times Limited 2013.

By a staff reporter

Activity in China's services sector contracted for the first time in ten months in June, according to a leading index.

The HSBC China services purchasing managers' index printed at 49.8, after a reading of 50.9 in May. 

A reading above 50 indicates expansion in the sector, while below 50 points to contraction.

HSBC chief economist for China Hongbin Qu said the underlying growth momentum is likely to be softening for services sectors, along with the slowdown of manufacturing growth.

"With sluggish growth of new orders, employment growth is under pressure," he said.

"As Beijing’s VAT reforms are likely to take time to filter through, we expect slower growth in service sectors in the coming months."

Earlier, China's non-manufacturing purchasing managers' index for June printed at 53.9, a slight fall from May's 54.3.