DRIVING THE DAY
1. Xi talks tough with Mattis
Relations with the US are increasingly tense. And not just on the trade front.
China’s unhappy about US support for Taiwan (SCMP):
- “The Pentagon is…reportedly considering sending warships through the Taiwan Strait and increasing arms sales to Taiwan.”
Meanwhile, the US is increasingly upset about China’s behavior in the South China Sea. US Defense Secretary James Mattis called China out earlier this month (NYT):
- “Despite China’s claims to the contrary, the placement of…weapons systems [in the South China Sea] is…for the purposes of intimidation and coercion.”
It was amidst this backdrop that Mattis met with Xi Jinping on Wednesday.
Before his trip, Mattis said that he planned to do “a lot of listening” in Beijing.
Here’s what Xi had to say (SCMP):
- “Our attitude is firm and clear.”
- “We would not lose a single inch of the lands we inherited from our ancestors.”
Despite the tough talk, the visit looks to have been positive for ties. Mattis and Minister of Defense Wei Fenghe had plenty of nice things to say about each other.
The big question: The Chinese know that Trump calls the shots. How much stock do they put in what Mattis says, given his ambivalent relationship with the US president?
SCMP: China won’t concede an inch, Xi Jinping tells US defence chief Jim Mattis on South China Sea and Taiwan
NYT: Mattis Accuses Beijing of ‘Intimidation and Coercion’ in South China Sea
FINANCE and ECONOMICS
2. PBoC takes a more hands-off approach to the RMB
Rapid CNY depreciation over the past several days has spurred debate in the markets.
- Is China just taking a hands-off approach to the currency?
- Or is it weakening the currency to alleviate the pain of coming tariffs?
Our take: It’s definitely the former. Depreciation is a natural market reaction to the pending trade dispute. The central bank is largely staying out of the way, but the pace of depreciation makes them a little nervous.
That is why they have already begun managing that pace (WSJ):
- “At least one state-owned bank, which has traditionally acted as the central bank’s agent when it intervenes in markets, sold large amounts of dollars after the U.S. currency breached the 6.60 level against the yuan, traders said.”
Get smart: China will continue to allow bouts of depreciation if that’s where the market continues to take the currency. But as soon as things look like they are moving too fast, the PBoC will step in to counterbalance.
FINANCE and ECONOMICS
3. NDRC zeroes in on offshore bonds
China’s macroeconomic planning agency, the National Development and Reform Commission (NDRC), is concerned about foreign debt.
That’s why the body published new rules limiting the ability of Chinese companies to raise funds via offshore bond markets. The rules also require that new issuance goes primarily toward paying down existing debt.
Regulators say offshore bond issuers have three main problems (China Banking News):
- The types of companies issuing offshore bonds aren’t very high-quality – “for example the overall ratings of local municipal investment platforms is comparatively low, and there has been rapid growth in the scope of offshore bond issuance by real estate companies.”
- “Risk controls for offshore bond issuance by enterprises need to be strengthened, with a focus on the repayment capabilities of enterprises.”
- “Further improvements are needed to co-ordination and cooperation mechanisms between government departments responsible for the regulation of offshore debt.”
Get smart: The NDRC is issuing these rules now because it is worried about the depreciation of the currency. When the CNY depreciated swiftly in 2015, companies had to quickly pay down foreign-denominated debt, which exacerbated capital outflows.
Over the past year, foreign debt has built back up. Officials don’t want a replay of 2015.
Caixin: 发改委限制房企外债资金投向 主要用于还旧债
China Banking News:
Offshore Bond Issuance by Real Estate Companies Restricted to Debt Repayments
FINANCE and ECONOMICS
4. Governments fight banks over bad debt
If you want a good idea of how China’s local government debt challenges are playing out, keep an eye on Hunan province.
We’ve highlighted developments in this province several times (see June 12 Tip Sheet). We think Hunan is a harbinger of what’s to come.
On Friday, the Changde city government called a meeting with representatives from local government financing vehicles (LGFVs) and banks..
The details of the meeting have been leaked. They provide a fascinating snapshot of the dynamic between local governments and local banks.
Officials ordered banks to:
- Provide preferential loans for LGFVs
- Extend overdue loans and amortization plans for most LGFVs
That’s not all. Get this: The local authorities even said that they will order LGFVs who don’t receive payment extensions from the banks simply not to pay. And they will punish banks that don’t cooperate.
But despite the threat, banks still refused.
Get smart: Despite the conventional wisdom, it’s not always true that banks and local governments are in bed with each other.
Local governments need a lifeline while they try to get their books in order. Banks want their money back. And both are facing heavy pressure from the central authorities to de-risk and deleverage.
POLITICS and POLICY
5. State Council wants farmers online
Wednesday’s State Council meeting focused on rural revitalization.
The government’s big idea:
- “The country will increase the use of the information technology, such as big data and the Internet of Things, in agricultural production.”
Our thought: Seems to be mandatory to include “big data” in just about any policy these days. But it’s not clear that it means much in practice.
- “E-commerce platforms should enhance cooperation with farmers, family farms, and cooperatives to provide farm produce better access to consumers.”
Get smart: Getting the rural economy more linked up with the digital economy is a good idea. But it won’t solve the relative lack of productivity in the agricultural sector. To do that officials will have to tackle a much thornier problem – land reform.
Gov.cn: 李克强主持召开国务院常务会议 听取深入推进“互联网+农业”促进农村一二三产业融合发展情况汇报等
POLITICS and POLICY
6. China to build more infrastructure
Wednesday’s State Council meeting wasn’t only about agriculture.
The meeting also focused on planners’ favorite subject – building infrastructure:
- “To raise transportation efficiency…60 percent of major seaports [are] expected to be directly linked into the rail network by 2020.”
- “Meanwhile, vigorous efforts will be made to link major ports along the Yangtze river with the rail network.”
Get smart: The main goal here is to shift more toward rail transportation, and away from roads, especially for commodities. That should help both to improve air pollution and to boost efficiency.
Get smarter: China’s built a lot of infrastructure in the past four decades. But it’s still not enough. Logistics costs are still nearly double what they are in developed economies, partly because of poor infrastructure.
Xinhua: China to step up agricultural development through information technology
POLITICS and POLICY
7. Will China adjust its industrial policy?
The State Council’s in-house think tank recently finished a report called “Thoughts on China’s Industrial Policy in the New Era.”
The findings are noteworthy.
Wei Jigang, the main author of the report makes the following arguments:
- “At the strategic level, China’s industrial policies have been successful…[allowing China to] catch up with developed countries.”
- “But the cost has also been high.”
- “Future industrial policy should be composed of more functional policies.”
- “Where the government doesn’t have a clear vision, it should adopt functional policies to allow the market to choose [the right approach].”
Some context: By “functional policies,” Wei means policies that are broad-based and support a competitive environment – like tax breaks, as opposed to direct subsidies.
Get smart: Wei’s ideas echo what now-Vice Premier Liu He said almost two decades ago. Thanks to his new position, Liu now has the opportunity to reboot China’s industrial policies along these lines.