Driving the Day
1.Trade talks stagger on
Working-level trade talks with the US continued on Tuesday. These talks are preparing the way for senior-level talks between Vice Premier Liu He and US Trade Representative Robert Lighthizer on Thursday and Friday.
The goal for this week (WSJ):
- “Both sides hope to hash out a framework of a deal…with the goal of getting it finalized in a meeting between President Trump and Chinese President Xi Jinping.”
Xi Jinping will meet with Lighthizer’s delegation – a sign of goodwill (SCMP).
The tough issues will have to wait (WSJ):
- “If both sides hammer out a broad framework of a deal this week, it would likely include the offers China is making but leave the thornier issues, such as China’s industrial policies, for the presidents to work out, according to the people.”
Back in DC, Donald Trump indicated that the March 1 deadline to finalize a deal could be extended (Reuters):
- “If we’re close to a deal where we think we can make a real deal and it’s going to get done, I could see myself letting that [deadline] slide for a little while.”
Get smart: Markets will continue to watch – and react – closely to the ups and downs of the negotiations. But Sino-US relations are all about the two leaders, and it will ultimately be up to Xi and Trump to come to a deal – or not.
WSJ: China, U.S. Seek to Narrow Gap on Trade for Trump, Xi to Close at a Summit
SCMP: Chinese President Xi Jinping to meet top US delegation on Friday in pursuit of trade war deal
Reuters: Trump says he could let China trade deal deadline slip, ‘not inclined to’
2.Local governments ramping up tax breaks
A host of local governments are slashing business taxes.
Some context: In early January, the State Council rolled out new measures to reduce the tax burden for small businesses.
Provincial governments areimplementatingthat policy (SAT):
- “More than 20 provinces, including Zhejiang, Shanxi, Beijing, Inner Mongolia, Fujian, Shandong, Sichuan, Yunnan, Jilin and Heilongjiang, have issued new policies to reduce taxes and fees [for businesses].”
- “According to plan published by the local governments, [they are instituting] is the maximum tax reduction…stipulated by the State Council, lowering taxes by 50%.”
There is likely more tax relief to come:
- “The tax reduction policy issued by the State Council also [gives local governments the ability to]…increase tax incentives, raise the threshold at which small-scale taxpayers pay VAT, and expand the scope of preferential policies for investment in start-up technology enterprises.”
Why it matters: Small businessescontinue to struggle amidst the economic slowdown and tight credit conditions. These policies seek to alleviate some of the pain.
What to watch: This local fiscal expansion is likely to have more of a positive effect for small businesses than anything the government has done to date. But it will take time to show up in China’s macro growth numbers.
And when it does, it will cushion the slowdown, rather thanramping up growth.
3.MSCI expands further into China
On Tuesday, we highlighted a piece from the FT, explaining that foreign investors are ramping up equity purchases in China.
MSCI may be addingfuel to the fireby adding more A-sharesto its key emerging market index (Caixin):
- “MSCI announced Monday that 12 securities will be added to the MSCI Global Standard Indexes’ China Index.”
- “The company did not remove any companies from the China Index.”
- “By market capitalization, Foxconn Industrial Internet, Meituan Dianping and Xiaomi will be the three largest additions to the MSCI Emerging Markets Index, according an MSCI statement.”
Some context: Any expansion of A-shares included in the MSCI index will support portfolio inflows into China. That’s because money managers that are benchmarked against the index will effectively be required to add A-share exposure to their portfolios.
There’s more to come in 2019:
- “In September 2018, MSCI proposed increasing the weight of large-cap Chinese A-shares in its indexes to 20%.”
- “It will increase the weight in two phases this year, one in May and one in August.”
- “MSCI said the initial 5% weight ‘provided strong evidence of positive market accessibility’and would thus like to expand.”
Our take: Chinese equities are likely to have a solid 2019.
Caixin: MSCI Adds New Chinese Stocks to Major Indexes
4.Triangular debt rears its head again
Reuters is out with a solid piece examining the blow up of a triangular debt web in Shandong province.
Some context: Triangular debt iswhen multiple companies cross-guarantee each other’s borrowing.
As Reuters points out, it rarely ends well:
- “The warning bells are…sounding in the once-prosperous eastern city of Dongying, a hub for oil refining and heavy industry in Shandong province.”
- “Here, at least 28 private companies are seeking to restructure their debts and avoid bankruptcy, mainly due to souring loans that they guaranteed for other firms.”
The scale of the problem can be mind boggling:
- “As of end-June, Shandong Dahai had outstanding guarantees on 2.67 billion yuan ($394 million)…equivalent to 48 percent of its net assets.”
Get smart: The potential for these cross-guarantees to all go bad at once, is one key reason that banks remain reluctant to lend to the private sector, despite official exhortations to do so.
Get smarter: While this is a widespread practice in China, in our view, it does not appear to be a systemic issue. So while it is tempting to think triangular debt will make China’s financial system implode, we are far from that scenario.
Reuters: Debt guarantee tangle: China’s private firms hit by default contagion
5.Han Zheng says ensuring employment is key
Executive vice premier Han Zheng inspected the National Development and Reform Commission on Tuesday. It was his second visit to the commission since being appointed executive vice premier in March.
The purpose of Tuesday’s visit was make sure that everybody was on the same page for their 2019 policy priorities.
Han laid out five major areas of reform:
- Energy, oil, and gas
- Science and technology
Pay attention: We should see movement in all of these areas. Expect more details at the lianghui next month.
Han also told NDRC officials to focus on employment (gov.cn):
- “We must closely watch changes in the employment situation, strengthen monitoring and warning [systems] for the employment market, preparerelated policy contingency plans, and guarantee stable employment.”
Get smart: We have said it before – Chinese leaders will continue tolerate lower growth, so long as it doesn’t destabilize employment.
6.AIIB to invest more in China
Asia Infrastructure Investment Bank (AIIB) Governor Jin Linqun, recently gave an interesting interview to Caixin.
The worsening global economy creates a more challenginginvestment environment, according to Jin.
Here’s how the AIIBplansto adapt:
- Work priorities will shift from the bank’s own institutional development to more actively managing investments.
- Funding for projects will increasingly come from the private sector rather than sovereign loans.
- The destination of investment will shift back to China. In fact, 10% of the bank’s total investment cap will go to China, up from 3%, previously.
That last point is sure to raise eyebrows, given widespread suspicion that the AIIB is more of a Chinese institution than a mulitlateral one.
But Jin’s got a solid argument:
- “The asset quality of China’s infrastructure projects is generally better than other developing countries.”
- “The higher return of Chinese projects will enable the AIIB to do more projects in high-risk countries and achieve greater development results.”
- “The [AIIB] can accumulate greater industry experience [in China], which will help similar projects to be carried out in other countries.”
Our thought: In the early days of the AIIB, Chinese leaders went to great lengths to argue that it won’t become another Beijing piggy bank. This won’t help their cause.