China’s Financial Reform: ‘Making Progress While Maintaining Stability’

There were no great expectations of China’s fourth quinquennial national financial work conference that has just ended in Beijing. And it seems to have met them.

These two-day meetings of top political leaders and policymakers set broad policy objectives for the coming five years. In the past they have provided a blueprint for significant financial-system reform. But with a leadership transition already underway, the start of a new five-year plan and growing nervousness among policymakers and political leaders alike about the volatile outlook for the global economy and the potential implications for China’s growth, there is no great appetite for much beyond keeping a steady ship.

“Risk-aversion should be the lifeline of our financial work,” said Prime Minister Wen Jiabao. He also said that there would be greater supervision of the banks, which, he said, needed to improve their governance and risk management.

Risk control and prudent macroeconomic management were the order of the day, as they were at last month’s annual economic work meeting. “Making progress while maintaining stability,” is the mantra. The emphasis is currently on the stability.

More detail about the financial work meeting will likely drip out over the coming days. The post-meeting statement dealt in generalities, but two leading topics of discussion were the currency and interest rates. Moves towards more market oriented interest rate mechanisms are necessary if China is to become more efficient at capital allocation, as it needs to be as its economy develops from its invest and export model of the past three decades. But steps have been tentative in the face of some vested interests who have thrived on cheap and ready bank loans. We expect the equally tentative steps to develop bond markets to be given priority over interest rate liberalization, with provincial and local governments being given more scope to sell bonds to firm up their finances. However, when it comes to developing a corporate bond market, don’t underestimate the political task in getting the big state owned enterprises to be supportive of a new source of credit that will be more demanding of their performance.

The internationalization of the yuan is also likely to continue at a measured pace, while the exchange rate against the dollar won’t be allowed to drift much higher. Policymakers feel that with the trade surplus shrinking the currency is at the right sort of level. It has risen by a third since the peg with the U.S. dollar was first broken seven years ago. Wen said China “will steadily proceed with efforts to make the renminbi convertible under capital account to improve its management of the foreign-exchange reserves”–though that is pretty much boilerplate.

This is an edited version of a post that first appeared on China Bystander.

Will Europe’s Politicians Let The Courts Make Fiscal Policy?

One overlooked aspect of the agreement struck by the member nations of the European Union over fiscal and budgetary alignment is the matter of enforcement. The failure to incorporate the proposed agreement into the EU’s basic treaty, the Lisbon Treaty, means that neither the European Commission nor the European Court of Justice will have standing to deal with recalcitrants. Both institutions’ writ runs only to treaty matters, not those covered by intra-EU sub-agreements and those between national governments, as this latest deal will be structured in the face of opposition by non-euro-using countries, notably the UK.

That is one reason that the agreement envisions the new fiscal and budgetary constraints being baked into national constitutions, and the European Court of Justice being given new powers to adjudicate on whether countries are baking in the Brussels-approved manner. This is a conscious attempt to put the governance of national fiscal policy under greater judicial and less political sway, just as the EU has used the courts to enforce central directives in other areas.

One of the failures of the Maastricht agreement that launched the euro 10 years ago was that countries’ compliance with the economic conditions for membership – holding budget deficits to no more than 3% of GDP was one of them, remember – was entirely in the hands of national politicians. For all the goodwill being expressed towards greater fiscal integration in the heat of the euro debt crisis, national politicians are not going to give up their power of economic policy making willingly. Many will see this as the judicial Trojan Horse that will lead to a Federal EU with full economic and political integration. National politics is going to continue to shape Europe’s fiscal integration, and markets will have to learn to live with all the uncertainty that implies.

Italy’s Political Problem

Italy doesn’t have an economic problem as much as a political one. While the country has underperformed economically over the past decade both relative to its eurozone peers and relative to its earlier self, as Daniel Gros, director of the Centre for European Policy Studies in Brussels, points out,

[Italy's] three most important measurable growth factors actually improved in both absolute and relative terms:

• Investment in physical and human capital; the former is high and the latter is improving rapidly.
• Structural indicators in terms of product and labour market regulation (all improving absolutely and relative to Germany according to OECD indicators).
• Investment in R&D (improving).

The only factors that have deteriorated absolutely and relative to the core of the Eurozone are indicators of governance – such as corruption and rule of law.

Italy’s performance has deteriorated dramatically over the last decade – the years of Berlusconi governments – on the three governance indicators the World Bank considers most important for an economy: the rule of law; government effectiveness in general; and control of corruption. Italy now ranks lower than any other eurozone country, including Greece, on all three.

Changing a country’s political culture to support good governance of the body politic is the hardest thing to achieve, yet “progress on these fronts might in the end be more important for growth than the reforms now being imposed by the EU,” Gros says.

Bonds, Not Bunga-Bunga Best Berlusconi

It’s not the bunga-bunga that gets them. It’s the bonds. Looks like Italy’s beleaguered prime minister, Silvio Berlusconi, is the latest to learn that. He squeezed his quickly cobbled together austerity package through parliament, but at the cost of his governing coalition holding together. What months, or is it years, of partying in questionable taste and the after scandals couldn’t do to him, the yield on his country’s sovereign debt could. Berlusconi has offered to resign, albeit at a time uncertain. Investors have spoken. Electors, it seems, weren’t consulted.

Draghi’s Unexpected Independence

Mario Draghi’s reputation as an inflation hawk took a back seat to his other reputation for being his own man when at his first meeting as head of the European Central Bank he surprised markets by cutting the central bank’s benchmark interest rate by a quarter of a percentage point to 1.25%. It would be too harsh to represent this as a slap in the face of his predecessor, Jean-Claude Trichet, who was criticized for raising rates, in the German interest, as it was taken to be, during a time of credit crisis, but Draghi’s reversal is a welcome sign of what will be a continuing need for independence especially in the face of the euro-zone leadership’s continuing inability to get a grip on its debt crisis. His diplomatic skills can mask the extent to which he is self-confident about following his chosen course, but as Europe politicians may find, being Jesuit-educated, Draghi will know how to make their minds follow.

Greeks Bearing Gifts For Beijing

Greece’s unexpected decision to hold a referendum on the euro-zone’s proposed bail-out has been a gift horse for China as it gives Beijing even more time to get the rest of the world used to the fact that it will be chipping in no more than a widow’s mite at best. China’s contribution to the euro-zone’s would-be 1 trillion euro bail-out fund, the European Financial Stability Facility (EFSF), has always been more likely to be more token than substantive, regardless of any wishful thinking on the part of China’s largest trading partner. Now, says deputy finance minister Zhu Guangyao, speaking ahead of the G-20 meeting in Cannes, “the fund has not established details of its investment options so we still can’t talk about the issue of investing”. The head of the fund, Klaus Regling, was in Beijing last weekend with his collection tin, but went away empty handed for reasons outlined here. Beijing is no more willing than Berlin, Brussels or Paris to take on the risks of loss. Why should anyone be surprised otherwise?

Europe’s Paper-Thin Debt-Crisis Solution

The markets’ giddy response to the eurozone debt-crisis solution agreed by European leaders this week is a case of investors willing themselves to see the glass half full. The combination of the eurozone’s bailout fund, the European Financial Stability Facility (EFSF), being bulked up to €1 trillion, a €100 billion recapitalization of Europe’s banks by June next year and private bondholders being asked to take a 50% haircut on Greek debt is at least more palatable than any of the doomsday alternatives–an unruly Greek default, an unraveling of the euro and a collapse of the banking system.

Yet the euroleaders’ plan, belatedly pulled together with all the one minute to midnight brinkmanship that Congressional leaders in the U.S. showed in July over America’s debt-ceiling debate, similarly depends on the details being fleshed out after the event. These include whence to raise the money for the EFSB and on what conditions to ensure the participation of the likes of China and the IMF. They also include the sleight of legal hand that will be needed to ensure that an orderly part Greek debt fault–for that is what the bondholders haircut is–does not trigger a credit default swaps crisis.

Getting those and all the other many, many other implementation details right will determine how much risk this solution has really taken out of the euro crisis, or whether it has just papered over the cracks.

China’s Muni-Bond Market Brought Back To Life

Reblogged from China Bystander:

This Bystander noted last year that moves were afoot to develop a municipal bond market as a way to put the financing of provincial and local governments on a more transparent footing, and to wean it from the off-balance sheet financing via captive investment vehicles that local authorities have resorted to get round restrictions on official borrowings. As of June, 2010, these captive investment vehicles accounted for 7.7 trillion yuan of local government borrowings (more than three-quarters of the total), …

China Shouts Fast, Moves Slowly In Currency War With U.S.

China will play its usual defense against the moves in the U.S. Senate to twist Beijing’s arm to appreciate its currency against the dollar: vociferous denunciation of Washington for turning protectionist and initiating trade wars while patiently waiting out the start of any actual hostilities, calculating that they will eventually recede.

The denunciation has duly come with Foreign Ministry spokesman, Ma Zhaoxu, saying the bill now in front of the U.S. Senate proposing punitive measures against any country that is shown to be manipulating its currency — for which read China — “seriously violates rules of the World Trade Organization and obstructs China-U.S. trade ties”. He told U.S. Senators to abandon protectionism and stop politicizing economic issues. He also told them to “stop pressuring China through domestic law-making”. Similar sentiments have been expressed by the central bank and the commerce ministry.

While perhaps nobody outside the U.S. Congress really believes that a sharp revaluation of the yuan on its own will eradicate America’s trade deficit with China or create the new domestic jobs the U.S. is having such trouble generating, Beijing will know that even if the Democratic majority in the U.S. Senate passes the bill, the legislation will likely founder in the Republican controlled House of Representatives. Even if it does not, it is highly unlikely to survive a presidential veto. That is the past pattern of such proposed legislation. Support for this year’s bill appears to be stronger, helped by its narrower provisions and the background of sluggish U.S. growth and joblessness, but the odds remain long that it will become law.

At the very worst, and the bill does become law, it will be cheaper politically for Beijing to fight any punitive measures through the WTO than it would to be seen to capitulate to foreign pressure. Meanwhile, it can bide its time, letting the gradual appreciation of the yuan that has been underway since June last year (up 7% against the dollar since then and 10% against the euro) ease the U.S. pressure that is anyway likely to abate after next year’s U.S. elections, while buying more time for the economy, particularly the export-manufacturing sector, to adapt.

China’s policymakers are quite happy for the yuan to appreciate. It will help them both fight inflation and restructure the economy. But they want do it to their timetable, not Washington’s — and they have the playbook to do that.

PMIs Top Up Glass To Half-Full

China’s Purchasing Managers’ Index (PMI), an indicator of the outlook for manufacturing, showed an uptick for September, reversing the mostly downward trend of much of the year. As ever, we caution reading too much into a single month’s figures, but the official numbers, released early after a leak of the HSBC version, stand in contrast to much of the bearish sentiment about China’s economy seen over the past week as investors have been swept up in a global glumness that the world economy is heading for a double-dip recession.

The glass half-full is that if the slowdown in China’s growth is stabilizing, even temporarily, it provides some hope that it can sustain some global growth at least for a while. And when we peer deeply into the glass, we see that HSBC’s input-price sub index showed a slight increase, to 59.5 from 55.9, suggesting a possible brake to the decline in global commodity prices seen since April as demand has weakened. The glass half-empty is that manufacturing usually increases in September in preparation for the Golden Week holiday.

September PMIs from around the world, though sending mixed signals, follow other indicators that show that, even if a double-dip recession can be avoided, the slowdown in growth worldwide is becoming entrenched. Matters haven’t slid back to the nadir of the 2008-09 slump, but they are not far off.

The danger is that protectionist pressures will force those two points closer. In the U.S. Senate, legislation is being discussed that would make it easier for punitive tariffs to be imposed on countries deemed to being manipulating their currencies, for which read China. World leaders did well to get through the 2008-09 slump by collectively agreeing not to go down that beggar-thy-neighbor road. That consensus is considerably more fragile today.

This post was first published on China Bystander.