HSBC and its China bank stakes

HSBC is in trouble. Its share price is down from over 800p in October 2008 to around 500p today with a market capitalisation of around £60.8bn.

The cause of a lot of its current problems was the disastrous purchase HFC - a US sub-prime lender that has sucked in cash (billions) and shows little sign of surviving. Despite this HSBC is clinging on to this investment.

It appears to have a similar attitude to its Chinese investments in Bank of Communications and insurer Ping An.

This is commendable and I suspect this is a good long term strategy. Indeed I would argue that HSBC should offload its US assets and buy more in China at current prices.

The decision by HSBC to keep the faith in its Chinese assets led to the following quote from a Bank of China spokesman. This blog post is inspired by this quote:

"We will not forget partners who sent charcoal in snowy weather and those who extracted the firewood from under the cauldron".

To get "cauldron" into a modern business paper such as the FT is impressive. I just have to work out which role HSBC is playing in relation to this quote. One imagines that they are pleased with HSBC for staying put and not selling off existing Chinese assets.

For now I think this is the right decision.

HSBC’s dead leg [FT]

HSBC dares to be different. Selling stakes in Shanghai-based Bank of Communications or insurer Ping An, currently registering almost $10bn of unrealised gains, could go a long way to resolving nagging doubts as to the bank’s capital adequacy. But the bank is staying put, to the delight of one lyrical Bank of China spokesman: “We will not forget partners who sent us charcoal in snowy weather and those who extracted the firewood from under the cauldron.”

The principled stance is commendable. But HSBC’s show of faith in China underlines the incongruity of its continued commitment to HFC, its US consumer finance business. The recent refurbishment of HFC’s Illinois headquarters – kitted out in the group livery – suggests that management is in no mood to sever ties with a business it bought six years ago.

Why not? This is what normally happens when investments turn out to be stinkers. HFC will have racked up losses of over $13bn by the end of next year – on top of the $15bn purchase price and $4.4bn of capital injections so far, Goldman Sachs estimates. More capital is probably on the way to pay down HFC debt, and cover realised losses as mortgage customers mail HSBC their housekeys. Whether HSBC needs more capital at the group level is the wrong question. What matters is that this dead leg has dragged it into the mire. HSBC’s share price has fallen by a quarter in the last month, almost rubbing out its premium to the sector. Knight Vinke, the dogged shareholder activist, says that most of the radical options for HFC – walking away, a debt restructuring, a spin-off with equity dowry – have been dismissed by management on the basis of a recovery in 2009, now unlikely, and by reference to the potential, but far from certain, danger of doing serious damage to the bank’s reputation. Management needs to come up with more compelling reasons for continuing to shovel in capital.

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Unemployment just keeps on rising

Unemployment in China is a BIG problem and getting bigger. The implications are serious and getting more serious by the day.

Apologies for a lack of posts - academia gets busy at times. I should be back on the China Economics case now.

While the West suffers and our banks collapse we should not take our eyes off China. If China internally combusts we have not begun to see the extent of the turmoil. Yet again we see the magical "8% growth" mentioned.

The article is worth reading in full. I provide a couple of insightful paragraphs.

As China's Jobless Numbers Mount, Protests Grow Bolder [Washington Post]

As a global recession takes hold and China's economy continues to slow, growing legions of unemployed workers are becoming increasingly bold in expressing their unhappiness -- expanding a debate over how to protect the Chinese economy into long-fought disputes over other issues such as freedom of expression and equality before the law.

During most of the past two decades, concerns about China's human rights record have been overshadowed by the speed of its economic development and growing political influence in the world.

But as the economic crisis has grown, so, too, have challenges -- both small and large -- to the state's power.

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Labor rights activist Li Qiang said China's economic problems have put the spotlight on social issues that have long existed -- such as the growing gap between the urban rich and the rural poor and the fight for worker rights -- but were played down by the government during the recent boom.

"The crisis in the West is purely economic. But in China it's a huge political problem," said Li, director of the New York-based China Labor Watch.

The ripple effects of the sharp economic downturn are growing: Crime is rising, as are labor strikes by taxi drivers, teachers, factory workers and even investors unhappy that their stock market holdings are now 70 percent off their peak.

Although Chinese authorities have been able to quickly disband the recent protests, there is concern that a single national-level event, if mishandled by authorities, could lead to a serious political crisis.

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Unemployment is now estimated to be at its highest levels since the Communist Party took over in 1949. Job creation and preservation has become a top priority of China's leaders, who are acutely aware of the role a deteriorating economy played in the 1989 Tiananmen Square protests.

Economists say that if the growth of China's gross domestic product dips below 8 percent -- a healthy rate in most countries -- it would be a disaster here. The reason is that the demand for jobs would far outpace China's ability to create them.

Estimates by government research agencies for urban jobless top 18 million, or 9 percent of the workforce -- a rate unimaginably high to those who remember the guaranteed cradle-to-grave employment during Mao's time. This figure doesn't include the growing number of jobless among the 160 million migrant workers who are mostly employed in factories. The rural unemployment rate could be as high as 20 percent. In addition, 1 million college graduates are not expected to be able to find jobs this year.

China's social security minister, Yin Weimin, has said that the employment situation in China is "critical," with people fighting for jobs that don't exist. This year as many as 24 million people will be competing for as few as 8 million newly created jobs.

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To combat unemployment, the Chinese government in recent weeks has reinstituted controls that in some ways turn back the clock to the "iron rice bowl" era that China has tried so hard to leave behind during 30 years of economic reforms.

Among the most radical measures is an order by some provinces and cities that prohibits companies from laying off workers without the explicit permission of the government. Other local governments are offering a subsidy of about $1,500 for every worker hired who had not already had a job elsewhere, and seed money for start-ups that will employ a certain number of people. The central government for its part has purchased millions of tons of cotton, soybeans, sugar and other products to prevent companies from experiencing financial problems that would lead to a reduction in their workforces.
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And as part of its massive $586 billion stimulus plan -- roughly 15 percent of its GDP -- China has embarked on several dubious public works projects.

A $3 billion metro rail system linking the southern manufacturing cities of Guangzhou, Dongguan and Shenzhen, for instance, has been criticized as a waste of money because there are already four railway lines linking the cities and the trains often run empty. Ditto a $4.5 billion highway connecting the Sichuan province cities of Chengdu, Zigong and Luzhou, because there are already highways from Chengdu to Zigong and from Zigong to Luzhou.

A bridge running from just outside Shanghai to a textile manufacturing center on the other side of a bay was also resurrected to create construction jobs. For years, its designers had been unable to get the $2 billion they needed to build it because its route would mostly duplicate that of another massive bridge that was already under construction.

That changed in November when at least six of the biggest employers at the other end of the bridge, in Shaoxing, went out of business. Even though there is less need because of the closures, blueprints for the second bridge were dusted off and, almost overnight, workers broke ground. The project is expected to employ about 250,000 people and indirectly provide jobs for 300,000 more.

The article finishes on a rather depressing note:

With job prospects bleak, that money can't last long. As a result, Tong said, the mood is desperate: "Workers are always threatening to jump from the buildings and commit suicide."

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Will Chinese growth REALLY hit 8%?

This blog has consistently stated that GDP may well come in below the crucial 7.5-8% level and have expressed concern on the impact this would have on the wider political economy.

I would place myself on the more dismal than usual side of the dismal profession that is economics. Perhaps I have been overly doom-laden on the costs of recession on China?

The alternative of course is that these predictions are over estimates or dare I said "made up". It appears to be a coincidence that we are hitting 8% so closely. If there is one thing I have learnt and that is to have grave doubts about Chinese data. I just do not believe these predictions.

China central bank sees GDP up 8% [FT]

SHANGHAI/BEIJING, Jan 6 - China’s economy will probably grow by about 8 per cent this year, the central bank’s research bureau forecast on Tuesday, the latest in a string of relatively optimistic estimates.

Some analysts have predicted a much sharper slowdown for the world’s fourth-largest economy, to as little as 5 per cent, as factory output growth grinds to a halt and exports shrink from their year-earlier levels.

However, government officials and researchers have centred around the view that China can engineer growth of about 8 per cent this year -- the pace officially targeted by Beijing as what it considers necessary to create enough new jobs.

The research bureau of the People’s Bank of China (PBOC) added its voice to that consensus, saying in a report that they expect a relatively modest slowdown from their estimate of 9.3 per cent growth for all of 2008. The economy expanded by 9.9 per cent from a year earlier in the first nine months of 2008.

The researchers also estimated that consumer prices would rise by less than 3 per cent in 2009, after an estimated increase of 6 per cent in 2008.

Writing in the official Shanghai Securities News, the team, led by Zhang Jianhua, head of the PBOC’s research bureau, cautioned that the risks of deflation were on the rise, fuelled in part by weakness in property investment and overseas demand.

”To effectively counter the risk of rapidly accelerating deflation, the key is to fully implement all manner of policies to expand domestic demand and support growth, and to speed up reform of pricing of basic goods,” they wrote, saying that the report represented their own views, not the central bank’s.

Some private investment banks have also said that they do not expect growth to slow as sharply as many others think it will.

Yiping Huang with Citigroup in Hong Kong said in a research note on Monday that the economy would probably grow by about 8.2 per cent in 2009, as industrial output rebounded sharply from the second quarter.

”We believe in the government’s ability to achieve its growth target,” Huang wrote

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Internet content crackdown continues

Google continues to get a pounding in China as do many other content providers as China renews its attacks.

If the sole aim is to remove porn then there can be few complaints (except from the billion or so that would undoubtedly access said material).

ChinaEconomicsblog will remain "vulgar" free although I believe we might still be blocked by the great firewall of China.

China cracks down on internet content [FT]

China’s government has accused the country’s leading internet search engines and web portals, including Google, of threatening public morals by carrying pornographic and vulgar content.

While Beijing regularly launches web censorship campaigns, the new crackdown is the first in which the government has targeted heavyweight companies such as Google and Baidu, the local rival that leads the Chinese search market. During the last campaign about a year ago, the authorities listed only small and little-known websites as responsible for spreading unhealthy content.

The 19 internet sites cited by the government on Monday included Sina, Sohu, Tencent and NetEase, among the country’s biggest web portals and each run by overseas listed companies, and blog hosting websites and discussion forums such as Tianya.

The move comes as the political leadership faces a raft of challenges, many of them organised through the internet.

Government censors are currently busy blocking reporting and debate about Charter 08, an appeal for democratic reform which has attracted signatures from hundreds of prominent intellectuals. Other forms of dissent, such as the voicing of demands for compensation in China’s poisoned milk scandal, have also been organised through the internet.

The government on Monday directed its criticism strictly at content that could be damaging to children or young people.

Search results on the pages of Google and Baidu had “large amounts of pornographic links [and] after notification from the complaint centre, the site did not take effective countermeasures”, the State Council Information Office said in a joint statement with other agencies distributed through official media.

People familiar with the internet industry in China said the move would serve as a powerful reminder of the self-censorship the authorities expect from internet portals.

Cai Mingzhao, a senior official at the SCIO, said that some websites had exploited legal loopholes and warned of stern punishment.

Late last year, state media attacked Baidu and later also other search engines for carrying links to unlicensed pharmaceutical websites. “Looking back, that was the first signal of a tougher tone in dealing with internet companies,” said one internet executive.

Nevertheless, the websites pilloried by the government censors were caught by surprise on Monday. A manager at Sohu said, ”We find this extremely strange and are still figuring out what exactly happened.”

Chen Tong, editor-in-chief at Sina, China’s leading news portal, said there was no point in being surprised about the crackdown. “Ensuring that your content is OK is a content provider’s responsibility in the first place,” he said.

Neither Baidu nor Google responded to requests for comment.

On Chinese blogging sites, pictures of scantily clad girls can often be seen along one side of the screen or in pop up windows. These were still appearing on Sina and other blog hosting pages on Monday.

China has the world’s largest number of internet users, some 390m according to the government’s last count.

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Crisis hits 2/3s of Beijing residents

Some newspaper articles are pretty pointless. This one is a good example of one of those articles.

We know there is a global recession, we know jobs are being lost and we know this will impact all sectors of society.

The headline in the People's Daily Online that "69.6% of Beijing residents affected by financial crisis" is just stating the obvious. In fact I am surprised the figure is so low. What do the other 30% do?

It turns out they are teachers. Teachers just need to wait until falling tax revenues leads to cuts to the education budget and the laying off (or hiring freeze) for teachers. That is probably a year or so away. It is just a matter of time.

69.6% of Beijing residents affected by financial crisis [Peoples Daily Online]

69.6% of the respondents said they were "directly affected" by the financial crisis, according to a specialized survey of over 2,000 respondents in 18 districts and counties in Beijing released by the Beijing Social Facts and Public Opinion Survey Center.

Those who believed that they were "severely" affected account for 15.7% of respondents. Of which, the percentage of respondents who chose this option was highest in the 41 to 50-year-old age group, reaching 22.2%.

Moreover, the survey shows that those who were least affected by the financial crisis were teachers, and those who were affected the most were "self-employed/freelance workers."

Among the 186 "self-employed/freelance workers" surveyed, 22.6% believed the crisis had a "major impact" on their lives.

Among households with incomes less than 10,000 yuan per month, the lower the income of the household the greater the impact they felt from the financial crisis.

Over 70% of households with incomes below 2,000 yuan per month believed that they were affected by the crisis.

Among the 55 households with incomes between 9,000 to 9,999 yuan per month, 32 households felt that they were affected by the financial crisis; they were the least affected group of all the households surveyed.

The survey also shows, in 2008, the salaries of 54.9% of the respondents remained basically unchanged, while over 26% experienced a drop in income.

Salaries of civil servants were the most stable, with 50 civil servants surveyed and 42 of them saying that their salaries basically did not change.

Meanwhile the "management in enterprises and public institutions" group shows the largest elasticity; of 250 respondents, 64 were given raises and 65 had their salaries cut.

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China revs up the car industry

The US government is not the only one that is looking to bail out its domestic car industry. Not surprisingly, and a lot more easily, China is following suit.

The reason is jobs but also to ensure the survival of local car manufacturers who with this support may survive where overseas competitors fail leaving a greater market share for the survivors if and when the global economy picks up again.

As with the US the importance of the car industry strategically and economically is not to be underestimated. The loss of domestic car makers can dent national pride although the UK is an excellent example of the benefits of letting the domestic car makers die. The UK has one of the most productive car manufacturing sectors in the world at the moment. The reason is that it is mainly German and Japanese owned. However, the jobs still exist and I suspect many of the shareholders of the parent companies are UK pension funds so what is the problem?

The US especially could learn from the UK. China should also be careful not to prop up inefficient loss makers. The fact that there are 45 domestic car makers suggests consolidation is essential - the fact 45 have survived so long is indicative of inefficiencies in the system whether it is related to government red tape or bad management.

I agree with the comments below - despite Chinese government support car sales could still contract dramatically. There is still a long way to go in this global recession.

China in push to prop up local carmakers [FT]

The Chinese government plans to support the car industry, the second-largest in the world, with the aim of ensuring sales growth of about 10 per cent in 2009.

The move is part of the continuing effort to stimulate the economy and shield the country from the effects of the global economic crisis.

The State Council, China’s cabinet, is expected soon to announce cuts in car purchase taxes and incentives for the development of clean fuel cars, to help support the flagging local car market, according to the official Shanghai Securities Journal.

After years of double-digit growth, Chinese passenger car sales fell 12 per cent year on year in November as consumer worries about economic growth sapped demand. Figures for December are expected next week.

The proposed sales tax cut on smaller vehicles could help carmakers such as Geely, one of the largest Chinese car companies. Geely said Monday it expects to boost sales 25 per cent this year as it introduces new models.

Government bodies will be required to buy cars developed by domestic carmakers when making fleet purchases, and Beijing will encourage further consolidation in the domestic car industry, the newspaper said. China has 45 carmakers compared with 15 in the US, the world’s largest car market.

Premier Wen Jiabao said last week that Beijing had developed plans to help the automobile and steel sectors.

Yao Hongguang, Shenzhen-based analyst at United Securities, said: “With such a basket of stimulus policies, sales growth in the car market this year can reach 10 per cent, still much lower than the compound growth rate of 15-20 per cent over the past five years.”

But JD Power, the leading automotive consultancy, said it was still predicting flat or slightly lower passenger car sales in 2009, at 5.8m units.

This is based on the assumption that the global economy will stabilise in the first quarter of this year, and that China’s economic stimulus policies offset negative pressures from overseas – neither of which are guaranteed to happen.

JD Power said in a December report that there was a 40 per cent chance the Chinese market could fall by 10 to 12 per cent, in spite of government efforts to support the market.

Beijing also took steps to support the local metals industry, announcing that it will allow tax-free imports of copper, nickel and cobalt concentrate, provided the finished products are exported, according to a statement on the Ministry of Commerce website.

“This is a stimulus initiative to help local smelters survive the financial winter,” said Wang Feng of Everbright Securities in Shanghai.

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China and the Hotel California Effect in Banking

ChinaEconomicsBlog is back after the Christmas break with a topic that has interested me for a while.

This is what I call the "Hotel California Effect" named after a paper by Holger Gorg a few years ago. Respect for sticking with the title even in the face of referees who did not understand what the title even meant.

This was the original paper:

Fancy a Stay at the 'Hotel California'? Foreign Direct Investment, Taxation and Firing Costs

Holger Gorg
University of Nottingham - School of Economics; Institute for the Study of Labor (IZA)

December 2002

IZA Discussion Paper No. 665

Abstract:
This paper looks at the trade off between investment incentives and exit costs for the location of foreign direct investment (FDI). This issue does not appear to have been tackled in much detail in the literature. The analysis considers the effect of profit taxation (as a measure of investment incentives) and an index of hiring and firing costs (proxying exit costs) on the location of US outward FDI in 33 host countries. The results suggest that US FDI, in particular in manufacturing is negatively affected by the level of profit taxation and exit costs. Hence, if countries want to attract FDI it may not suffice that incentives are provided in order to ease the entry of multinationals. Instead, it also appears to be important that exit costs are at a level attractive to multinationals. In other words, multinationals may not check into an attractive looking Hotel California type host country if it is difficult to leave.

Keywords: Foreign Direct Investment, Exit Costs, Firing Costs, Investment Incentives, Taxation

JEL Classifications: F23, H25, J65
Working Paper Series

For those still confused there are lyrics in the Eagles classic song of the same name (the final 3 lines) that read:

We are programmed to receive.
You can checkout any time you like,
But you can never leave!


To me this reminds me of the Chinese FDI policy. China has done very well managing to attract FDI from all over the world. Yet China has not been tested on how easily that FDI is allowed to leave.

The FT cover this issue in today's paper.

As an economist with a good knowledge of China it was clear that the massive investments by UK and US banks in Chinese banks would be high risk to say the least. If these investments were made with a 30-40 year outlook then fine and indeed on paper there have been short term profits from China's stock market boom. The question, as we know from the current crisis, is whether these assets can be sold at the perceived market price.

Routes out of China will be difficult to negotiate [FT]

Last week UBS became the first overseas bank to offload its stake in a Chinese bank in a move expected to trigger a wave of divestments.

Foreign financial institutions including Goldman Sachs, Citigroup, HSBC, TPG, Temasek, Allianz and Royal Bank of Scotland own stakes in leading Chinese lenders worth tens of billions of dollars.

These holdings were mostly acquired in 2005 and 2006 when Beijing was keen to import western capital and expertise to help reform its moribund banking sector.

Many in Beijing and elsewhere are now asking whether the likes of RBS will be tempted to sell out and book handsome profits in order to help repair balance sheets strained by the financial turmoil.

As some of the foreign banks position themselves for possible divestments, many are also wondering what happened to all the talk about “strategic partnerships” and “risk management assistance” that accompanied the original investments.

“The foreign banks promised little and have delivered even less [to their Chinese partners],” according to one person who was deeply involved in negotiations between foreign investors and Chinese banks. “But the Chinese side didn’t really know what to ask for and were more focused on getting deals done as a precursor to very lucrative IPOs.”

At least four other people involved in foreign investments in Chinese banks have said that, although there was interest at one level of the government in introducing western management practices and risk controls, the foreign investors were mainly brought in to provide window dressing for initial public offerings.

With names such as Goldman Sachs, Bank of America and RBS on their share registers, Bank of China, China Construction Bank, Industrial and Commercial Bank of China and Bank of Communications that were technically bankrupt a few years earlier were able to achieve higher valuations when selling shares in Hong Kong and Shanghai.

UBS was considered to be in a slightly different category from the banks that signed up for “strategic partnerships” because its $500m investment in BoC was always considered a financial investment – a “pay to play” commitment that helped it to win a lucrative mandate to advise on the $10bn Hong Kong listing of Bank of China in June 2006.

Last week, UBS decided that the 1.3 per cent stake was no longer core to its strategy and sold it – for $835m – as soon as a three-year lock-in period expired.

UBS stressed that it was “committed” to its relationship with BoC and to its other mainland businesses.

But dealmakers say that any foreign institution mulling a stake sale will have to weigh carefully the potential downside, at a time when Beijing is trying to garner support for its largest banks.

Bank of America last month cancelled a plan to sell more than $3bn worth of its shares in CCB after being told by senior government and banking officials that Beijing was unhappy with the timing of the sale, according to people familiar with the matter.

The cancellation has raised concern among other banks which, like BofA, invested in Chinese banks as “strategic partners” that they will not be able to sell down shares.

“The Chinese stock market is in a terrible situation right now and if all the big foreign investors are running away from the banks then that would hurt confidence even more and the government would not be keen to see that happen,” said Wu Yonggang, an analyst with Guotai Junan, a Chinese brokerage.

Stake sales will also be limited by the need to find buyers for the shares.

“Banks round the world are reviewing non-core holdings and many will no doubt decide to sell their Chinese bank stakes,” says one banker in Hong Kong. “But these share sales can not all come at the same time as they will not be digested by the market.”

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