High-Level Shanghai Communist Party Official Under Investigation; Brief Review of Goldman Sachs' Report on Chinese Banking Sector

Top US, Chinese Diplomats Set to Hold Second Talks in a Month; China Unveils Final Version of Generative AI Rules; Traders flock back to China tech stocks after premier acknowledges economic role

Welcome to this issue of The China Brief. Today is July 13, 2023. Here at The China Brief, we bring you the latest news on China's politics, economy, and society from global media sources, along with exclusive expert analysis. If you find our content helpful, please subscribe to our newsletter.

High-Level Shanghai Communist Party Official Under Investigation

After the Director of the Standing Committee of Shanghai Municipal People's Congress, Dong Yunhu, was taken into custody on Wednesday (July 12) on suspicion of severe disciplinary and legal violations, the Standing Committee of the Shanghai Municipal Committee of the Communist Party of China held an overnight meeting. The committee staunchly backed the decision made by the CPC Central Committee and called on leading cadres to consciously cleanse their social circles. This news was disseminated by the WeChat account "Shanghai Release", an official information outlet of the Shanghai Municipal Government. The meeting was chaired by Chen Jining, the Secretary of the Municipal Party Committee.

During this assembly, the Municipal Committee emphasized that the disciplinary inspection and supervision investigation into Dong Yunhu epitomize the Communist Party's unyielding stance against corruption. They urged to learn profound lessons and persistently drive the comprehensive development of strict party governance, aiming to ensure vigilance against corruption and promote integrity consistently.

The meeting further underscored the need for leaders at all levels to cultivate personal virtue, exercise power righteously, and discipline themselves. Leaders were called upon to consciously purify their social circles, maintain self-discipline, introspection, caution, and self-motivation, practicing caution in all aspects, including solitude, relationships, and their actions. They are expected to diligently educate, manage, supervise cadres, and strictly manage relatives and staff.

Dong Yunhu is the most significant "tiger" struck down since the 20th National Congress of the Communist Party and a rare occurrence of a minister-level official being investigated while still in office in Shanghai for many years. It is understood that he was taken away by the disciplinary inspection department on Tuesday (11th). The "Liberation Daily" published on the same day reported his visit to the Shanghai Academy of Social Sciences for research and exchange with experts and scholars on July 10th.

However, the internet is rife with speculation concerning the reasons behind the investigation of Dong Yunhu. Some believe that it might be a clean-up of the "Zhejiang Gang" by the newly appointed Chen Jining, but such theories are not necessarily accurate. Others suggest it is a move to cleanse the influence of Ying Yong, the current Supreme Procurator, yet this conjecture also lacks substantiated evidence. In fact, Dong Yunhu's problems may be linked to the Shanghai Television Station, which has long been considered an important venue for officials and media personnel interactions. Presently, CCTV's Dong Qing and Ouyang Xiadan are also embroiled in this issue.

Dong Qing's image and career have been affected due to her husband Mi Chunlei's debts. Her television works have been pulled off air, and her current condition is a cause for concern. Meanwhile, Ouyang Xiadan's name has been removed from the list of "CCTV hosts," and she is presently exploring new lifestyles.

As for Dong Yunhu, while there are numerous rumors circulating in society, the official stance on the actual situation remains undisclosed. However, Dong Yunhu's downfall has brought joy to many, as he was considered a Marxist hardliner, once regarded as China's number one human rights figure, who later managed Tibet's foreign propaganda work. His investigation may be solely a consequence of his own problems and is unlikely to involve other high-ranking officials.

Brief Review of Goldman Sachs' Report on Chinese Banking Sector

A week ago, Goldman Sachs published a tripartite series of analyses relating to the banking sector in China.

The first report fundamentally assumes that: the debt of China's local governments can be rolled over, the risk of default is limited, and the scale of debt can continue to grow. The question it answers is: given the aforementioned assumption, what would be the impact on the profitability of China's banking sector?

The second report, building on the discussion of the impact of local government debt on bank profitability from the first report, further analyzes non-performing loans in other areas, specifically the real estate industry, and their effect on the Chinese banking sector.

The third report concerns the influence of local government debt, as discussed in the first report, and non-performing loans in various sectors represented by the real estate industry, as mentioned in the second report, on the dividends of various banks. The logic is straightforward: potential losses will inevitably affect bank dividends, thereby affecting bank share prices.

From a qualitative standpoint, the three reports are comprehensive and impartial. The basic assumption of the first report is likely to hold true in the short term. The issue of China's local government debt is essentially not an issue since the majority of Chinese banks are owned by the central government. If local governments owe vast amounts of loans to banks owned by the central government and find it difficult to repay, as Goldman Sachs reports, it can indeed roll over its debts by borrowing anew to pay off the old, continuing the cycle. In the process of this loan evergreening, China's banking system will have to bear certain costs, as pointed out by Goldman Sachs, leading to a decrease in the bank stock valuation.

However, regarding local government debt, in addition to Goldman Sachs' roll-over solution, there are other resolution methods such as debt relief or proactive restructuring to reduce the scale and cost of the debt. Concurrently, the current distorted fiscal framework between the central and local governments needs to be altered to prevent unrestrained local government borrowing and further accumulation of debt. Obviously, such comprehensive and systematic solutions require time. Currently, some local governments face default risks due to the impact of the COVID-19 pandemic, especially when the central government lacks a clear understanding of the scale of local government debt, rendering the introduction of these solutions challenging. Therefore, as stated earlier, the basic assumption in Goldman Sachs' first report holds true in the short term.

From a macroeconomic perspective, China's economy is undergoing a challenging structural transformation. The economic growth engine is shifting from traditional investment (especially real estate) to a new tech-innovation engine. The old engine's thrust has sharply declined due to policy intervention, and the new engine's momentum is currently limited. Given China's lack of a basic social security system (such as unemployment insurance, personal bankruptcy, and re-employment training) to support the structural transformation, the process is exceptionally challenging. The path out of the current predicament for the Chinese economy and banking sector, as well as the issues raised in Goldman Sachs' reports, fundamentally depends on the progress of the structural transformation. If this process is smooth, the issues raised in Goldman Sachs' reports can be resolved through growth driven by the new engine. If this process is not smooth or requires a prolonged time to complete, even with proactive local debt restructuring and fiscal framework reshaping as mentioned above, it would still be difficult for the Chinese economy and banking industry to fully escape from the current predicament.

At the end of this month, the Politburo of the Communist Party of China will hold a regular meeting to summarize the economic work of the first half of the year and set the tone for the economic work in the second half. Last week, Xi Jinping, the General Secretary of the Communist Party of China, visited Suzhou and Nanjing, the most innovative cities in China, presumably in preparation for the upcoming meeting. From the choice of inspection locations (not provinces mired in local debt crises) and the wording of the press release, the focus for the second half of the year seems to be on plastering and delaying existing economic problems (such as debt), avoiding the kind of economic stimulus implemented in response to the 2008 global economic crisis, and actively promoting economic structural transformation. This process, as I have mentioned, is extremely challenging.

Regarding the impact of the current economic predicament on the valuation of each bank's stock, it depends on the parameters chosen for the valuation model and the analyst's understanding of each bank, which is beyond my knowledge. As for investment advice, I can only share some rough ideas from a macroeconomic and financial stability perspective: 1) The Chinese banking system is indeed in a process of "cracking without breaking," as analyzed in the Goldman Sachs reports. 2) In such a process, the best strategy for investors is to avoid all bank stocks and shift their focus to the new engine of economic growth. In fact, most investors and media discussing the Chinese economy often focus on the many issues faced by industries related to the old engine, while neglecting the burgeoning industries related to the new engine.

Top US, Chinese Diplomats Set to Hold Second Talks in a Month

Bloomberg

US Secretary of State Antony Blinken and China’s top foreign policy official, Wang Yi, will meet in Jakarta on Thursday to discuss the deteriorating ties between the two countries. The meeting comes as the US and China are attempting to rebuild communication channels and reduce frictions amid a tit-for-tat trade war. The relationship between the two countries remains tense, with US officials’ emails having been breached in a hack that Microsoft has said originated from China. Despite this, Chinese leader Xi Jinping said after Blinken’s visit to Beijing last month that it was “very good” that ties were steadying.

China Unveils Final Version of Generative AI Rules

Bloomberg

China has released official guidelines for generative artificial intelligence (AI) services, becoming one of the first countries to regulate the advanced technology. The rules, set to go into effect on 15 August, require platform providers to carry out a security review and register their services with the government. Offshore providers of generative AI tools that target Chinese residents must also comply with the regulations. However, Chinese-developed tools that serve only overseas users are not subject to the guidelines. The regulations remove provisions for fines and the three-month grace period for rectifying problematic content.

Traders flock back to China tech stocks after premier acknowledges economic role

South China Morning Post

China's technology stocks have seen a resurgence in buying following a shift in Beijing's attitude towards the sector. The Hang Seng Tech Index rose 8.6% this week, while the Nasdaq Golden Dragon China Index jumped 6.3% for its best weekly performance since March. The renewed optimism comes after Premier Li Qiang and the country's top planning body acknowledged the importance of the industry to economic growth and innovation, leading to hopes that Beijing has moved away from its tough crackdown on the sector to a more supportive stance.

China renews call for US to lift sanctions; 'open' to Raimondo visit

Reuters

China has once again called on the United States to lift "unilateral" sanctions against Chinese enterprises. The US has imposed sanctions on Chinese companies accused of using forced labor in the Xinjiang region, a claim that China denies. China's commerce ministry spokesperson stated that the US has "seriously damaged Chinese companies' interests" and urged the US to stop its suppression of Chinese firms and lift its sanctions. The statement comes ahead of a possible visit by US Commerce Secretary Gina Raimondo to China. China has expressed openness to the visit and is in communication with the US on the matter. The two countries have agreed to keep channels open for economic talks.

Chinese exports plummet, except to Russia

Deutsche Welle

Chinese exports experienced a significant decline in June compared to a year earlier, according to official data released on Thursday, putting pressure on Beijing to introduce more stimulus measures in order to revive the struggling recovery. The decline in Chinese exports has been impacted by both weakened global consumer demand and tensions with the United States. China reported a 12.4% drop in exports in June compared to June 2022, while imports also fell by 6.8% during the same period, reinforcing concerns about weakening domestic demand. China's trade surplus reached $70.2 billion in June, compared to $65.81 billion in May.

Tesla’s $1,670 Electric Quad Bike for Kids to Launch in China

Bloomberg

Tesla will start selling the Cyberquad, an electric quad bike inspired by its Cybertruck, in China. Priced at 11,990 yuan ($1,670), the Cyberquad is targeted at children aged 8 to 12 and has a range of 13 kilometers and a battery life of 1.5 hours. It has a top speed of 8 kilometers per hour and a maximum recommended weight of 50 kilograms. The Cyberquad was originally unveiled as a concept in 2019 and has already been sold in other countries. China is a crucial market for Tesla, with its Shanghai factory accounting for over half of the company's global electric vehicle output.

U.S. tech can't quit China and Netflix dives into Asia

Nikkei Asia

A growing number of U.S. tech companies are becoming increasingly dependent on China for their sales, despite efforts to decouple the two countries' tech supply chains. According to data from Nikkei Asia, 17 of the top 100 global companies in China by sales in the most recent fiscal year were U.S. tech-related firms. Apple was the top company on the list, while Qualcomm and Tesla were also heavily dependent on China. Greater China remains Apple's second-largest source of revenue, while Tesla made 22% of its sales in the country in 2022, up from 8% in 2018. The ongoing tensions between the U.S. and China are expected to continue, meaning that U.S. tech firms will have to "accept that a new status quo is forming," according to an expert.

China shuts 'fake' foreign investors out of stock connect programs

Nikkei Asia

China's securities regulator, the China Securities Regulatory Commission (CSRC), is closing a loophole that allowed mainland investors to trade onshore shares via stock connect programs with Hong Kong. Starting from July 24, mainland investors will be fully banned from buying A-shares through the northbound trading links. The CSRC issued a policy in 2022 to prohibit brokerage companies in Hong Kong from opening stock trading accounts for mainland investors to crack down on what it deems "fake foreign capital." The ban is aimed at reducing the risks of cross-border capital flow and maintaining the stability and long-term development of the stock connect programs.

What the World Doesn’t Understand About China’s Ambitions

Bloomberg

In this episode of Stephanomics, host Stephanie Flanders interviews Keyu Jin, a professor at the London School of Economics and author of The New China Playbook. Jin discusses the misunderstandings surrounding China's ambitions and goals in the world. She argues that China is not trying to displace the US, but rather improve living standards for its middle-income earners. Jin also talks about China's economy, its relations with the US and Europe, and the skills gap contributing to high youth unemployment. She notes that while there is widespread gratitude and deference towards the government within China, this could change if slower economic growth leads to fewer high-quality jobs.

Chip wars: How ‘chiplets’ are emerging as a core part of China’s tech strategy

Reuters

Chinese chip startup Chipuller acquired chiplet technology from struggling Silicon Valley startup zGlue in 2021, according to Reuters. Chiplet technology, which packages small semiconductors together to create a more powerful chip, has become increasingly important to China as it looks to achieve self-reliance in semiconductor manufacturing. The acquisition of the technology coincides with a push for chiplet technology in China that began about two years ago. Chinese authorities have increasingly highlighted chiplets in recent years and have referred to them as part of a strategy to increase China's capabilities in key and cutting-edge technologies. Chipuller's acquisition of the chiplet technology comes as China is investing more in the area, with corporate announcements indicating that further major investments are on the way. Chipuller's chairman, Yang Meng, said that chiplets have a special meaning for China given the restrictions on wafer fabrication equipment, and that the technology is the core driving force for the development of the domestic semiconductor industry.

Chi­na’s ex­ports plunge most in 3 years amid high­er in­ter­est rates

Al Jazeera

China's exports have seen their biggest drop in three years, falling 12.4% in June compared to the previous year. This follows a 7.5% decline in May and highlights the challenging global economic outlook due to rising interest rates. China's imports also fell 6.8% in June, more than expected by economists. Central banks around the world have raised borrowing costs to combat rising inflation, while tensions with the US and trade restrictions on the Chinese tech sector have added further pressure. Beijing has set a growth target of around 5% for this year.

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