Yellen, China's ambassador held 'frank and productive' discussion; Exclusive Insight: Behind China's sluggish recovery lies the onset of a 'balance sheet recession'

China Forex Regulator’s Foreign Funds Seen Topping $1.5 Trillion; Chinese exchanges top global IPO markets in the first half of the year; Technological cooperation is cementing U.S.-India security tie

Welcome to this issue of The China Brief. Today is July 04, 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.

Exclusive Insight: Behind China's sluggish recovery lies the onset of a "balance sheet recession."

By the end of 2022, China had ended its zero-COVID policy, followed by a significant increase in bank credit in the first quarter. There were signs of economic recovery in the monthly economic data. However, the data for April and May 2023 started raising concerns once again.

In my opinion, there are at least three reasons behind the sluggish recovery:

A large number of enterprises have already closed down during the zero-COVID policy period. These enterprises can be likened to withered crops, while credit can be compared to rainfall. When the crops have already died due to drought, more rainfall becomes meaningless.

The real estate industry, which plays a significant role in driving GDP growth, is currently undergoing deleveraging. The primary task for developers is to reduce debt, making it difficult to borrow for land purchases and construction of new houses. Many families, facing declining property values, have not seen a reduction in their mortgage payments. Their top priority now is to repay their mortgage as quickly as possible and reduce their debt, rather than borrowing new funds for consumption or investment in real estate.

Due to the combination of the zero-COVID policy and cooling measures in the real estate market, local governments are facing financial difficulties and focusing on debt repayment rather than borrowing to promote economic development.

Japanese economist Richard Koo refers to the situation where companies or households intensify debt repayment as their assets shrink during an asset price decline as a "balance sheet recession." At this point, the goal for companies is not to maximize profits but to minimize debt as quickly as possible. Similarly, for households, the objective is not to borrow for investment gains but to reduce the debt incurred from purchasing assets whose value has declined. Monetary policy becomes less effective during this period since economic agents prioritize debt repayment rather than borrowing new funds.

It is essential for readers to note that the "balance sheet recession" currently occurring in China is precisely the intended outcome of the real estate industry's deleveraging efforts and various policies aimed at curbing housing prices. It is a deliberate action by the central government, rather than an accidental occurrence. Deleveraging is the objective, and recession is the economic cost of deleveraging. In the real estate industry, we observe numerous non-systemically important developers going through deleveraging or bankruptcy (which does not trigger financial system stability concerns) and being delisted from the stock market. Systemically important developers like Evergrande undergo debt restructuring aimed at reducing debt and extending repayment deadlines, with government assistance and support if necessary. Many residents are also deleveraging or facing bankruptcy due to the inability to repay their mortgages, leading to the legal auctioning of properties.

Objectively speaking, the enormous bubble in the real estate market and the astonishing leverage ratios of developers pose significant risks to the Chinese economy. If these issues are not addressed promptly and allowed to accumulate, the consequences when they eventually explode at some point in the future would be unimaginable. Identifying problems early and promptly controlling them before they escalate is indeed the right approach. However, there may be alternative solutions to consider. For instance, a gentler approach could involve temporarily stabilizing housing prices and actively promoting the transformation and upgrading of the Chinese economy to increase residents' income. This way, the ratio of housing prices to income would naturally decline in 5-10 years. But regardless of the reasons, since the Chinese central government has chosen the more aggressive path of deleveraging, disregarding the economic costs, similar to the Federal Reserve's aggressive interest rate hikes to combat inflation without considering financial system stability, or China's decision to pursue zero-COVID without considering economic costs a few years ago, several related issues naturally arise.

China Forex Regulator’s Foreign Funds Seen Topping $1.5 Trillion

Bloomberg

China's State Administration of Foreign Exchange (SAFE), which is formally under the control of the People's Bank of China (PBOC), controls investment funds with overseas assets worth at least $1.5tn, according to research by Zoe Zongyuan Liu. Liu argues that there should be greater focus on SAFE in assessments of China's geo-economic strategy, as it controls three times more assets than the China Investment Corporation, the country's flagship sovereign wealth fund. SAFE's funds help shape the global economic environment by taking equity stakes in companies in strategic sectors, allowing China to secure access to overseas markets, resources and technologies.

Chinese exchanges top global IPO markets in the first half of the year

South China Morning Post

China was the most active market for initial public offerings (IPOs) in the first half of 2019, accounting for almost half of global fundraising. Chinese companies raised a total of $31.3bn from IPOs on the Shanghai, Shenzhen and Beijing exchanges in the first six months of the year. The Chinese government has implemented capital market reforms, allowing companies to more easily sell shares. This has led to an increase in fundraising, particularly in the artificial intelligence sector.

Technological cooperation is cementing U.S.-India security ties

Nikkei Asia

Mistrust of China has solidified India's role in the US's China strategy, and geoeconomic and technology cooperation has become the driving force behind the US-India relationship, according to Ved Shinde, a research assistant with the Asia Society Policy Institute in New Delhi. India's anger at China's territorial aggression in the Himalayas means the US is the natural partner for New Delhi to counter China's military advantages. The US sees India as a valuable partner to restore strategic equilibrium in the Indo-Pacific region and push back against China's efforts to oust Washington.

Alibaba Said to Weigh Options for Video Platforms Youku, Tudou

Bloomberg

Alibaba is conducting a strategic review of its video streaming platforms Youku and Tudou as part of its ongoing restructuring plans. One option under consideration is to inject the assets into Alibaba Pictures Group, which could expand the business scope of the Hong Kong-listed company. Alibaba's digital media and entertainment business narrowed its losses in Q1 2022, partly due to Youku's investment in content and production capability.

Yellen, China's ambassador held 'frank and productive' discussion - US

Reuters

U.S. Secretary of Treasury Janet Yellen and China's ambassador to the United States, Xie Fang, had a "frank and productive discussion" ahead of Yellen's visit to Beijing this week. Xie expressed China's concerns on economic and trade issues and called for the United States to take action to resolve them. He also expressed hope for stronger dialogue between the two countries.

China, Honduras launch negotiations over free trade agreement

Reuters

China and Honduras have begun talks over a free trade pact, following the recent establishment of diplomatic and economic relations between the two countries. Honduras broke off its longstanding ties with Taiwan in March and has since sought to establish relations with mainland China, the world's second-largest economy. Last month, Beijing approved Honduran imports of bananas, coffee, and shrimp.

China home sales falter amid dented buyer confidence

South China Morning Post

Home sales in China fell by 28.1% in June among the 100 largest developers by sales compared to the same month last year, according to CRIC, one of China's largest real estate brokers. The figures show that the sector remains in crisis and will continue to weigh on the country's economy as developers suffer amid a lack of buyer confidence. Sales rose by 8.5% month-on-month, the lowest recorded growth in what is normally a buoyant month.

Chinese Doctor Who Edited Babies’ Genes Wants to Fix Alzheimer’s

Bloomberg

Chinese scientist He Jiankui, who gained global attention for gene-editing babies in 2018, is now proposing to use a similar technique to prevent Alzheimer's disease. He plans to test whether a specific genetic mutation can reduce the formation of brain plaques associated with Alzheimer's. The study will first be trialled on a mouse, and no human embryos will be implanted. He is serving a lifelong ban on working in reproductive technology and will require government permits and ethical approvals to proceed. He's previous use of gene-editing technology was widely condemned. Most countries, including China, ban the altering of genes in human embryos due to potential unintended consequences.

Is a glob­al debt bomb about to ex­plode?

Al Jazeera

Low-income developing countries are facing a debt crisis, with the majority of these nations either in or near debt distress. The global public debt levels are also high, at 92% of GDP at the end of 2022. The debt crisis is not yet a global contagion, but it is a growing concern. Poorer countries were hit hardest by the COVID-19 pandemic and had to rely on external loans to survive. The debt situation was exacerbated by the increase in global commodity and food prices due to Russia's invasion of Ukraine. The debt crisis is not global in scale but is confined to developing countries. However, the debt crisis is not unprecedented, with similarities to past shocks. The debt crisis has spilled over into geopolitics due to the involvement of major new lenders such as China and private bondholders. China holds more than half of Zambia's external debt and is the largest official bilateral creditor for more than half of the countries in the G20 Debt Service Suspension Initiative. The G20's common framework to coordinate debt treatments has not been successful, and negotiations have been marred by a blame game between Western nations and China. The common framework needs to be redesigned to bring China fully into the debt restructuring process. The involvement of private creditors is also crucial, and they should be included proactively in the process. The IMF, World Bank and G20 have set up the Global Sovereign Debt Roundtable to address these issues and speed up debt restructuring.

‘China is slowing’: economic recovery stalls as yuan slips, uncertainty abounds

South China Morning Post

Chinese residents are depositing stacks of US dollars into Hong Kong banks as concerns about China's economy grow. The uncertainty surrounding China's economic growth has been spreading, as the post-coronavirus recovery appears to have fizzled out. Chinese residents are seeking to deploy some of their assets overseas and are taking advantage of the high interest rates in Hong Kong due to rate increases by the US Federal Reserve. The lack of confidence in China's future economic growth has led to a decline in the yuan, further fueling negative sentiment. Economists have revised down their growth forecasts for the second quarter, and the Chinese government is facing pressure to regain the confidence of people and investors. The government needs to boost confidence in the private sector and avoid excessive interference while supporting the real estate sector, which is a crucial pillar of the Chinese economy.

US set to restrict China's access to cloud computing - WSJ

Reuters

The Biden administration is preparing to restrict Chinese companies' access to U.S. cloud-computing services, according to the Wall Street Journal. The new rule would require U.S. cloud-service providers to seek U.S. government permission before providing cloud-computing services that use advanced artificial-intelligence chips to Chinese customers. The restriction is expected to be implemented by the U.S. Department of Commerce in the coming weeks as part of an expansion of its semiconductor export control policy. China has also announced controls on the export of metals used in the semiconductor industry as part of its ongoing dispute with the U.S. over access to high-tech microchips.

Do Democracies Always Deliver?

Foreign Policy

In his book "Defeating the Dictators: How Democracy Can Prevail in the Age of the Strongman," Charles Dunst argues that democracies need to identify their own deficits and remedy them in order to maintain their edge in the global competition against autocracies. He suggests that democracies deliver when they can provide a good life for their citizens, which includes ensuring basic needs such as healthcare and education, functional state institutions, and a strong economy. Dunst warns that autocracies today are more capable and attractive than in the past, as they can provide a high quality of life even while denying basic political rights. He points to examples such as Singapore and the United Arab Emirates, which have built infrastructure and provided social services that rival those of democracies. To rejuvenate democracy and better compete with autocracies, Dunst recommends investing in human capital and innovation, building robust physical and digital infrastructure, expanding healthcare and workers' rights, addressing corruption, and enacting smart immigration policies. However, the book's methodology is questionable, as it focuses on highly anomalous autocracies and overlooks the broader picture of dictators around the world. Additionally, some of the recommendations for overcoming gridlock and passing reforms in democracies are unrealistic. The book also overlooks the advantages that democracy provides in foreign policy, such as building alliances and signing international agreements. Overall, democracies can defeat dictators by providing stable economic institutions and freedoms, building military power, and deepening alliances and partnerships with like-minded states.

China Needs to Boost Government Borrowing, Policy Adviser Says

Bloomberg

China can avoid a “balance sheet recession” if the government takes decisive action to boost borrowing and spending, according to Liu Lei, a researcher at the National Institution for Finance and Development. While economists argue that China’s high debt limits the government's ability to provide further stimulus, Liu stated that the government has ample room to leverage up. Liu argued that Beijing should prioritise lifting growth, which would naturally reduce debt levels in the economy.

Yellen’s China Visit Aims to Ease Tensions Amid Deep Divisions

NY Times

US Treasury Secretary Janet Yellen is set to visit China for the first time since the Biden administration took office. However, tensions between the two countries remain high, and major breakthroughs are not expected during Yellen's visit. The US has maintained tariffs on Chinese goods imposed by the Trump administration, and Biden has been working to restrict China's access to critical technology such as semiconductors. The Biden administration is also considering further controls on advanced chips and American investment in Chinese technology. Meanwhile, China has been investing heavily in its domestic semiconductor capacity but remains years behind the US. The US is also employing a policy of "de-risking" or "friend-shoring," which involves enticing supply chains for key products out of China. Furthermore, there are concerns about China's use of economic coercion against other countries and its tightening national security laws. The weakening of China's currency, the renminbi, is also a source of concern for the US.

Europe’s Top Diplomat to Visit Beijing as Economic Rivalry Grows

Bloomberg

The European Union's top diplomat, Josep Borrell, will visit Beijing next week for meetings with Chinese officials. The trip comes as Europe seeks to navigate its economic rivalry with China. Borrell will meet with Foreign Minister Qin Gang and other senior figures during his visit. The EU plans to raise "strategic issues" with China, including human rights practices and Russia's war in Ukraine. The two sides will continue dialogue on economic and trade issues, with a potential leaders' summit at the end of the year. The visit comes as Beijing attempts to persuade Europe to take a less hawkish stance than the US, which has imposed export controls on China to limit its access to advanced technology. In response, Beijing has imposed restrictions on exporting two metals crucial to the semiconductor, telecoms, and electric-vehicle industries. Borrell's visit follows a trip by EU climate chief Frans Timmermans, who is meeting with Chinese officials this week to discuss climate, biodiversity, and environmental protection issues. The visits were postponed earlier this year when both officials tested positive for Covid-19.

‘People are nervous’: Taiwan’s wealthy shelter money overseas in fear of China conflict

Financial Times

As tensions rise between China and Taiwan, some wealthy Taiwanese individuals are exploring options to protect their wealth and prepare an exit strategy. The fear of a potential military conflict has prompted some Taiwanese to diversify their assets and invest in highly portable assets such as art and diamonds. Wealthy individuals connected to Taiwan's ruling Democratic Progressive party are reportedly driving this push to move assets offshore. While there is no panicked rush of outflows, some wealthy families are quietly moving their money abroad, though it is difficult to determine the exact amount. Taiwan has long been among the countries with the highest proportion of wealth held in offshore tax havens. The root of this imbalance can be traced back to the late 1980s and early 1990s when Taiwanese companies began investing in China, despite Taipei's ban on such assets. Many Taiwanese set up shell companies in tax havens such as the British Virgin Islands and Cayman Islands to avoid detection. However, several factors are changing this pattern, including Taiwanese companies shifting manufacturing away from China and Taipei beginning to tax residents on their global income from this year. As a result, some wealthy Taiwanese families are making administrative adjustments and setting up trust structures to help conceal ownership. This restructuring of offshore assets coincides with many family groups addressing succession plans and looking for different immigration and investment destinations for their next generation. Malta and Singapore are popular jurisdictions for these wealthy families. The wealth management industry hopes that these changes will create new business opportunities, particularly offshore. However, many wealthy Taiwanese still prefer to invest in physical assets such as property and gold, which they see as more secure in times of uncertainty. Despite the possibility of conflict, they are reluctant to sell Taiwan property.

China Banks Offer 25-Year Loans to LGFVs to Avert Credit Crunch

Bloomberg

China's largest state banks, including ICBC and China Construction Bank, are offering loans with ultra-long maturities and temporary interest relief to local government financing vehicles (LGFVs) to prevent a credit crunch in the $9tn debt market. The banks are ramping up loans that mature in 25 years, instead of the usual 10-year tenor for corporate lending, to qualified LGFVs with high creditworthiness. Some loans also waive interest or principal payments for the first four years, with the interest being accrued for later payment.

Chinese ‘GaN’ semiconductor firm is probed in US amid IP dispute with competitor

South China Morning Post

China's Innoscience, which makes gallium nitride-on-silicon (GaN-on-Si) semiconductor devices, is being investigated by the US International Trade Commission (USITC) following an intellectual property complaint from competitor Efficient Power Conversion. Innoscience was founded in 2015 and has the largest dedicated 8-inch GaN-on-Si wafers manufacturing capacity globally, able to produce 10,000 wafers per month. GaN semiconductor technology is expected to grow by over $5bn between 2022 and 2027.

China's Great Wall Motor to enter Vietnam amid peers' ASEAN push

Nikkei Asia

Chinese carmaker Great Wall Motor has announced plans to enter the Vietnamese market in August with its Haval H6 hybrid model. The company also intends to build an assembly plant for new-energy vehicles in Vietnam by 2025. Initially, the Haval H6s will be exported to Vietnam from Great Wall Motor's manufacturing facility in Thailand. Vietnam is the fourth-largest auto market in the Association of Southeast Asian Nations (ASEAN) region. Great Wall Motor is also in talks with the Thai government about producing fully electric vehicles (EVs) in Thailand and hopes to make the country its Southeast Asia EV manufacturing hub. The company has a presence in several Southeast Asian markets and plans to expand further into the region. Other Chinese automakers, such as Guangzhou Automobile Group's Aion, are also targeting the Southeast Asian market.

China Inc. shows how generative AI can be serious business

Nikkei Asia

Chinese companies are scaling less sophisticated AI solutions to solve practical challenges in their market, according to Benjamin Speyer, CEO of Serica, a global technology and financial advisory firm. Speyer argues that Western companies should take lessons from China's ability to rapidly adopt, scale, and commercialize new technologies to enhance their own capabilities and global competitiveness. While the US currently dominates the AI sector, China is snapping at its heels, with high technology adoption rates, mass digitalization, government support, and an abundance of science, technology, engineering, and math graduates. However, Chinese companies face challenges including a lack of private-sector funding, a small proportion of Chinese websites globally, and a shortage of high-level AI talent. In response, Chinese companies are focusing on practical solutions to pave the way for future advancements. Speyer says Western companies must take Chinese innovation seriously and learn from their approach to AI, or they risk being left behind in emerging markets, where China's approach will have inherent advantages.

Hong Kong’s talent hunt is giving its property market a needed boost

South China Morning Post

Hong Kong is showing signs of recovery as the mainland border reopened in February. Total tourist arrivals have reached over 10 million for January to May, leisure visitor numbers are rising, and retail sales, hospitality demand, and meetings and events are increasing. The recently launched Top Talent Pass Scheme, which grants a two-year working visa to professionals and graduates who earn HK$2.5 million or more annually or have graduated from one of the world's top 100 universities, has also boosted the leasing market. However, challenges remain, including regional competition, a shaky global economy, and volatile exchange rates.

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