China's US Treasuries Holdings Dipped?

Beijing’s long-feared dumping of US Treasuries, or the use and value of the PBoC’s central bank reserves was ignited again. The revelation that Chinese holdings of US Treasury obligations fell in December by $34.2 billion, to $755.4 billion, brought new fears. But are they justified?

In December 2009, China slipped below Japan to become the second largest recorded holder of U.S. treasuries, as it continued to unwind holdings of U.S. Treasury bills and Japan bought over US$11 billion in treasuries. China's recorded stock of U.S. treasuries has fallen from US$800 billion in July 2009 to US$755 billion at the end of 2009. China has been shifting back to purchases of longer-dated treasuries after buying more T-bills in late 2008 and early 2009. China's holdings of Treasury bills has fallen from a peak of US$210 billion in May 2009 to US$70 billion at the end of 2009. This shift implies that China may be purchasing some U.S. assets through intermediaries. China's net purchases of long-term Treasury bonds were US$4.6 billion in November.

In mid-2008, China surpassed Japan to become the largest single holder of U.S. Treasury securities. After a sharp increase in its T-bill purchases in late 2008, China gradually reduced its U.S. short-term debt holdings and shifted into long-term Treasuries in 2009.

China dropped its overall holdings , yes, but the article fails to mention the shift in holdings by other key countries that offset completely China's sell-off. In December, the UK and Japan jointly increased their holdings by more than China dropped its holdings, + $US 36.4 bn vs. -$US 34.2 bn. China's current portfolio is really not that difference from recent history. China's December share of US Treasury holdings, 20.9% (as a % of total foreign holdings), is barely off its 2007-2009 average, 21.4%. But Japan's holdings are way off, and could revert towards the average, 23.7%.

p/s photos: Padma Priya

India's Economic Strength Compared To China

Why is China the “workshop of the world” when Indian labour is even cheaper and her entrepreneurs admired worldwide? There are many reasons, including (until recently) the anti-foreign-trade policies and small-scale industry reservation policies as well as poor infrastructure in power, roads, water and ports. Perhaps even more important are the restrictive labour laws and certain other regulations, which encourage Indian manufacturing units to “stay small”, thereby forgoing the classic industrial economies of scale and scope.

Both China and India have sizable population, both are seeing a growing middle class by improving the economic livelihood of those in the rural areas. Yet as an economic engine or superpower, India seems to be bogged down by certain factors. The biggest division is that one is state planned centralised economy while the other is probably to most democratised country in Asia with many "almost independently managed states". However, thats the big picture, the reality would show that India's economy is more powerful and resilient in many ways when compared to China.

As a percentage of GDP, China's domestic consumption is the lowest of all major economies, hovering at just 1/3 of GDP. Most of China's growth in 2009 had come from infrastructure spending or speculation in domestic assets. In India, the domestic consumption accounts for 2/3 of GDP - now that is food for thought. China's artificial suppression of the yuan restricts domestic spending. As great as the surpluses are, more than 3/4 of China's capital goes to the 120,000 state controlled entities. That being the case, most of the profits in China end up in state coffers.

The OECD’s Investment Policy Review of India says India has designed policies to encourage investment as part of market-oriented reforms since 1991 that have paved the way for improved prosperity.

“Restrictions on large-scale investment have been greatly relaxed. Many sectors formerly reserved to the public sector have been opened up to private enterprise. Import substitution and protectionism have been replaced by an open trade regime,” the OECD report notes.

But further reforms are needed. India’s policy framework for FDI still remains restrictive compared with most OECD countries. Meanwhile, its investment needs remain massive, with poor infrastructure holding back improvements in both living conditions and productivity.

India’s growth is led by domestic demand and growing incomes in the coming years will continue to boost domestic demand and industrial activity. Reforms, the growth of home-grown corporations and rising scale of foreign direct investment are also pluses. Large domestic savings (37% of GDP in 2007), both by households and corporations, have played a pivotal role in India's economic growth. High domestic savings and the development of homegrown corporations have boosted investment (39% of GDP in 2007), helped by cheap foreign capital. Combined with a large private consumption (55% of GDP in 2007) base and a low trade dependence (imports and exports account for around 20% of GDP), the Indian economy is perceived by foreign investors as a "domestic demand-led story".

Due to the economic slowdown in 2008, household savings in financial assets fell to 10.9% of GDP in 2008 from 11.5% in the previous two years led by the large decline in holdings of shares and debentures. Households also shifted their savings from mutual funds to bank deposits due to an increase in risk aversion in 2008. With the decline in risk aversion in 2009, households will slowly shift back to equities. India's gross domestic saving rate might have declined from 37.7% in 2007 to 31% in 2008-09.

Indis' middle class stands at a formidable 300m while China's figure is around 150m. Half of China's population is in rural areas while India still have 2/3 of them in rural areas. According to a recent study by MIT School of Management, China's absolute levels of poverty and illiteracy have doubled since 2000, while India's have been halved! In India, economic growth in rural areas have outpaced growth in urban areas by 40%. Rural India now accounts for half of India's GDP, it was 42% in 1982, and it contibutes about 2/3 of India's growth . Rural China accounts for only 1/3 of China's GDP, and contributed to just 15% of the country's growth.

Increasing the growth potential and attaining the Chinese type of economic growth is constrained by India's democratic set-up, which requires political consensus to implement economic reforms. Coalition governments in the recent years have slowed the approval of reform and liberalization-oriented legislations. However, policymakers argue that slow and sequenced reforms and liberalization over the years have in fact helped India achieve strong and sustainable economic growth and limited the impact of global cues on the Indian economy.

India's medium term challenges include reducing dependence on foreign oil, increase efficiency in oil consumption to reduce its impact on fiscal and trade deficits. Cutting down oil and agriculture subsidies to reduce unproductive fiscal spending and large budget gap. Structural reforms include improving agriculture yields, development of infrastructure, health care and education access to increase absorptive capacity of economy. Other challenges include: The stance on Foreign Institutional Investors (FIIs) and capital inflows, and managing their role in generating credit and asset bubbles. Balancing private sector and foreign investors' role with concerns about social stability. Reducing corruption, and income and wealth inequality, especially between states and between rural and urban areas. Boosting human capital development and job creation can raise consumer spending, especially for the lower and middle income groups and in rural areas. Liberalizing foreign investment caps, broadening and deepening the domestic capital markets, easing capital controls on companies to borrow from abroad, and improving financial intermediation of domestic savings can buoy investment.

We should reconsider India in relation to China in their path to dominating the global economic scene over the next 20 years. Both will be taking very different path and will have major consequences to the global competitive paradigm. China's still lags in a several areas and the rural dislocation and to a certain extent the "forgotten group" being left behind will have grave social and economic costs in the coming years, if not properly managed and improved on.

p/s photos: Asin

Should We Worry About The Chinese Banks

Thanks to the current financial combustion, many of the usual top banks have been cut at their knees. Many China banks have been elevated up the biggest bank ladder. The strong equity run up over the past 6 months in China has pushed their valuations even further ahead of the rest. But just how solid are the Chinese banks. We all know that many of these banks still have tons of "unsettled loans to state owned companies". Their recent aggressive bank lending, exhorted by Beijing, meant that their loan portfolio cannot be too pretty.

China's banks posted relatively flat profit growth in H1 2009 as new lending more than doubled. The surge in liquidity meant that non-performing loans decreased as a percentage of assets (mostly due to an increase in the denominator). Regulators have indicated that lending standards will tighten in H2, which along with the need to meet new capital adequacy requirements could eat into profits. However, a shift toward longer-term loans and and shift of savers into demand deposits may increase the net-interest margin for banks, which fell in H1 2009 due to lower interest rates.

• ICBC, the world's largest lender by market value, posted a 2.9% rise in profit for H1 2009 on a 17% jump in total assets, dramatically slower than the 57% profit growth posted in H1 2008. H1 profit rose to RMB66.42 billion (US$9.72 billion) as the bank issued RMB865 billion in new loans (up 19% y/y). Non-performing loans fell to 1.81% of assets from 2.29% at the end of 2008. The bank's net interest margin fell 70 basis points to 2.25% on lower interest rates.
• John Foley, BreakingViews: "For now, ICBC's balance sheet is iron-clad. Tangible common equity is a healthy 5% of total assets. Loans are 58% of deposits." But a tide of liquidity may just be refinancing risky commercial loans, pushing off problems for later.
• FT's Lex notes that the increase in equity prices encourages a shift from term to demand deposits which cost the banks less and could improve interest margins in Q3. Moreover the effects of higher capital adequacy ratios will not come until late in 2009 or more likely early in 2010.
• China's second largest bank by market value, China Construction Bank (CCB), profit fell 4.9% from H1 2008 to RMB55.8 billion in H1 2009. CCB reported RMB29.55 billion (US$4.33 billion) in net income for Q2. Net fees and income increased as the bank set aside 7.8% less in provisions for bad loans. Net interest margin narrowed to 2.46% from 3.29% on lower interest rates.
• Much of the decline in NPLs of ICBC and CCB was due to write-offs and a higher recovery rate. CCB’s coverage ratio grew to 150% in Q2 2009, meaning it is the first big bank to meet the new capital restrictions which will be implemented in 2010, a step that should reduce its costs in H2 2009.
• Bank of China (BoC), the third largest lender, reported a 2.5% drop in profits for H1 2009, though Q2 saw a 21.5% increase over Q1. Its net-interest margin was 2.04%, down 68 basis points from H1 2008, and its net interest income fell 8.3% to RMB74.7 billion (US$10.9 billion). BoC had the highest exposure to the U.S. housing market at the start of the crisis. The bank still held US$2.2 billion in U.S. subprime investments at the end of H1 and its impairment losses on subprime-related investments stood at US$4.67 billion (down from US$4.84 billion at end of Q1).
• China's banking regulator noted that 12 small and midsize commercial banks saw net profit fall an average 19% in H1 2009.

How Much will Non Performing Loans Increase?

• The increase in NPLs may come in mid to late 2010 given that they tend to peak 12-18 months after a credit boom. However, the revival in property markets and increase in mid to longer-term loans may limit the deterioration of assets.
• Fitch: Loan growth is driven by monetary policy that encourages banks to expand loan portfolios. Banks make up for lower loan margins with expanded loan volumes and an assumption that stimulus-related credit losses will be covered by the central and/or local government. The increase in corporate loan portfolios and credit expansion may threaten the medium-term outlook for Chinese banks.
• Higher NPLs/credit costs will be driven by lower collateral values, declining recoveries and higher NPL formation levels. The sector’s 2009 NPL ratio may rise 74bps to 3.0%.
• Net interest margin expansion, a lower tax rate and fee income helped boost earnings in H1 2008
• China plans to make it easier for banks to participate in M&A, as part of encouraging consolidation and taking steps to liberalize China’s financial system by allowing banks to be less affected by the government’s interest-rate policy.

p/s photos: Kelly Lin