What Will AAPL’s Profit Margins Be? Just Ask Foxconn… And Discover A Stunning Development In China-US Wage Parity

What Will AAPL’s Profit Margins Be? Just Ask Foxconn… And Discover A Stunning Development In China-US Wage Parity

Tyler Durden on 01/27/2014 15:23 -0500

In just over an hour Apple will report earnings which are expected to be a sole silver lining among the otherwise dreary retail landscape of the fourth quarter. However, those curious for an advance glimpse of what AAPL’s margins may be are advised to look no further than its chief supplier – Taiwanese mega contract manufacturer FoxConn, with over 1.2 million employees on the mainland. The reason Foxconn may be of interest is that as Reuters reports, as a result of soaring wages on the mainland, and in its ongoing strategy to keep worker compensation as razor thin as possible, the fabricator is now actively looking to expand outside of China. Among the places considered? Indonesia of course. And, drumroll, the United States! In other words, from the perspective of Foxconn, US labor now has greater wage competitiveness than China.

From Reuters:

Beset by rising costs and labour unrest in China, Chairman Terry Gou told employees on Sunday that Foxconn is considering diversifying away from its manufacturing heartland. The world’s largest contract maker of electronic goods has little choice if it’s to protect margins and stay ahead of peers who have adapted the Foxconn playbook into their own success stories.

“The U.S. is a must-go market,” said Gou, speaking at the group’s annual party on Sunday to mark the end of the Chinese year. Many customers and partners have asked Foxconn to open shop in the U.S., Gou said, with an eye on advanced manufacturing much closer to their home base.

At the same time, Indonesia will be a top priority this year as a potential production base with attractive costs and skills. That would tie in with Foxconn’s deal to design and market phones in the country with BlackBerry Ltd as the Canadian company seeks to reverse its decline in the smartphone business.

“Foxconn has no choice but to do it,” said Danny Lee, a fund manager of Mega Financial Holding’s fund unit. “China is no longer a manufacturing hub for companies worldwide, especially so for the PC industry.”

In the U.S., Foxconn businesses like flagship unit Hon Hai Precision Industry Co Ltd, Foxconn Technology Co Ltd and FIH Mobile could take advantage of geographical proximity to open up new deals with partners like Apple as they develop new gadgets.

“I think they’re looking more closely at the U.S. in order to move closer to some of their biggest clients. Obama is also really pushing to return manufacturing to America and boost employment opportunities,” said Kuo Ming-Chi, an analyst at Taipei-based KGI Securities.

This is indeed a stunning development: recall that we asked, rhetorically, back in May 2011 “With China Forecast To Reach Wage Parity With The US In Five Years, Is A New Manufacturing Golden Age Coming To The US?” Or some time in early 2016. Well, nearly 3 years later, we get the first proof that wage parity may indeed be coming, and much faster than previously expected.

Is the Fed to thank for this imminent manufacturing renaissance? Recall what we said in 2011:

the more the Fed exports inflation, paradoxically the faster the US manufacturing job base would see a long overdue renaissance.Which certainly means that the Fed will never stop with its monetary easing stimulus until such time as labor costs in the two countries, on whatever subjective metric is dominant, finally hit parity. The only question, as noted above, is what will China do in the interim as it realizes the Fed has put it in check – will China focus on developing its middle class, with an outcome being the mirror image of the current Nash equilibrium, in which the Chinese middle class would buy from the US, or will China defect before the “export country” to “consumer class” transition is complete and everything falls apart.

It is quite possible that while China was napping, the Fed’s exporting of wage inflation just succeeded to get the US to relative wage parity with China – something most considered impossible as recently as 5 years ago. However, if indeed true, this means that the Chinese response will only have more urgency now that it suddenly may find itself competing with workers from places such as the US.

In the meantime, if Foxconn’s margins have indeed collapsed as the above would seem to suggest, watch as they pass through these rising labor costs to its marquee clients. Like Apple. For the answer if this indeed happened, we will know in just about an hour.

The world’s biggest salmon farmer, Norway’s Marine Harvest, is looking to rally U.S. investors around the aquaculture sector’s role in meeting a substantial portion of the world’s growing need for food

Marine Harvest Seeks to Garner Interest From U.S. Investors

Company Seeking Organic Growth Together With Mergers, Acquisitions

KJETIL MALKENES HOVLAND

Jan. 27, 2014 8:22 a.m. ET

OSLO—The world’s biggest salmon farmer, Norway’s Marine Harvest, MHG.OS -1.06% is looking to rally U.S. investors around the aquaculture sector’s role in meeting a substantial portion of the world’s growing need for food through increased fish production.

Marine Harvest will be listed on the New York Stock Exchange Tuesday, joining U.S.-listed protein companies that may be more familiar to American investors, including Tyson Foods Inc. TSN -0.35% and Sanderson Farms Inc. SAFM -1.86% It will be the first listing abroad by one of the many companies in Norway’s booming aquaculture industry.

“There are many U.S.-listed protein companies. We want to be the first one based on protein from the ocean,” Marine Harvest Chief Executive Alf-Helge Aarskog said. He noted that some of the key land-based protein farmers are priced higher than Marine Harvest.

Marine Harvest isn’t seeking to raise new funds through the listing of American Depository Receipts on the Big Board. It’s looking instead to attract more interest—including broadening its appeal to institutional investors who have previously been limited in their ability to invest. “We want to grow even faster,” Mr. Aarskog said, adding that his company would like to couple organic growth with mergers and acquisitions and farm species in addition to salmon.

Food producers are among a number of agricultural-related companies benefiting from a predicted rise in demand for food. Farmed fish, representing only 9% of the global fish production for human consumption in 1980, are now responsible for 47% of the stock, according to the United Nations’ Food and Agriculture Organization.

The Oslo-based farming giant, which produces more salmon than any other company in the world, has a market capitalization of 31.1 billion Norwegian kroner ($5.1 billion). Marine Harvest has been expanding from fish farming into fodder production via acquisitions, and it has established facilities in Asia while also constructing a new fodder plant in Norway.

The company, forged from a merger in 2006 with Pan Fish ASA and Fjord Seafood ASA, is 27% owned by Geveran Trading Co., an entity controlled by shipping magnate John Fredriksen.

Norway’s fish-farming industry has seen rapid growth over the past 40 years, becoming the second-largest fish exporter after China as of the beginning of this decade. And times have been good for the industry’s key players. Mr. Aarskog said that “2013 was a good year for salmon prices.” While production volumes remain steady, “demand is growing,” with more people eating sushi and smoked salmon.

The rise of fish farming comes amid concerns about overfishing in the world’s oceans. Captured-fish volume has stabilized at around 90 million tons annually, while the output of farmed fish has expanded by 60 million tons, or 12 times its volume in the three decades ending in 2010, the U.N.’s FAO said.

Growth has come with concerns. Fish farmers, including Marine Harvest, face threats that include disease, fish escape, tighter regulations and the need to use lower-protein vegetable fodder as global overfishing limits access to higher-protein feedstock. Major investments are also needed to fight parasites, Mr. Aarskog said.

Gandhi Fails to Impress in TV Interview Debut

January 27, 2014, 11:39 PM

Gandhi Fails to Impress in TV Interview Debut

NIHARIKA MANDHANA

In the first extended television interview of his political career on Monday night, Rahul Gandhi probably didn’t win many converts.

Fielding sharp questions from TV anchor Arnab Goswami, Mr. Gandhi, who is now leading the electoral charge of India’s ruling Congress party, offered nary a sound bite. He avoided passionate responses and wasn’t goaded into attacking his main adversary, opposition leader Narendra Modi of the Bharatiya Janata Party.

Instead, Mr. Gandhi struck a wonky tone, articulating what he said was a long-term agenda to revamp his own party and India’s political system, which he called closed and predatory, doing too little to help the hundreds of millions of poor in the world’s second-most-populous country.

Mr. Gandhi, the fourth generation scion of the Nehru Gandhi family, said he disliked the widespread prevalence of dynastic politics in India. On his own position of privilege, Mr. Gandhi said he hadn’t chosen to be born in India’s most politically powerful family, but was now faced with a choice, he said, between walking away and sticking around to drive change.

Mr. Gandhi brushed aside as “superficial” questions about recent corruption scandals or how he would lead his party to victory in the forthcoming general elections, which are due by May. He said repeatedly his party would win the elections, but added that he wasn’t afraid of defeat.

“What I was scared of,I lost,” he said, referring to the assassinations of his grandmother Indira Gandhi and his father Rajiv Gandhi. “I’m not scared of anything,”

Mr. Gandhi said he would remain single-minded in his effort to change Indian politics. He repeatedly emphasized the need to transform the way candidates are picked to fight elections, the concentration of political power in a few hands and barriers to the empowerment of women.

“He laid out a 20 year plan to change politics, but didn’t quite spell out how he would do it or what his party would do in the interim,” said Ashok Malik, a Delhi-based political analyst.

When asked specific questions, Mr. Gandhi sought to draw the conversation back to what he saw as the fundamental questions. Mr. Gandhi complained that he hadn’t been asked about “how we will build this country or how we will empower our youngsters.”

Siddharth Varadarajan, an analyst, said in a televised interview that Mr. Gandhi had failed to turn his call for change into a concrete plan addressing real political questions.

“He is unwilling to engage the politics today,” Mr. Varadarajan said.

Mr. Gandhi didn’t offer his opinion of Narendra Modi, the opposition Bharatiya Janata Party’s prime ministerial candidate. He accused Mr. Modi’s government of “abetting and pushing” deadly riots in Gujarat in 2002, but didn’t offer specifics.

On several questions on a series of corruption allegations involving his party’s governments and leaders in the last decade, Mr. Malik said he seemed out of his depth.

“But then, when you’re going to be asked about 10 years of a government’s time in office and 60 years of your party’s work, you can’t be entirely prepared,” Mr. Malik said

Indian Investors Lose Faith; Country’s Retail Stockholders Are Dumping Shares After Years of Nursing Losses

Indian Investors Lose Faith

Country’s Retail Stockholders Are Dumping Shares After Years of Nursing Losses

SHEFALI ANAND

Jan. 27, 2014 6:11 p.m. ET

MUMBAI—India’s blue-chip stocks have held up relatively well in the recent emerging-market selloff. But that is little consolation to the country’s retail investors, who are dumping shares after years of nursing losses.

Many individual investors in the world’s second-most-populous country have grown disillusioned with paltry returns on shares of small and midsize companies. Although these companies account for the vast majority of the stocks listed on the Bombay Stock Exchange, they have fallen behind the 30-share benchmark Sensex index since the 2008 financial crisis. Many of these firms have struggled to grow amid a sharp slowdown in India, and some are struggling to repay debt taken on when India’s economy was booming in the mid-2000s.

Individual investors in India in the past have been a key driver of the country’s stocks, and the absence of many of these investors from the latest run-up raises questions about the prospect of further meaningful gains and exposes the market’s vulnerability to fleet-footed global investors.

The Sensex hit a fresh record Thursday, the same day the MSCI Emerging Markets Index slid on weak Chinese economic data. India’s blue-chip index is down 3.1% since then, compared with a 4.6% decline in the MSCI.

India’s broader S&P BSE 500 index in recent days has trailed the Sensex and is 15% below its record set in January 2008. Another index that reflects share-price performance of medium-size companies remains 38% below its 2008 record.

From the start of September through Friday, Indian mutual funds, a proxy for the behavior of individual investors, unloaded $1.6 billion of shares, representing an acceleration of selling from earlier in the year, according to data from the Securities and Exchange Board of India.

In the same period, foreign institutional investors poured about $9 billion into Indian stocks, according to the regulator. This represents a pickup in buying by global fund managers, many of whom are betting the growth outlook for India’s downtrodden economy will brighten if federal elections in the spring usher in reform-minded lawmakers.

Analysts and strategists attribute the rise in Indian shares in past months partly to these foreign inflows.

But many retail investors aren’t convinced that the gains will stick. India’s economy is forecast to rise 4.8% in the year ending March 31 by trade association Federation of Indian Chambers of Commerce and Industry. That would be the worst showing since 2003.

Phiroj Uttaray, a 34-year-old engineer in the eastern state of Orissa, first invested in stocks in 2005. Mr. Uttaray bought mostly smaller companies, such as wind-turbine maker Suzlon Energy Ltd. 532667.BY +2.15% and engineering firm and property developer Hindustan Construction Co. 500185.BY +1.73% Both companies are wrestling with heavy debt burdens, which have crimped profits. In the span of a year, shares of Suzlon Energy rose almost 50%, closing at a record 2,273 rupees ($36.23) on the National Stock Exchange in early January 2008. Wednesday, the stock closed at 10.25 rupees.

Mr. Uttaray has seen the value of his portfolio of shares fall more than 85% since 2008, and lately has been paring his holdings. “I’ve lost faith,” he says.

Out of the 500 companies in the S&P BSE 500 index, 30 companies have attracted two-thirds of foreign-investor inflows since 2012 through Sept. 30, 2013, according to estimates by BNP Paribas Securities India. Some, but not all, of the 30 companies are components of the Sensex.

These companies, such as HDFC Bank Ltd. 500180.BY +0.07% , software firm Tata Consultancy Services Ltd. 532540.BY +0.30% , and cigarette maker ITC Ltd.500875.BY -1.11% , remain a draw for foreign investors because they are perceived to be better-managed and have less exposure to the unpredictable nature of India’s politics and domestic economy.

Anjun Zhou, managing director and head of Multi-Asset Research at Mellon Capital Management Corp., which oversees $350 billion of assets, expects Indian shares to benefit from a faster pace of growth boosted by a rise in exports. The money manager holds Indian shares, mostly blue chips.

But Ms. Zhou says domestic investors’ flagging participation in India’s stock market could discourage global investors from boosting their own exposure. “We do monitor what domestic investors are doing, and we try to understand the reason behind their caution,” she says.

Not all domestic investors are staying away. Mumbai banker Raj Sen, 39, says his portfolio of individual stocks has lost value since 2011, but he has since turned to buying stock mutual funds instead to capture a larger swath of the market. He believes stocks will rise over the longer term as increasing consumption by India’s one-billion-plus population drives economic growth.

“Opportunity is still there,” Mr. Sen says.

Still, many of India’s retail investors are waiting for the right moment to sell.

Mansukhlal Mehta, 73, has been investing his retirement savings in stocks since 2000. He says the value of his stock investments has been halved in the past five years, and he expects more tough times ahead.

“I feel that things are not going to go that well,” says Mr. Mehta. Small investors and their brokers, he says, “are all crying, every day.”

Trading on Abenomics

Trading on Abenomics

Japan needs to stop worrying and learn to love imports.

Jan. 27, 2014 11:58 a.m. ET

News that Japan in 2013 notched its biggest trade deficit since 1985 is shaking a country long accustomed to being a big-time exporter. Much of the angst is overdone. But there are some important lessons in the data for Prime Minister Shinzo Abe as his economic revival program enters its second year.

The merchandise trade deficit for the year came to 2.4% of GDP, despite some decline in December. Exports started to pick up a bit as anemic recoveries in Europe and the U.S. grind on and trade ties with China rebuild after political tensions over territorial disputes. The key point is that the eye-grabbing headline numbers are mainly an artifact of Mr. Abe’s weak-yen policy. This helps explain the increase in exports and imports, although not in the way many suppose.

Conventional wisdom holds that a weaker yen allows Japan Inc. to boost export volumes by cutting its foreign-currency prices and gobbling up market share abroad. Yet Japanese companies have instead booked higher yen-denominated profits on a falling volume of exports. Note that while exports in 2013 fell 1.5% compared to 2012 when measured in units shipped, measured by value they increased 9.5%. The weak yen also boosted the value of imports, which increased some 15% when measured by yen-denominated value but grew only 0.4% in volume.

That is not to downplay the significance of the yen-denominated trade deficit. The quantity of yen Japanese are earning and spending matters, not least to the Japanese themselves. But understanding the monetary aspect of the trade data explains why Mr. Abe’s monetary policies won’t fix the economy, and what he should be doing instead.

On the corporate side, companies have enjoyed a weak-yen windfall over the past eight months, and the central bank’s Tankan survey suggests managers are starting to believe the yen may remain around its current level for the longer term rather than rebounding to its pre-Abe strength. That would normally encourage companies to invest in new capacity.

But managers also recognize that manufacturing is an increasingly dicey proposition in Japan. Costs remain high, and in the case of imported inputs are rising thanks to yen weakness. An aging population coupled with strong popular resistance to immigration suggest manufacturing labor will be ever-harder to come by.

This helps explain why, while corporate investment has picked up somewhat in recent months, companies are holding back and are reluctant to commit themselves to wage hikes. Despite more generous one-time bonuses, nominal wages are more or less stagnant.

That means real wages are falling, thanks to the inflation Mr. Abe’s monetary policy is starting to create, as evidenced by the run-up in import values. Households also face a three-percentage-point hike in the consumption tax come April. Little wonder that consumer confidence has fallen significantly after an initial bout of enthusiasm when Mr. Abe launched his revival plan.

The trade deficit by itself isn’t worrying. An aging society such as Japan’s inevitably will import more than it produces, while exporting capital to earn returns that allow it to pay for its imports. But the growing gap between Abenomics and reality is a problem.

The weak yen was supposed to stimulate exports, which was supposed to stimulate corporate investment and wage growth, which was supposed to stimulate domestic consumption. That chain hasn’t materialized. Instead, companies are earning more today but still worry about their future amid weak export volumes, while households are saddled with inflation fears.

Mr. Abe might instead try “leaning in” when it comes to the trade deficit. His most important proposal to date would do precisely that: If Japan signs on to a Trans-Pacific Partnership multilateral trade deal, it will open the economy to an unprecedented amount of imports. The new competition will stimulate more of the corporate investment Japan needs in long-sheltered and highly inefficient domestic-facing service industries.

This might be a tough sell for a public long accustomed to thinking of Japan first and foremost as a high-tech factory for the world, and for investors with a similar mindset. But the recent run of trade deficits is a reminder that change will come to Japan one way or another. Mr. Abe’s real challenge is to align economic policies to reality before reality strikes back.

Some Thais Want Their Political Rivals to Stop Playing the Royal Card

Some Thais Want Their Political Rivals to Stop Playing the Royal Card

JAMES HOOKWAY

Jan. 27, 2014 7:40 p.m. ET

PATHUM THANI, Thailand—For decades, Thais have looked to King Bhumibol Adulyadej to referee political disputes. But with the king now 86 years old, some people here say it’s time to sort out their own problems.

Elevated to almost divine status with the help of the military during the Cold War, King Bhumibol has interceded during flashpoints over the years. Sometimes he has sided with street protesters demanding more democracy and accountability; at others, he has endorsed autocratic military rulers.

Unlike some other Asian royal houses that have faded into the background or, in Nepal’s case, been abolished, Thailand’s monarchy is still part and parcel of everyday life here, despite not having any formal power.

The royal anthem is played before sporting events and before films in movie theaters, while Thai TV news summarizes the family’s activities each day at 8 p.m. Thailand’s lèse-majesté laws penalize criticism of the royal family with prison terms of up to 15 years.

But as King Bhumibol enters the twilight of his long reign, the political divides here in Southeast Asia’s linchpin economy are widening as protesters, many of them invoking the name of the king, try to check the growing power of the country’s elected leaders. And some supporters of the populist government say it is time to stop using the king’s name for political leverage.

“We’re not really supposed to talk about these things in Thailand,” says Wutthipong Kotchathammakhun, a leader of a pro-government “Red Shirt” splinter group here, just north of Bangkok. “But we want people to understand how the establishment is using ‘the sky’ to grab power for itself,” he says, using a common term to refer to the royal family.

The king himself has remained silent on the monthslong standoff playing out on the streets of Bangkok.

The clash represents an almost existential struggle to determine what kind of country Thailand should be in the 21st century. On one side are Thailand’s traditional power bases in the military and technocratic political parties, and in the rival camp are supporters of populist politicians backed by billionaire businessman Thaksin Shinawatra.

In recent weeks, tens of thousands of mostly urban, middle-class protesters have massed on the streets of Bangkok, led by Suthep Thaugsuban, a brawny, 64-year-old political deal maker who has reinvented himself as the leader of what he calls “the people’s revolution.” The crowds are calling for Mr. Thaksin’s younger sister, Prime Minister Yingluck Shinawatra

, to quit and allow an unelected council to take over and shape Thailand’s democracy to a form more to their liking.

Ms. Yingluck has said she won’t resign and plans to press ahead with new elections set for Sunday, which she is widely expected to win and which the opposition has vowed to boycott.

The protesters aren’t coy about invoking the name of King Bhumibol. During frequent parades around Bangkok’s busy business district, many wear yellow head bands declaring “I Love the King.” Some of their placards accuse Mr. Thaksin, who was overthrown as prime minister in 2006 and now lives abroad, of plotting to usurp the king’s powers—a charge Mr. Thaksin has consistently denied, and which the king hasn’t publicly commented on.

The Thai army also has a strong and visible attachment to the monarchy.

But the more the demonstrators play the royal card—by making lèse-majesté allegations or simply waving royalist placards—the more they risk undermining the institution in the eyes of millions of Thais who have repeatedly voted for the Shinawatras.

“Everything the royalists do is working against the long-term interests of the monarchy,” says David Streckfuss, a Thailand-based scholar and author. “The lèse-majesté laws, trying to secure the positions: any of it, really, is bad for the monarchy.”

Mr. Wutthipong, a rapid-fire talk-show host on a community radio station, leads one of the most visible groups that sprang up to demand the return of democracy after the 2006 coup.

Better known by his nickname, Koh-Tee, he has a yen for donning a beret a la Argentine revolutionary Che Guevara and has constructed a makeshift open-air stage in Pathum Thani. Here, he and his followers complain about Mr. Suthep’s persistent invocation of the king, who has remained silent on the most recent political conflict.

“The royalists don’t want an election. They know they will lose, so they try to seize power any way they can,” Mr. Wutthipong, 49 years old, says, handing out Buddhist amulets to protect security guards at the rear of the stage. He has been questioned by police and released without charge in connection to clashes with Mr. Suthep’s supporters in Pathum Thani.

Other Red Shirt leaders such as Nattawut Saikeua have warned of a mass uprising if the military seizes power again.

Mr. Suthep says he is arguing only for an interim government to pursue his contentious reform plans before elections are held, and aims to prevent the Feb. 2 vote from going ahead. One protester was killed in clashes with Red Shirts Sunday after Mr. Suthep’s supporters tried to stop advance voting, adding to the nine people who already have lost their lives in political violence in recent months.

China’s investment/GDP ratio soars to a totally unsustainable 54.4%. Be afraid.

China’s investment/GDP ratio soars to a totally unsustainable 54.4%. Be afraid.

Posted on 24 January 2014 by Mike Riddell

Once upon a time, Western opinion leaders found themselves both impressed and frightened by the extraordinary growth rates achieved by a set of Eastern economies. Although those economies were still substantially poorer and smaller than those of the West, the speed with which they had transformed themselves from peasant societies into industrial powerhouses, their continuing ability to achieve growth rates several times higher than the advanced nations, and their increasing ability to challenge or even surpass American and European technology in certain areas seemed to call into question the dominance not only of Western power but of Western ideology. The leaders of those nations did not share our faith in free markets of unlimited civil liberties. They asserted with increasing self-confidence that their system was superior: societies that accepted strong, even authoritarian governments and were willing to limit individual liberties in the interest of the common good, take charge of their economies, and sacrifice short-run consumer interests for the sake of long-run growth would eventually outperform the increasingly chaotic societies of the West. And a growing minority of Western intellectuals agreed.

The gap between Western and Eastern economic performance eventually became a political issue. The Democrats recaptured the White House under the leadership of a young, energetic new president who pledged to “get the country moving again” – a pledge that, to him and his closest advisers, meant accelerating America’s economic growth to meet the Eastern challenge.

The passage is the opening to the highly readable and hugely influential 1994 paper The Myth of Asia’s Miracle. The period referenced is the early 1960s, the dynamic president was John F. Kennedy (read Bill Clinton), and the rapidly growing Eastern economies were the Soviet Union and its satellite nations (read East Asia). Author Paul Krugman took on the prevalent East Asian euphoria by drawing disturbing parallels between the unsustainable way that the Asian Tigers were managing to generate supersonic growth, and how the recently obsolete Soviet Union had also once achieved seemingly miraculous growth rates. Krugman’s paper gained widespread attention at the time (even more so post the 1997 Asian crisis), and succeeded in refocusing attention on the concept of productivity. It mattered not what the growth rate was, but how it was achieved.

To explain this and briefly summarise, consider what actually drives economic growth. Growth accounting shows that GDP per capita growth comes from two main sources; inputs and efficiency. The ‘inputs’ can be split into labour (e.g. growth in employment) and capital (e.g. the accumulation of physical capital stock such as machines and buildings). But long term, sustained per capita economic growth tends to come not from increases in the ‘inputs’, but from increases in efficiency, of which the main driver is technological progress. Nobel Laureate Robert Solow showed in his seminal 1956 paper that technological progress had accounted for 80% of US per capita growth between 1909 and 1949, although more recent studies have suggested a still substantial figure of more like 45-55% thereafter.

Krugman pointed to previous research showing that the Soviet Union’s rapid growth had not been due to efficiency gains. Indeed, the USSR was considerably less efficient than the US, and showed no signs of closing the gap. Soviet growth had been solely due to the ‘inputs’, and input-driven growth has diminishing returns (e.g. there is a finite number of workers you can educate). The USSR’s growth was largely ‘built on perspiration rather than inspiration’.

In a similar way, the Asian Tigers’ rapid growth was due to an ability to mobilise resources. There was no great improvement in efficiency, and no ‘miracle’ – it could be fully explained by the employed share of the population rocketing, education improving dramatically, and an enormous investment in physical capital (in Singapore, investment as a share of output jumped from 11% to more than 40% at its peak). But these were one time changes; they weren’t repeatable.

Fast forward to 21st century China.

There is a perception that China’s rocketing growth rate has always been reliant on heavy investment, but that’s not the case. Investment, or capital formation, has of course been an important driver, but the ‘pre 2008’ China did achieve rapid productivity gains thanks to the rise of the private sector and technological catch-up as the economy slowly began to open its borders.

In the chart below, I’ve looked at how much the world’s biggest economies have invested as a percentage of their GDP, and compared this to the countries’ GDP per capita growth rates. Countries with higher investment rates tend to have higher GDP growth rates and vice versa, which is intuitive and supports the discussion above. Since the 1990s, most (but not all) emerging/developing countries have been positioned towards the top right hand side with higher investment and higher growth rates, and the more advanced economies have typically been towards the bottom left with lower investment and lower growth rates. In one extreme you have China, where investment has averaged over 40% of GDP, and the GDP per capita growth has averaged a phenomenal 9.5%. The fact that China’s growth rate is well above the trend line in the chart is indicative of the productivity gains that China has achieved over the period as a whole on average. The country with the weakest investment rate is the UK.

Post 2008’ China looks a different animal. Productivity and efficiency seems to be plummeting, where GDP growth is becoming dangerously reliant on the ‘inputs’, namely soaring investment. We’ve all heard about how China’s leaders desire a more sustainable growth model, featuring a rebalancing of China’s economy away from investment and export dependence and towards one that is more reliant on domestic demand and consumer spending (e.g. see the 12th 5 year plan covering 2011-2015 or the Third Plennum). In practice, what we’ve instead consistently seen is an inability or unwillingness to meaningfully reform, where any dip in economic growth has been met with yet another wave of state-sponsored overinvestment. (Jim recently blogged about economist Michael Pettis’ expectation that China long term growth could fall to 3-4%, a view with which I have a lot of sympathy. Please see also If China’s economy rebalances and growth slows, as it really must, then who’s screwed? for an additional analysis of the implications of China’s economic slowdown).

It was widely reported earlier this week that China’s 2013 GDP growth rate fell to a 13 year low of 7.7%, a slowdown that seems to have continued into 2014 with the release of weak PMI manufacturing reading yesterday. But much more alarming is how the makeup of China’s growth has changed: last year investment leapt from 48% of China’s GDP to over 54%, the biggest surge in the ratio since 1993.

The chart below puts China’s problems into perspective. As already demonstrated, there is a strong correlation between different countries’ investment rates and GDP growth rate. There also tends to be a reasonable correlation over time between an individual country’s investment rate and its GDP growth rate (Japan’s experience from 1971-2011 is a good example, as shown previously on this blog). Over time, therefore, a country should be broadly travelling between the bottom left and top right of the chart, with the precise location determined by the country’s economic model, its stage of development and location in the business cycle.

It should be a concern if a country experiences a surge in its investment rate over a number of years, but has little or no accompanying improvement in its GDP growth rate, i.e. the historical time series would appear as a horizontal line in the chart below. This suggests that the investment surge is not productive, and if accompanied by a credit bubble (as is often the case), then the banking sector is at risk (e.g. Ireland and Croatia followed this pattern pre 2008, Indonesia pre 1997).

But it’s more concerning still if there is an investment surge accompanied by a GDP growth rate that is falling. This is where China finds itself, as shown by the red arrow.

Part of China’s growth rate decline is likely to be explained by declining labour productivity – the Conference Board, a think tank, has estimated that labour productivity growth slowed from 8.8% in 2011 to 7.4% in 2012 and 7.1% in 2013. Maybe this is due to rural-urban migration slowing to a trickle, meaning fewer workers are shifting from low productivity agriculture to higher productivity manufacturing, i.e. China is approaching or has arrived at the Lewis Turning Point (see more on this under China – much weaker long term growth prospects from page 4 of our July 2012 Panoramic).

However the most likely explanation for China’s surging investment being coupled with a weaker growth rate is that China is experiencing a major decline in capital efficiency. Countries that have made the rare move from the top left of the chart towards the bottom right include the Soviet Union (1973-1989), Spain (1997-2007), South Korea (1986-1996), Thailand (1988-1996) and Iceland (2004-2006). Needless to say, these investment bubbles didn’t end well. In the face of a labour productivity slowdown, China is trying to hit unsustainably high GDP growth rates by generating bigger and bigger credit and investment bubbles. And as the IMF succinctly put it in its Global Financial Stability Report from October 2013, ‘containing the risks to China’s financial system is as important as it is challenging’. China’s economy is becoming progressively unhinged, and it’s hard to see how it won’t end badly.

This entry was posted in Countries, macro and politics and tagged emerging, macro & politics byMike Riddell

. Bookmark the permalink.

Mobile Karaoke App Changba Adds Live Broadcast, Closer to YY Music’s Business Model

Mobile Karaoke App Changba Adds Live Broadcast, Closer to YY Music’s Business Model

By Tracey Xiang on January 26, 2014

Changba, the most popular mobile Karaoke app in China, added a live-singing feature for users to have friends to sing together, just like in a room of a brick-and-mortar Karaoke club.

Unlike in the offline world that only invited friends can join in a Karaoke party, all the singing parties on Changba are open to every user. Named ‘Karaoke show in private rooms’, the channel in Changba shows all the singing parties. Any user is allowed to open a room and rooms can be searched by room numbers.

In each room, you can choose to sing songs or just listen to others’ singing and buy virtual gifts to singers you like. Participants in a room can leave comments or chat with each other or invite other users to join in.

The live-singing feature is almost the same with the model of YY Music, 9158, 6.cn and a handful of others. An investor of such a service once told me that fans feel more encouraged to buy virtual gifts to singers during live shows. The revenue growth of YY Inc. has been driven by the live singing show business. So far Changba is the only one of those above-mentioned that started and has been focusing on mobile. YY Music moved slower on mobile, but the company said in late 2013 that they found it easier to make money on mobile than previously thought.

Prior to this live broadcast feature, Changba users needed to record singing first and save on the platform. Their audiences can buy them virtual gifts when listening to the recorded songs. Changba began monetization one year ago through virtual gift sales and planned to make money from potential advertisers.

Other revenue sources include mobile gaming, premium service subscriptions and emoticon sales. Changba announced 100 million registered users in October last year with 30 million being monthly active.

As Internet TV Grows Popular, Regulator Mulls Show of Force

01.24.2014 16:55

As Internet TV Grows Popular, Regulator Mulls Show of Force

People like the idea of getting programs and movies from the Net, but the media watchdog is not as amused

By staff reporter Qin Min

(Beijing) – Chinese companies have been busily tapping the potential of the Internet protocol television (IPTV) business over past year. More than 20 new Internet TV screens and streaming boxes have been launched by various companies.

At the end of 2013, Tencent Holdings rushed to launch its IPTV product, Weixin TV, in partnership with Internet video content provider iCNTV and manufacturer Skyworth. Earlier in the year, e-commerce giant Alibaba Group released a set-top streaming box developed with content provider Wasu Digital TV Media Group Co., and Baidu Inc also released its IPTV and streaming box based on its video subsidiary iQIYI.

Internet companies have shown they are ambitious about exploring the growing market, one that also involves appliance manufacturers, telecom operators and broadcasting companies. However, behind the excitement are some uncertainties because regulators are mulling gradually tightening controls.

A Free-for-All

In mid-December, the State Administration of Press, Publication, Radio, Film and Television, the country’s media watchdog, held a symposium on IPTV oversight with representatives from various industry players.

“The meeting lasted an afternoon,” one attendee said. “The essence was strengthening oversight of the IPTV market.”

The implication, the meeting participant said, was that authorities thought IPTV services had crossed the line.

A broadcast industry source said that the IPTV market is too disorderly, with all sorts of content, including foreign programs, available. The industry, at least in the eyes of some, has circumvented regulation on content and the media regulator is considering updating its polices.

IPTV service is subject to a policy set out in 2011 in the so-called Document 181. The policy separated IPTV service operations into two parts: the integrated broadcasting platform and the content service platform.

The former is responsible for program integration and broadcast control, and the latter is responsible for program content review and copyright management. The idea was to put IPTV service in a manageable environment separate from ordinary Internet activity.

To date, seven institutions have obtained integrated broadcast licenses, and 10 have obtained content service licenses. Document 181 stipulates that all IPTV content should be placed on content service platforms and then broadcast through the integrated broadcast platforms. But most IPTV products have breached this provision, carrying programs directly from the Net.

“This made broadcast regulators unhappy,” the industry source said. “They’re bound to strengthen oversight.”

About 10 million streaming boxes were sold in 2013, the source said, and less than 20 percent of them had partnered with licensed parties. Meanwhile, about 26 million IPTV sets were sold, most of which use content platforms run by manufacturers. Many of the products allow users to download a variety of applications and content directly from the Internet.

This sort of free-for-all indeed seems to be spurring the media regulator to act, but “right now, in what form, when and how the policy will be introduced has not been decided,” an official at the watchdog said.

A source close to regulators said the rules would focus on cracking down on unauthorized streaming boxes, misconduct at online video aggregation websites, and the connection between IPTV producers and licensed parties. He expects they will be introduced in early February.

“Previously (the watchdog) was only responsible for oversight of content,” an executive at a video website said. “This time people are saying they want to manage everything from software to hardware, so much that they don’t rule out enforcing the law in conjunction with other ministries and commissions.

“It hopes to reference radio and television broadcasting management approaches to regulate IPTV.”

The Debate

Many online video companies are nervous about the possibility of intensified oversight, and argue that if it is too strict it will not be conducive to the development of the industry. The main question, it seems, is whether IPTV service should be supervised according to Internet or television.

A source in the industry said computers, mobile phones and televisions are simply different broadcast channels, and standards should be unified.

“Think about it. The same group of people can watch content on a computer or mobile phone during the day, but at night they can’t watch it on television,” the source said. “Isn’t that funny?”

Zhuo Yue, president of Wasu’s Internet business unit, says the IPTV industry is still in its early stages. Document 181 has been misread at times, he said, and many companies have crossed the line with out-of-control content. If control and guidance of the industry are not stepped up in the early stages, uncivilized growth of the entire industry will be the likely result, leading to price wars, illegal services of inferior quality and excessive competition. From this perspective, tighter regulation is understandable, Zhuo said.

Liu Miao, president of online video site and IPTV producer Letv’s government affairs department, said that that the industry is on the verge of breaking out and may impact many traditional industries. He, too, argues that the time is ripe for clearer rules.

Zhang Zejing, an analyst at Hong Yuan Securities, put it another way:

“Fundamentally speaking, licenses represent profit.”

The problem is authorities awarded licenses to seven state broadcasting institutions, but many of these agencies have, in effect, “rented out” the licenses to private companies, established joint ventures or signed contractual joint operations under which they do not have to pay for costs but can get substantial income.

“The capital threshold for independent operators of integrated broadcast control platforms is high,” Zhang said. “Estimated investment is a billion yuan to cover 2 million beta users.

A manufacturer of IPTV hardware suggested that the regulator should encourage private companies and market liberalization, going so far as to say: “They should launch a pilot program for private companies to operate content services platforms.”

Many industry sources also say private companies with copyrights, funds and operating capabilities deserve the confidence of regulators and they should be allowed to operate content platforms.

Despite the calls for more industry liberalization, ideology presents a tricky “red line” – no pun intended – in a country where the Communist Party insists on having the final say on what is acceptable in media and art. However, amid the rise of the IPTV business, regulation has proved thorny. The story, it seems, is to be continued.

E-Investing Spurs Banks to Raise Interest Rates for Deposits

01.24.2014 16:45

E-Investing Spurs Banks to Raise Interest Rates for Deposits

As investors empty their accounts in favor of Net funds like Yu E Bao, many big financial institutions have begun ‘to mount an all-out counterattack’

By staff reporters Zhang Yuzhe and Liu Zhuozhe

(Beijing) – Many big banks in the country have moved to offer the highest possible interest rates for deposits despite the central bank’s advice they not do this.

The lenders had to act because they were losing customers fast to the emerging league of high-yield money market funds offered by Internet companies such as Alibaba Group and Tencent Holdings, an executive at a large bank said.

The benchmark annual interest rates on three-month to five-year term deposits range from 2.6 to 4.75 percent. Banks are allowed to raise them by up to 10 percent, but most large ones set theirs lower than the limit. Most of the money market funds, meanwhile, carry yields higher than 5 percent and offer convenient, free withdrawals.

Bank deposits have been siphoned off into investment funds, including Alibaba’s Yu E Bao, which last year rose in value by an average of 3 million yuan every minute. In less than seven months, it has grown into the country’s largest public fund, with more than 250 billion yuan in investment as of January 15.

“The pressure of the deposits shifting was enormous,” the executive said, “We have no choice but to mount an all-out counterattack.”

The central bank advised the Big Four banks and the Bank of Communications not to increase their deposit interest rates. This advice came in the form of “window guidance,” where the regulator tells banks what to do but the requirements are often not mandatory.

The headquarters of China Construction Bank has delegated the authority to offer maximum interest rates to as low as branches on the city level, a source with knowledge of the matter said. The notice did not set any threshold on the size savings accounts must be to enjoy the higher interest rates, meaning that branch officials can make that decision, too.

Bank of Communications recently raised its interest rates to the ceiling for term deposit accounts with at least 30,000 yuan. Bank of China has done the same, raising interest rates for one-, three- and five-year term deposits of at least 50,000, 100,000 and 200,000 yuan, respectively, to 10 percent above their benchmark interest rate.

Bankers say they are frustrated with Yu E Bao and the like because the funds they sucked away are reinvested into banks in the form of interbank deposits.

“Technically the money is still in the bank, but now here comes Yu E Bao, which does not do anything but shifts money around and forces banks to abruptly raise the cost of deposits from 0.35 percent (for demand deposits) to 7 percent,” a banker said.

The current set of benchmark interest rates has been in effect since July 2012. Since Yu E Bao was launched in June, many small and medium-sized banks have also raised their deposit interest rates to the ceiling.

Vietnam’s Ex-Banker Gets Life Over $230m Fraud Case

Vietnam’s Ex-Banker Gets Life Over $230m Fraud Case

By Agence France-Presse

 on 6:34 pm January 27, 2014.

Huynh Thi Huyen Nhu, 37, is led out of the courtroom at a local People’s Court House in Ho Chi Minh City on Jan. 27, 2014. (AFP PhotoVietnam News Agency)

Hanoi. A Vietnamese court Monday sentenced a former banker to life in prison for a fraud involving more than $230 million, one of the communist country’s largest-ever such cases.

Huynh Thi Huyen Nhu, 37, was convicted alongside 22 other defendants who were given sentences of up to 20 years in prison after a three-week trial ended Monday, a clerk at the People’s Court in the southern metropolis of Ho Chi Minh City told AFP.

Nhu raised some $231 million in loans from individuals, companies and other banks when she worked for the state-run Vietnam Joint Stock Commercial Bank for Industry and Trade (Vietinbank).

She claimed to be raising funds on the bank’s behalf, the Tuoi Tre newspaper reported.

Nhu forged some 200 documents and hired other people to counterfeit the official stamps of Vietinbank and other companies in order to obtain the loans, the report said.

The court ordered Nhu to return all the money she had stolen, it added.

Nhu had racked up debts by making a series of disastrous investments in real estate and then “turned to swindling” in order to repay her debts, it said.

The judge dismissed her lawyer’s argument that former employer Vietinbank should take responsibility and compensate clients for their losses, VNExpress reported.

“(Nhu) was the gang leader who took all responsibilities and Vietinbank knew nothing about her fraudulent acts,” the report said.

Vietnam is one of the world’s most corrupt nations, according to watchdogs.

Corruption, mismanagement and inefficiency at state-run companies — a pillar of the communist country’s economy — are seen as fueling longstanding economic woes.

The country’s leaders have pledged to tackle corruption amid rising public anger, leading to a recent series of high-profile trials of former officials and bankers for corruption, fraud and embezzlement.

In November a former banker and his business associate at a large state bank were sentenced to death for embezzling $25 million.

Two former top executives at scandal-hit national shipping company Vinalines were sentenced to death in December for embezzlement as the group almost collapsed under some $3 billion of debt.

China Trust “Bailout” To “Unidentified Buyer” Distorts Market As “Risks Are Snowballing”

China Trust “Bailout” To “Unidentified Buyer” Distorts Market As “Risks Are Snowballing”

Tyler Durden on 01/27/2014 10:35 -0500

In a 2-line statement, offering very few details, ICBC’s China Credit Trust Co. said it reached an agreement to restructure the CEG#1 that ha sbeen at the heart of the default concerns in recent weeks. The agreement includes a potential investment in the 3 billion-yuan ($496 million) product but didn’t identify the source of funds, or confirm whether investors would get all of their money back. The media is very excited about this entirely provisional statement and we note, as Bloomberg reports, investors in the trust product must authorize China Credit Trust to handle the transaction if they want to recoup their principal which will involve the sale of investors’ rights in the trust at face value (though no mention of accrued interest). As BofAML notes, however, “the underlying problem is a corporate sector insolvency issue…  there may be many more products threatening to default over time,” and while this ‘scare’ may have raised investors’ angst, S&P warns “a bailout of the trust product [leaves] Chinese authorities with a growing problem of moral hazard,” and they have missed an opportunity  for “instilling market discipline.”

1) ICBC issues a 2 line statement on a CEG#1 restructuring – no details and no comments from anyone involved

China Credit Trust Co. said it reached an agreement to restructure a high-yield product that sparked concern over the health of the nation’s $1.67 trillion trust industry…

Beijing-based China Credit Trust’s two-line statement on its website didn’t identify the source of funds, or say whether investors would get all of their money back.

2) Investors claim they “could” be able to sell their rights to the CEG#1 trust to an “unidentified buyer” at par (though receive no accrued interest as far as is clear)

Industrial and Commercial Bank of China Ltd. told investors of a China Credit Trust product facing possible default about an offer in which they can receive back their full principal, according to an investor with direct knowledge of the offer.

Rights in the 3 billion-yuan ($496 million) product issued by China Credit Trust Co. can be sold to unidentified buyers at a price equal to the value of the principal invested, according to one investor who cited an offer presented by ICBC and asked to be identified only by his surname Chen.

China Credit Trust earlier said it reached an agreement for a potential investment and asked clients of ICBC, China’s biggest bank, to contact  their financial advisers.

3) “A default was bound to lead to systemic risks that China is unable to cope with, so in that sense a bailout is a positive step to stabilize the market,”

As one analyst noted, the PBOC is running scared…

“It indicates the government still won’t tolerate any ultimate default and retail investors will continue to be compensated in similar cases.”

4) This confirms S&P’s recent warning that “A bailout of the trust product would leave Chinese authorities with a growing problem of moral hazard,” and an opportunity for “instilling market discipline” will have been missed.

…said Xu Gao, the Beijing-based chief economist at Everbright Securities Co. Still, implicit guarantees distort the market and “delaying the first default means risks are snowballing,” he said.

5) of course, China may have shown its moral hazard hand on this occasion but as BofAML warns, “We suspect that, at a certain point, the involved parties will be either unwilling or unable to bail them out [again], which may trigger a credit crunch…The underlying problem is a corporate sector insolvency issue…  there may be many more products threatening to default over time.”

There are plenty more trust products facing maturity/default in the short-term…

The most volatile part of the system is the financial market and the weakest link of the financial market is shadow banking. Within the shadow banking sector, we believe that the trust market faces the biggest default risk because credit quality here is among the lowest. The stability of the shadow banking sector is based on public confidence and any meaningful default will chip away some of the confidence. We suspect that trust defaults by private borrowers may work on public sentiment gradually while any LGFV trust default may immediately trigger significant market volatility. 2Q & 3Q this year will be another peak trust maturing period.

China’s Default That Wasn’t

AARON BACK

Jan. 27, 2014 9:26 a.m. ET

Those who hoped a high-profile default would deliver a needed shock of moral hazard into China’s financial system will be disappointed. The question is whether investors are getting the message anyway.

Like clockwork, a mysterious third party has sprung to the rescue, allowing China Credit Trust to repay the principle on high-yield investment products tied to a struggling coal miner. Savers will miss some interest payments and get a lower effective yield, but otherwise escape unharmed. So does the reputation of Industrial and Commercial Bank of China, 601398.SH -1.18% the country’s largest commercial lender, which sold the trust products to clients.

In a $9.4 trillion economy, a nearly $500 million set of trust products appears too big to fail.

The hand of the state seems to be at work. Officials in the miner’s home province were actively involved in coming up with a solution, The Wall Street Journal reported. The bailout involves the third-party investor taking an equity stake in the coal company, which came only after the company suddenly gained approval to restart a closed mine.

In China, this kind of result is typical. More than 20 trust products valued at a total of more than $3.9 billion have run into payment issues since 2012, according to UBS economist Wang Tao. In around half of these cases, investors were paid back by trusts or third-party guarantors, while others have been caught up in lengthy legal processes.

There are signs that the publicity around the case may help educate investors on risks in the system. ICBC Chairman Jiang Jianqing said on CNBC he hoped such a learning process was taking place. So should ICBC shareholders. If pressured by customers or the government to take such products onto its balance sheet, the bank would see a substantial erosion of capital ratios.

According to Nomura economist Zhiwei Zhang, sales of trust products in January are down nearly 70% from December and 50% from a year earlier as investors shrink from risk. This will intensify credit stress, making it harder for trusts to roll over short-term loans to stressed borrowers. Expect more such episodes.

This is all part of the difficult process to allow genuine failures in the Chinese financial system, ostensibly what the Communist Party leadership meant when it said markets should play a “decisive role” in the economy. For the past several months, new awareness of risk has showed up in financial prices, with yields on interbank loans and government bonds rising and becoming more volatile.

Like many times before, an unknown hero rode to the rescue in this credit drama. But at least some Chinese investors may be slowly waking up to the fact that there aren’t enough white knights to save everyone.

Shadow Lender Strives to Avert Loss

China Credit Trust Co. Appears to Have Found a Way to Pay Back Investors

LINGLING WEI

Updated Jan. 27, 2014 4:04 a.m. ET

BEIJING—China avoided a potentially destabilizing hit to its creaky financial system after a major shadow lender arranged a bailout for buyers of an investment product that was on the verge of going bust.

Analysts said the fact that investors will avoid a financial hit—and that it remains unclear who will pay the tab—risks sending a message that reckless investing and lending can continue with impunity, analysts said. That, they said, could ultimately damage the financial system.

China Credit Trust Co. told investors on Monday that it will restructure the loan behind a 3 billion yuan ($496 million) high-yielding investment product that is scheduled to come due on Jan. 31. Under the restructuring, the roughly 700 investors in the product would get their principal back but not the last of three interest payments, according to two investors who have been notified of the payment plan.

China Credit said it made the move by swapping the debt for equity in the borrower, a struggling coal-mining company. The equity was then purchased by an investor it didn’t name. China Credit officials confirmed the payment plan, as well as its notice to investors, but declined to comment further.

The move could help calm near-term market jitters over what are known as trust products, a pillar of China’s non-bank shadow-banking system. Had China Credit missed the Jan. 31 payment, the trust product would have become the first to result in significant losses for investors and could have shaken confidence in China’s financial system.

But the restructuring leaves unanswered long-term questions about China’s financial health, analysts say. “The underlying issue is that there is too much debt in the system that has gone to wasteful projects,” says David Cui, China strategist at Bank of America Merrill Lynch.

“At a certain point, the involved parties will be either unwilling or unable to bail out [troubled investors or borrowers], which may trigger a credit crunch,” Mr. Cui says.

Lending by shadow bankers—an assortment of trust companies, insurers, leasing firms and other informal lenders—rose 43% last year from 2012, to 5.165 trillion yuan, data from China’s central bank show, becoming a major factor in China’s rising debt levels.

The shadow banks raise funds by offering yields far higher than are available from ordinary bank deposits, lending to borrowers considered too risky for traditional banks, such as heavily indebted local governments, property developers, coal producers and other companies in sectors burdened by overcapacity.

Some traditional banks in China sell investment products on behalf of these informal lenders as a way to offer higher yields to customers. China’s largest bank by assets,Industrial & Commercial Bank of China Ltd. 601398.SH -1.18% , sold the China Credit Trust product to investors but has said repeatedly it isn’t responsible for the risk.

Economists and analysts worry that China’s shadow bankers are introducing risks into its financial system by backing projects that may never pay off and failing to disclose fully what they are asking investors to fund. They say that because banks sometimes sell problem loans to such lenders, but then have to provide credit to the purchasers, the shadow system appears to give banks a way to get rid of problem loans, but doesn’t really do so.

“Chinese banks have already accumulated high credit risks on their balance sheets. But distorted growth in shadow banking could lead to further unintended buildup of credit risks that banks may not fully appreciate,” says Liao Qiang, an analyst at Standard & Poor’s. “Certain parts of the shadow-banking sector, notably trust companies, may prove to be the weak link of China’s financial system.”

China’s economic slowdown could expose more such problems. Government data show that the pace of factory production slowed in December and a purchasing managers’ index indicated that the manufacturing sector had begun to contract in January. China’s economy expanded by 7.7% in 2013, faster than other major economies but well below the double-digit gains of the past 30 years.

Government officials worry that a hit to investors will lead to highly publicized protests and could undermine faith in the overall financial system. In the case of the product sold by China Credit, local government officials have played an active role in putting together the restructuring plan, according to people with direct knowledge of the matter.

China Credit, which is about 33% owned by state-controlled People’s Insurance Company (Group) of China Ltd., sold the product, called “Credit Equals Gold No. 1”, in 2011 through ICBC. It offers annualized returns of between 9% and 11%.

The trust firm then lent the funds to an obscure coal-mine operator in northern China’s Shanxi province, called Zhenfu Energy Group. The company is owned by Wang Pingyan, a farmer turned entrepreneur. As coal prices plunged and some of his mines were forced to shut down due to accidents and local protests, Mr. Wang found himself short of cash to pay off creditors. Mr. Wang, who has been detained by authorities in connection with his financing activities, couldn’t be reached for comment. A representative for his company declined to comment.

China Credit warned investors earlier this month that it might not be able to repay them when the product matures at the end of the month. Last week, China Credit disclosed that the coal company had received key government permission to reopen a mine and that another coal project has won support from local authorities and the community, according to a document reviewed by The Wall Street Journal. Obtaining licenses will permit the mines to start operating and generate revenues.

Europe treads softly in challenging big banks’ power

Europe treads softly in challenging big banks’ power

4:13am EST

By John O‘Donnell and Huw Jones

BRUSSELS/LONDON (Reuters) – Europe will consider how to challenge the dominance of its big banks this week, but any new rules to isolate risky trading will take years to begin and there will be no attempt to split off market betting from deposit taking.

In a blueprint expected on Wednesday, the European Commission will outline how trading by banks can be walled off from customers’ cash, but the debate among countries, many of whom are skeptical of the need to change, starts only in 2015.

After the collapse of Wall Street’s Lehman Brothers in 2008, world leaders pledged to tackle banks that were ‘too big to fail’ to shield taxpayers.

Yet in the more than six years of crisis that toppled banks in Europe and sucked in countries from Greece to Spain, little progress has been made, and the size of banks such as Germany’s Deutsche Bank (DBKGn.DE:Quote, Profile, Research, Stock Buzz) or France’s BNP Paribas (BNPP.PA: Quote, Profile, Research, Stock Buzz) remains Europe’s Achilles heel in the event of another crash.

Their vast scale is also blamed for fuelling risky trading and growth in the multi-trillion dollar derivatives market.

The proposed new rules, which are still many years off, signal that European policymakers have largely backed down in the face of banking resistance.

On Wednesday, the European Commission is set to outline its proposals for a new law, including a ban on trading by banks using their own funds and separating other types of trading from the ‘safe’ side of banking – taking deposits.

If agreement is reached, which is also in doubt, the rules would only take effect in 2017, some two years after similar action in the United States.

BUCKLE UNDER PRESSURE

The fact that it has taken so long to even broach the issue signals that, except in crisis, the political will is lacking.

“The pressure has been so high from the banks that the Commission’s proposal will be very limited. It won’t change anything,” said Monique Goyens, director general of consumer group Beuc, who was a member of an advisory group on the issue led by Finnish central bank governor Erkki Liikanen.

“The ‘too big to fail’ that we wanted to address is not going to be addressed if this does not have more teeth.”

Liikanen recommended mandatory separation of banks’ ‘proprietary’ trading with their own funds and other market betting into a separate legal entity. It would have its own capital to cushion risks but would remain within the bank.

On this count, the EU draft law is set to go further, and, like the Volcker Rule in the United States, ban banks from engaging in such trading, which has shriveled in any case.

The U.S. rule, however, applies to all banks, while in the EU it will only apply to lenders above a certain size, taking in the top 30 or so banks.

In the EU draft, other types of trading, such as derivatives, should be put in a separate division, as Liikanen suggested. The United States has a similar set-up, known as the “push out rule”, forcing some commodity, derivatives and equity trades to be walled off.

Crucially, however, the EU law stops short of physically breaking up big banks into retail and wholesale units, a step critics say is needed to remove the too-big-to-fail threat.

Germany and France, which are determined to shield their flagship lenders from any such shake-up, have repeatedly attacked the plans, privately warning Brussels last week not to overstep the mark.

Deutsche Bank, one of Europe’s largest banks, has total assets of more than 1.6 trillion euros – two thirds the size of Germany’s economy – and lends to the country’s top companies.

France has resisted interference in the structure of its big banks, including BNP Paribas and Credit Agricole (CAGR.PA: Quote, Profile, Research, Stock Buzz). Paris sees these ‘national champions’ as critical in financing their economy as well as a bulwark against foreign investors making inroads into its financial system.

France and Germany want the European Commission to soften the separation rules for non-proprietary trading to avoid crimping the flow of credit. They also do not want to ban proprietary trading.

‘NUCLEAR’ THREAT

Britain will also oppose any law from Brussels that would crimp its ability to decide how to deal with its biggest banks. It wants the retail arms of banks to hold more capital, with some risky trading kept within the wholesale arm.

The result is a patchwork of different reforms globally.

In Europe, with elections to the European Parliament in May and a changeover of the EU Commission’s top officials later in the year, nothing will happen for now.

“This proposal serves only as food for discussion and will have to be presented to the newly elected European Parliament,” said one EU official.

Germany and France’s line of argument closely follows that of industry, which claims that regulatory interference could damage their ability to lend to the economy. But Thierry Philipponnat, a former investment banker who leads Finance Watch, which campaigns for tighter regulation, challenged this.

“European banks lent only 28 percent of their balance sheets to households and corporations, with the remaining going into financial markets and, in particular, derivatives,” he said, pointing to an 80 percent surge in the size of the banking system during the decade to 2011.

“The paradox is that if you are big, you get implicit state support because you are too big to fail. And so you grow even bigger with risky activity that makes the entire system more fragile.”

Even banking lobbyists privately concede that big banks pose a risk. “We’ve done the equivalent of closing a few coal-powered power stations but created a number of nuclear reactors,” said one. “If they go belly up, God help us.”

China and Taiwan officials set a date for talks next month, the United Daily News reported today, paving the way for the first official government-to-government meetings since a civil war six decades ago

First Chinese-Taiwan Government Meeting Set, Daily Reports

Gandhi Aide Sees Toilets Helping Congress to Surprise India Win

Gandhi Aide Sees Toilets Helping Congress to Surprise India Win