Cablegate: Financial Sector Bubbles Still Contained, Say East China
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TAGS: ECON EFIN EINV PGOV CH
SUBJECT: FINANCIAL SECTOR BUBBLES STILL CONTAINED, SAY EAST CHINA
CONTACTS
1. (SBU) Summary: Chinese policymakers are taking only
moderate steps to dial back the financial system and deflate any
incipient asset bubbles, according to East China financial
sector contacts. There is a good chance that the pace of
financial sector liberalization will pick up this year, starting
with the launch of stock market index futures and other simple
derivates in the first quarter. However, problems could emerge
over the medium term, as China's financial system is
misallocating capital to the state sector. End Summary.
2. (SBU) Visiting Economic Minister Counselor William Weinstein
met with Shanghai-based contacts on China's stock market and
securities industry on January 19-20. These included Peter
Alexander, Principal of Z-Ben Advisors, Steve Lee, Chief
Executive Officer, HSBC Jintrust Fund Management Company, and
Gao Feng, Executive Director, Deutsche Bank (China).
===========================================
Asset Bubbles Forming, But Not Overwhelming
===========================================
3. (SBU) Chinese policymakers and market players are debating
the extent to which bubbles exist in China's financial sector as
a result of economic stimulus funds being siphoned off into the
stock market and real estate sector, said Gao. Nonetheless, he
said, the bubble in the residential property market, for
instance, is not that worrisome, since Chinese households are
not as leveraged as U.S. households were. Alexander was
dismissive of the recent claim by short-seller Jim Chanos of the
hedge fund Kynikos Associates that "China is Dubai times 1,000."
Naysayers like Chanos cannot understand the Chinese
government's ability to channel resources into economic growth,
said Alexander.
4. (SBU) Both Gao and Alexander, though, said inefficient
financial market operations could lead to future problems.
China's recently inaugurated small-cap, high-growth stock
market, Chinext, is "an accident waiting to happen," said
Alexander, because getting listed is all about the company's
relationship with the stock underwriters. Gao pointed to
misallocation of resources to local government development
agencies, where debts have reached RMB6-7 trillion
(approximately US$880 million to US$1 trillion), although he
noted this is still only around 10 percent of deposits in the
banking system.
5. (SBU) More worrying for Gao, China appears to be financing
itself into a form of "state capitalism." Thus, even though
household consumption is up, it is state-owned enterprises that
monopolize earnings and have "hijacked policy," said Gao. Lee
offered a more hopeful outlook, predicting that China's equity
markets, with a current market capitalization of US$3.5
trillion, would double within the next five to ten years as
foreigners gain greater access, Chinese household move their
savings into the market, and Chinese companies are privatized
through market listings. Alexander was also hopeful that
domestic consumption will take off, noting that young people's
consumption is very high once they are assured of steady income.
==================================
Government Response Limited So Far
==================================
6. (SBU) The Chinese Government response to the potential
SHANGHAI 00000034 002 OF 004
financial system bubbles has been moderate so far, our contacts
agreed. In the stock market, authorities are more concerned to
reduce the volatility of trading, rather than targeting a lower
overall market valuation, said Alexander. Similarly in real
estate, said Gao, government policy is to allow speculation on
the high end of the market, while keeping price rises down on
the middle and low end by increasing the supply of affordable
housing -- even though at present the local authorities have
fallen far behind their affordable housing construction targets.
Gao suggested that the government would be slow to introduce a
property tax, since it would be difficult to implement and
therefore would not reduce speculation.
7. (SBU) The government is reducing its maneuvering room by
approaching the potential asset bubbles from a political angle
rather than an economic one, said Gao. For example, the
renminbi exchange rate has "definitely created an imbalance,"
said Gao, but Chinese authorities do not want to be seen as
caving into international pressure by removing the peg.
Therefore, China has lost control of its monetary policy and
officials are not able to raise interest rates without
attracting hot money, especially given low rates around the
globe, said Gao. Alexander said that this has forced Chinese
authorities to wait for the U.S. Federal Reserve Bank to first
raise interest rates, even though inflation trumps unemployment
as a concern.
==================================
2009 an Off Year for Fund Managers
==================================
8. (SBU) Managed funds experienced a net outflow of investors
in 2009 as they cashed out of funds that had regained their
breakeven value, buoyed by the stock market rise, said Lee.
While the market surge in the first nine months meant that the
total assets under management of the funds industry reached
US$2.6 trillion by year end, up from US$2 trillion at the
beginning of the year, nonetheless the number of fund units held
by investors declined, he said. For the most part, said Lee,
retail investors still remain on the sidelines. However, HSBC
Jintrust did not see a net outflow in 2009, because it had taken
a hit from investors the previous year: HSBC Jintrust products
were doing well in 2008 when other funds fell below their
breakeven point, so investors redeemed their HSBC Jintrust
products to provide liquidity as they waited for the underwater
funds to rise again.
9. (SBU) Despite their difficulties holding onto investors in
2009, Alexander said fund management in China is a lucrative
business because the government has mandated a 1.5 percent
management fee. The government did not do this only to assure
profits, but also because if the firms were allowed to set their
own fees they would compete for customers by lowering the
management fees and "half the managers would disappear,"
creating disruption for retail investors, said Alexander.
============================================= =====
CIC Continues to Emphasize Passive Fund Management
============================================= =====
10. (SBU) China Investment Corporation (CIC) -- China's
sovereign wealth fund established in 2007 -- has been "working
as hard as it can not to buy U.S. bonds," said Alexander. Of
the total US$300 billion CIC manages, an additional US$60
billion has been allocated to a variety of fund managers since
SHANGHAI 00000034 003 OF 004
June, with half of this going into passive investments, such as
funds that track the S&P 500, he said. Alexander has heard that
CIC could get an additional US$200 billion from China's foreign
exchange reserves this year, making it one of the world's
largest sovereign wealth funds, but he believes that CIC's
portfolio will not exceed 15 percent in direct equity.
11. (SBU) CIC President Gao Xiqing leads the process for
choosing fund managers, said Alexander, as compared with CIC
Chairman Lou Jiwei, who focuses on CIC's direct investments in
companies. Alexander said that CIC's Gao had been hoping to
retire as vice chairman of the National Social Security Fund,
where he had built a reputation as preferring conservative,
transparent management of the assets through outside fund
managers. This reputation was why Gao was selected for the CIC
position, but Gao's strategy had led to disagreements with Lou,
said Alexander, until the present split of duties was arranged.
Gao's advocacy of openness also appears to be diluted -- on the
one hand Alexander says CIC "wants to be like the Norwegians,"
but on the other he admits the first annual report (for 2008)
was "a joke" and that he is hoping for increased disclosure in
the 2009 report.
============================================= ========
Expecting Progress on Financial Market Liberalization
============================================= ========
12. (SBU) The year 2010 will see many new steps to liberalize
the financial services sector, said Alexander, because officials
pushing for changes want to launch them before 2011, when
politics in advance of the 2012 leadership change will stifle
any further moves. Both Alexander and Gao pointed to the launch
of stock market index futures trading, which Gao said should
start by the end of the first quarter; even before that, said
Gao, he expects trials for short selling and margin trading,
which are stepping stones for trading of stock index futures.
(Note: On January 8, Chinese media reported that the State
Council has endorsed in principle the launch of stock index
futures, with regulators suggesting final preparations could
take three months. End note.) Hu Jintao's January 15 visit to
Shanghai was significant in demonstrating support for the
development of Shanghai as an international financial center,
said Lee, since one of Hu's stops was the offices of China
UnionPay -- which holds a monopoly in the domestic credit card
business -- where he urged the company to increase its
international presence.
13. (SBU) Trusts will probably remain on the forefront of
financial product innovation this year, said Alexander. A great
deal of money is flowing into trusts, he said, and trusts are
"filling in the gaps" of the financial system, creating real
estate investment trust (REIT) vehicles, investing in
infrastructure, and more riskier financing, such as mezzanine
financing, which offers holders less rights in case of a
bankruptcy.
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Comment
=======
14. (SBU) Shanghai financial sector players remain sanguine
that financial markets are not overshooting in the wake of
2009's record surge in bank lending, and that Beijing will
therefore not be tempted to take blunt administrative measures
SHANGHAI 00000034 004 OF 004
to shut down speculation. There is some support for this theory
in both the stock market, which has remained mostly flat since
its selloff in August 2009, and the real estate market, in which
trading volume has dropped off following the end of favorable
tax and mortgage policies at the end of last year. However,
Chinese media is widely reporting strong lending growth by banks
in the first two weeks of January, along with rumors that
Chinese regulators have shut down lending by some banks -- or
even required them to retract loans already extended -- for the
rest of the month. If the financial system continues to pump
credit into the economy, Chinese authorities are more likely to
put increasingly strict administrative controls in place than
they are to raise interest rates, which would just encourage
further hot money inflows. Even this may not be soon enough,
though, should a further stock market slump or a drop in housing
prices cause consumers to pull back in a "double dip" economic
slowdown.
15. (SBU) EconMinCoun has cleared on this cable.
CAMP