As China enters a brave new era and looks to gain even greater political and economic prominence around the world, new opportunities and challenges will emerge for organisations doing business in the country. Treasury Today Asia analyses the forces driving the country’s transformation and looks at what this all means for treasury.
President Xi Jinping heralded the dawn of a “new era” for China at the recent 19th Party Congress. He proclaimed that thanks to decades of “tireless struggle”, China stood “tall and firm in the east” and it was time for China to transform itself into “a mighty force” that could lead the world on political, economic, military and environmental issues. He called this the “China Dream”.
Xi’s words come at a time of broader global upheaval, with uncertainty awash in the world’s other great spheres of power. It is therefore possible that Xi is being opportunistic and taking advantage of the chaos elsewhere to further China’s ambitions. Xi has certainly positioned himself as the opposite to US President Donald Trump by denouncing isolationism and championing cooperation among nations, which gives weight to this claim.
Yet a broader analysis of Chinese political and economic systems shows that rather than being opportunistic, Xi is simply guiding China on a course that it has been on for over a decade now. And as China spreads its wings, gaining even greater political and economic prominence around the world, new challenges and opportunities will emerge. Indeed, rather than just bringing a “new era” for China, the country’s ambitions may usher in a new era for the world. As a result, corporates, perhaps more than ever, need to keep a close eye on what is happening.
Changing economic direction
China’s economy – the world’s second largest – powers the country’s global aspirations. However, it is an economy currently in transition. This has seen growth in China’s economy slow down, with growth rates dropping from double digits to between 6% and 8%. A decade ago, the 6.9% GDP growth posted in 2016 would have spelt trouble for China’s leadership, which measured its success on these numbers. Today, China’s economic ambitions are different and these numbers are regarded as the “new normal”. The focus for the government is on quality and sustainability, rather than the pace of China’s economic growth.
Driving the shift to quality economic growth is the rebalancing of the economy. The objective of this structural transformation is to reduce the dependence on investment and manufacturing and shift towards a more service, innovation, and household consumption-driven economy. “This is something the government has been pursuing for some time and the evidence of this is starting to come through,” says Louis Kuijs, Head of Asia Economics at Oxford Economics. “For example, the role of consumption in the economy is rising whilst the role of investment is declining in line with what we all would like to see. There has been a pronounced trend towards a larger role for the service sector in the economy.”
This positive news has seen China enter 2018 on a decent footing. However, some sizeable risks still exist. “When it comes to China, sentiment often changes faster than the underlying risks,” says Kuijs. “High levels of debt, which is the big risk people were emphasising a year ago, have not gone away. If anything, debt is still only rising as a share of GDP.”
These debt levels saw China’s long-term sovereign credit ratings cut by one notch to A+ from AA- last year by S&P Global Ratings. And the rating agency still has concerns about China’s macro-credit path, calling it “unsustainable”.
“Credit growth remains higher than nominal GDP growth, although the gap has narrowed in the past year or so,” says Paul Gruenwald, Chief Economist at S&P Global Ratings. “Although there is a healthy rebalancing toward consumption taking place, GDP growth targets need to be lowered below 6% in the medium term and reform of the credit-heavy state enterprise sector needs to be accelerated.”
Balancing risk and growth
The careful balancing of risk and growth is what Julia Wu, President of J.P. Morgan Chase Bank China and Head of Corporate Banking for J.P. Morgan China, pinpoints as the biggest trend in China right now. “The government has publicly stated that preventing systemic risk is its top priority,” she says. “This is why it is pushing local corporates to deleverage, pushing the banks to bring off-balance sheet items back onto the balance sheet, and strengthening the regulatory regime.”
China’s vast shadow banking sector is one area that has come under particular scrutiny. This has led the regulators to put several reforms in place to curb risks. One of the most notable for corporates has been the measures introduced by the CSRC to strengthen China’s money fund industry – which has total assets under management of around RMB6.5trn. These measures impose tighter limits to reduce concentration risk, limit a fund’s exposure to any single borrower and reduce a fund’s ability to invest in assets with a lower credit rating. Asset managers are also no longer able to promise investors a guaranteed rate of return.
Another area of China’s shadow banking industry impacted by the regulators is the use of entrusted loans – loans that are made from one company to another with a bank earning revenue by guaranteeing and arranging the transaction. Towards the end of 2017, Beijing began to clamp down on these products, meaning that banks are no longer able to provide guarantees for the loan. They have also stopped the loans from being used to buy equities, bonds or derivatives by the company borrowing.
Whilst these moves are clearly a step in the right direction to drive risk out of China and align the country more closely with ‘international standards’, there is a fear that they will negatively impact growth. However, with China’s economy growing faster than expected in the fourth quarter of 2017, this isn’t happening just yet.
China is also balancing its regulatory tightening by loosening its grip on other parts of the economy. Notable moves include the launch of bond connect – a mutual market access scheme that allow investors from mainland China and overseas to trade – which further integrates China’s financial markets with international markets. Elsewhere, China has said that it will remove foreign ownership limits on banks, while allowing overseas firms to take majority stakes in local securities ventures, fund managers and insurers – a move that will make China’s banking sector more competitive.
J.P. Morgan’s Wu says that local Chinese corporates will feel the biggest impact of these changes. “They are clearly going to have to deleverage faster than they might have initially expected,” she says. “These companies, especially those heavily engaged in or reliant on the shadow banking sector, will also be required to rethink their processes and operations.”
This will accelerate a broader evolution within many Chinese companies that are looking to adopt best in class principles to ensure they also achieve lasting and sustainable growth. “Many local corporates are moving overseas and expanding their operations,” explains Wu. “At the same time, they are also refocusing to ensure they concentrate on their core business.”
Both these trends are requiring enhanced treasury capabilities, says Wu. “Treasury teams of local corporations are very interested in how global businesses manage risk and liquidity when operating across many different markets. They are then coming to us and asking for solutions that provide them with visibility, efficiency and that also enable them to hedge risks.”
Tied to this uptick in treasury sophistication, Wu is seeing many companies looking to centralise their treasury activity. “Hong Kong is becoming a very attractive destination now for Chinese corporates looking at establishing regional or global treasury centres,” she says.