stock markets in crises

Krisis Finansil Cina: Perspektif Kebijakan Moneter, Corporate Finance (Analisa Laporan Keuangan), dan Investment Banking (Valuasi Nilai)
oleh : Sando Sasako
Jakarta, 28 Maret 2016

ISBN 978-602-73508-5-4

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Krisis Finansil Cina
 


Daftar Isi

Kata Pengantar iii
Kata Pengantar dalam buku ‘Corporate Financing’ v

Daftar Isi vii
Daftar Tabel x
Daftar Bagan xi

Pendahuluan 1
Masalah Pengukuran 1
Data, Informasi, Fakta 2
Data Mining 4
Pemilahan Data 5
Business Intelligence 7
Analisa Kuantitatif 8
Analisa Data 8
Self-Organising Map 9
Hambatan bagi Efektivitas Analisa Data 11
Confirmatory Data Analysis 11

Analisa Finansil 11
Standar Akuntansi Keuangan (PSAK, GAAP, IFRS) 12
Peran Perusahaan Audit dalam PSAK 12
Analisa Finansil sebagai Alat Ukur Kinerja Keuangan 12
Analisa Fundamental 13

Rasio-rasio Finansil 14
Pertumbuhan 14
Produktivitas 14
Kontribusi terhadap Stakeholder 14
Dividend Policy Ratios 14

Rasio-rasio Aktivitas Usaha 15
Perputaran aset (asset turnover) 15
Perputaran aset rata-rata (asset turnover) 15
Rasio perputaran aset tetap (fixed assets turnover) 15
Perputaran piutang (receivables turnover) 16
Rata-rata periode penagihan (average collection period) 16
Perputaran inventaris (inventory turnover) 16
Periode inventaris (inventory period) 16

Rasio-rasio Likuiditas 17
Rasio lancar (current ratio, CR) 17
Rasio modal kerja (working capital ratio) 18
Rasio cepat (quick ratio, QR) 18
Rasio kas (cash ratio) 18
Pendapatan lancar (current income) 19
Rasio pendapatan bunga (Time Interest Earned, Interest Coverage) 19
Rasio investasi terhadap kebijakan (investment to policy ratio) 19
Rasio utang lancar terhadap inventaris (current debts to inventory ratio) 19

Rasio-rasio Profitabilitas 19
Marjin laba kotor (gross profit margin) 20
Marjin laba bersih (net profit margin) 20
Return on Equity (ROE) 20
Return on Asset (ROA) dan Return on Capital Employed (ROCE) 20
Return on Capital (ROC) dan Return on Invested Capital (ROIC) 21
Return on Investment (ROI) 21
Beban bunga (Interest Coverage, Times Interest Earned) 22
Beban finansil (financial leverage) 22
Efisiensi beban finansil (efficiency of financial leverage) 22

Rasio-rasio Struktur Modal 23
Rasio utang terhadap modal (debt to equity ratio) 23
Rasio kapitalisasi (capitalisation ratio) 24
Tingkat pertumbuhan ekuitas (equity growth rate) 24
Beban finansil (financial leverage) 24
Rasio utang (debt ratio) 24
Rasio modal saham terhadap aset tetap bersih 24
Rasio utang lancar terhadap modal saham (Current Debts to Net Worth Ratio) 24
Rasio kewajiban total terhadap modal saham (Total Liabilities to Net Worth Ratio) 25
Rasio aset tetap terhadap modal saham (Fixed Assets to Net Worth Ratio) 25

Rasio-rasio Kecukupan Modal 25

Solvabilitas 25
Solvency ratio (SR) 26
Rasio utang terhadap aset (Debt to Asset Ratio, DAR) 26
Rasio utang terhadap modal (Debt to Equity Ratio, DER) 26
Kemampuan laba menutup biaya tetap (Fixed Charge Coverage). 26
Rasio pinjaman terhadap aset (Loan to Asset Ratio, LAR) 27
Rasio pinjaman terhadap simpanan (Loan to Deposit Ratio, LDR) 27

Risks vs Rewards 27
Risiko Mencari Keuntungan 28
Efek Domino Risiko 29
Rent-Seeking Behaviours 30

When the Deal Slips Away 32
Indikator Kesulitan Finansil 34
Indeks Kerentanan 36
Stress Test 38
Indeks Stabilitas Sistem Keuangan 40
Financial Stability Index 43
Indeks Kesehatan Finansil ala IMF 44
Laporan Stabilitas Finansil Global ala IMF 48
Operasi Moneter 48
Inflasi Terencana sebagai Prasyarat Kestabilan Finansil 50

Dinamika Pasar Finansil 52
Dinamika Aset Finansil 53
Kerapuhan Sistem Finansil 54

Krisis Finansil 55
Menelikung Krisis Finansil 56
Kasus LTCM 57
Krisis Subprime Mortgage 60
Kasus Lehman Brothers 63
Krisis Eurozone 64
Spiral Kekacauan Krisis Eurozone 65
Debt Exposures of PIGS 66
AS 68
Inggris 69
Jerman 69
Perancis 70
Jepang 71
Yunani 72
Irlandia 73
Italia 74
Portugis 74
Spanyol 75
Some PIGS are More PIGS 76
Krisis Finansil Cina 77
Kenapa Cina menjadi begitu penting? 78
Bermain dengan nilai tukar 81
Pasar CNH 82
Dominansi nilai tukar CNH terhadap CNY 87
Qualified Foreign Institutional Investor 90
Renminbi Qualified Foreign Institutional Investor 90
Qualified Domestic Institutional Investor 91
Qualified Domestic Individual Investor 91
Shanghai-Hong Kong Stock Connect 91
Pilot Free Trade Zones 91
Mainland-Hong Kong Mutual Recognition of Funds 92
Kenapa pasar finansil Cina bisa crash? 92
Ketika gelembung finansil Cina mulai pecah 93
Pelonggaran likuiditas sebagai solusi ancaman resesi 94
Aksi pemadam kebakaran ala pemerintah Cina 96
Permasalahan fundamental ekonomi Cina 99
Beban utang Cina 101
Kebijakan dan otoritas moneter Cina 102
Pasar obligasi Cina 103
Obligasi Panda 105
Obligasi dim sum 106
Daftar emisi obligasi dim sum 108
Aksi pemerintah Cina terhadap masalah tunggakan utang 110

Policy and Politicisation 113
Primary Dealer 113
Solusi Teoritis, Bisa dan Benarkah? 116
Kebijakan Too Big To Fail 117
Cashless Solution 118
Minyak sebagai Mata Uang dan Sumber Kemakmuran 120
Negative Interest Rates Policy 125

Kas 129

Pengadaan Aset 130
Asset Investment 130
Asset Financing 131
Capital Expenditures 132
Menghitung Biaya Modal 134
Biaya utang 134
Biaya saham preferensi 134
Biaya laba ditahan 134
Biaya ekuitas eksternal 135
WACC 135
Biaya modal marjinal 136
Break point 136

Off-Balance Sheet Financing 136
Perubahan Portofolio The Fed 136
OBS sebagai Produk Inovasi Menyembunyikan Risiko Finansil 137
MBS sebagai Produk Rekayasa Finansil Penyebab Krisis 2008 139
Bencana Prilaku Berisiko Berlebihan 141
Bertaruh pada Aset Fiktif 142
Akuntansi OBS 144
Fleksibilitas Pasal Karet 145
Penyesuaian Pasal Karet 146
Memanfaatkan Celah Hukum 147

Equity Financing 148

Debt Financing 149

Struktur Modal 152
Teori Struktur Modal 153
Teori Pensinyalan 154
Struktur Modal dalam Praktek dan Realitas 155
Menghitung Tingkat Optimal Struktur Modal 155
Besar Beban Operasi 156
Analisis EBIT/EPS terhadap Efek Beban Finansil 157
Besar Beban Finansil 157
Besar Beban Total 158
Efek Struktur Modal terhadap Harga Saham dan Biaya Modal 159
Likuiditas dan Arus Kas 159

Struktur Finansil 160
Ukuran Optimal Beban/Struktur Finansil 161

Valuasi Nilai 162
Corporate Financing vs Investment Banking 163
Pentingnya Valuasi Nilai 164
Valuasi Usaha 164
Komponen Pendapatan 166
Komponen Neraca 167
Komponen Arus Kas 167

Time Value of Money 168
Future Value 169
Future Value Interest Factor for i & n 169
Present Value 169
Present Value Interest Factor for i & n 169
Future Value untuk Anuitas Biasa 169
Future Value Interest Factor untuk Anuitas Biasa 170
Future Value untuk Anuitas Awal 170
Present Value untuk Anuitas Biasa 170
Present Value Interest Factor untuk Anuitas Biasa 170
Present Value untuk Anuitas Awal 170
Present Value untuk Perpetuities 171
Present Value untuk Aliran Arus Kas Variabel 171
Future Value untuk Aliran Arus Kas Variabel 171
Future Value untuk Periode Semesteran atau lainnya 171
Amortisasi Pinjaman 172

Referensi 173
Web 173
e-book 177
Buku 180

Daftar Lampiran

Lampiran – Variabel yang umum dipakai sebagai ukuran stabilitas finansil 181
Jenis data yang digunakan dalam laporan stabilitas finansil beberapa bank sentral (AT-ES) 181
Jenis data yang digunakan dalam laporan stabilitas finansil beberapa bank sentral (GB-TR, ECB, IMF) 182
Variabel yang umum dipakai sebagai ukuran stabilitas finansil 183

Lampiran – Ukuran dan skenario dalam laporan stabilitas finansil global, Okt. 2015 185
Ukuran likuiditas 185
Ukuran utang korporasi di pasar emerging 187
Asumsi dalam skenario gangguan pada pasar aset global 189
Mekanisme transmisi kejutan dalam skenario gangguan pada pasar aset global 190
Asumsi dalam skenario normalisasi yang berhasil 191
Mekanisme transmisi kejutan dalam skenario normalisasi yang berhasil 192

Lampiran – Ukuran Kerentanan Finansil 193
Indikator valuasi risk appetite / aset 193
Indikator ketidakseimbangan non-finansil 194
Indikator kerentanan finansil 195
Indikator Kebijakan Macroprudential 196

Lampiran – Daftar Indikator dalam ISSK Bank Indonesia 197

Lampiran – Profil Cina 199

Lampiran – Jumlah (instrumen) utang Cina menurut emiten, domestik, nasional, internasional, 2015Q2-2015Q4 201

Daftar Tabel

Table 1 – Aktivitas M&A di business intelligence dengan nilai >$100 juta, 2009-2014q1 7
Table 2 – Beberapa indikator kebijakan macroprudential 36
Table 3 – Indikator pengukuran stabilitas sistem keuangan 42
Table 4 – Indikator utama kesehatan finansil ala IMF 45
Table 5 – Indikator tambahan (encouraged) bagi kesehatan finansil ala IMF 45
Table 6 – Indikator parsial dan bobot dalam indeks stabilitas perbankan Republik Ceko 47
Table 7 – Indikator kesehatan finansil ala ECS (Macro-Prudential Indicators) 47
Table 8 – Tiga skenario stabilitas finansil 48
Table 9 – Operasi moneter menurut standing facility 49
Table 10 – Pentingnya likuiditas yang lentur (resilient) 50
Table 11 – Penambahan likuiditas menurut jenis instrumen OPT 50
Table 12 – Penyerapan likuiditas menurut jenis instrumen OPT 50
Table 13 – Nilai ekspor dan impor AS-Cina untuk 5 produk utama, 2014-2015 (US$ juta) 100
Table 14 – Nilai ekspor dan impor AS-Cina untuk produk teknologi tinggi, 2015 (US$ juta) 100
Table 15 – PDB Cina, 2010-2014 dalam milyaran ¥ dan US$ 101
Table 16 – Nilai obligasi pemerintah dan korporasi di Cina, 2002-2015 (US$ milyar) 101
Table 17 – Buletin harga obligasi di pasar uang Hong Kong, 11 Maret 2016 107
Table 18 – Daftar 22 primary dealer di Amerika Serikat, 2014 114
Table 19 – Beberapa veteran primary dealer pilihan Bank Sentral Amerika 114
Table 20 – Daftar 19 primary dealer di Indonesia, 2014-2015 115
Table 21 – Nilai derivatif 25 bank terbesar di AS, Nov. 2015 (US$ milyar) 119
Table 22 – Ringkasan Perlakuan Transaksi Sekuritisasi menurut UK GAAP 145
Table 23 – Jenis data yang digunakan dalam laporan stabilitas finansil beberapa bank sentral (AT-ES) 181
Table 24 – Jenis data yang digunakan dalam laporan stabilitas finansil beberapa bank sentral (GB-TR, ECB, IMF) 182
Table 25 – Variabel yang umum dipakai sebagai ukuran stabilitas finansil 184
Table 26 – Ukuran likuiditas 186
Table 27 – Ukuran utang korporasi di pasar emerging 188
Table 28 – Asumsi dalam skenario gangguan pada pasar aset global 189
Table 29 – Mekanisme transmisi kejutan dalam skenario gangguan pada pasar aset global 190
Table 30 – Asumsi dalam skenario normalisasi yang berhasil 191
Table 31 – Mekanisme transmisi kejutan dalam skenario normalisasi yang berhasil 192
Table 32 – Indikator valuasi risk appetite / aset 193
Table 33 – Indikator ketidakseimbangan non-finansil 194
Table 34 – Indikator kerentanan finansil 195
Table 35 – Indikator Kebijakan Macroprudential 196
Table 36 – Daftar indikator pembentuk ISSK 197
Table 37 – Profil Singkat Cina 199
Table 38 – Indikator Ekonomi Cina, 2011-2017 200
Table 39 – Utang Cina menurut emiten, domestik, nasional, internasional, 2015Q2-2015Q4 202

Daftar Bagan

Figure 1 – Diagram alur hierarki DIKW (Data-Information-Knowledge-Wisdom) 3
Figure 2 – Kontinuum pemahaman dalam konteks DIKW 3
Figure 3 – Proses data mining 4
Figure 4 – Hubungan antara Data, Informasi, dan Intelijen 6
Figure 5 – Analisa eksplorasi data 9
Figure 6 – Taksonomi ketidakpastian 27
Figure 7 – Igloo ketidakpastian 28
Figure 8 – PV perusahaan berutang 32
Figure 9 – Skema indeks kerentanan dan komponennya 37
Figure 10 – Siklus pengawasan macroprudential 38
Figure 11 – Prasyarat bagi antisipasi dan pencegahan ketidakstabilan sistem finansil 39
Figure 12 – Hubungan antara stabilitas sistem finansil dan stabilitas moneter 39
Figure 13 – Keterkaitan antar-variabel dalam BAMBI (Banking Model of Bank Indonesia) 41
Figure 14 – Beberapa indikator pembentuk Indeks Stabilitas Sistem Keuangan (ISSK) 42
Figure 15 – Peran Bank Indonesia dalam menciptakan stabilitas moneter 49
Figure 16 – Bentuk interaksi antara BI, pempus, dan pemda dalam mengendalikan inflasi 51
Figure 17 – Perkembangan aktivitas perbankan internasional 52
Figure 18 – Aset Riel dan Aset Fiktif Bank-bank di AS, 1995–2000 58
Figure 19 – Nilai Derivatif dan Modal 25 Bank AS Ternama (US$ milyar) 59
Figure 20 – CDOs direpresentasikan dalam bentuk building blocks, The Big Short, 2015 60
Figure 21 – Pasar rumah di AS, 1989-2006 61
Figure 22 – Pemetaan proses penularan krisis finansil 2008 62
Figure 23 – Pinjaman sektoral dari Bank of England, 1997-2012 63
Figure 24 – Utang-piutang PIGS 67
Figure 25 – Utang AS ke 4 negara adidaya dan PIGS 68
Figure 26 – Utang Inggris ke 4 negara adidaya dan PIGS 69
Figure 27 – Utang Jerman ke 4 negara adidaya dan PIGS 70
Figure 28 – Utang Perancis ke 4 negara adidaya dan PIGS 71
Figure 29 – Utang Jepang ke 4 negara adidaya dan PIGS 71
Figure 30 – Utang Yunani ke 4 negara adidaya dan PIGS 72
Figure 31 – Utang Irlandia ke 4 negara adidaya dan PIGS 73
Figure 32 – Utang Italia ke 4 negara adidaya dan PIGS 74
Figure 33 – Utang Portugis ke 4 negara adidaya dan PIGS 75
Figure 34 – Utang Spanyol ke 4 negara adidaya dan PIGS 76
Figure 35 – Cadangan Devisa Cina, Des. 1999 – Jan. 2016 78
Figure 36 – Tiga Kekuatan Ekonomi Dunia 79
Figure 37 – Nilai perdagangan Cina dengan negara lain (impor + ekspor) 80
Figure 38 – Nilai tukar bilateral yuan terhadap 3 mata uang dunia, USD, ¥, dan €. 81
Figure 39 – Cadangan devisa Cina dan nilai tukar CNY dan CNH 83
Figure 40 – Selisih CNY dengan CNH, Agustus 2010-Januari 2016 83
Figure 41 – Selisih tajam antara CNY dan CNH berdampak pada lonjakan bunga antar-bank di bulan Januari 2016 84
Figure 42 – Intervensi pasar CNH bisa menyesuaikan bunga CNH dengan CNY, 20151110-20160126 85
Figure 43 – Pasar deposit CNH, Maret 2009 – Des. 2015 86
Figure 44 – Distribusi CNH menurut bank sentral (offshore yuan’s swap line), Nov. 2015 88
Figure 45 – Penyelesaian perdagangan dalam CNH, 2009Q3-2015Q4 89
Figure 46 – Pasar deposit CNH menurut negara, 2014 89
Figure 47 – Beberapa alternatif indikator pertumbuhan ekonomi Cina mengacu pada penurunan yang lebih besar (greater slowdown), 2010–2015 95
Figure 48 – Indeks Saham Gabungan Shanghai (SCI), Mei 2015 sampai 5 Februari 2016 97
Figure 49 – Indeks Saham Gabungan Shanghai, 1 Januari 2015 – 8 Maret 2016 98
Figure 50 – Triple policy trilemma 99
Figure 51 – Pasar obligasi Cina, 2003-2014 104
Figure 52 – Aktivitas perdagangan pasar sekunder obligasi Cina, 2000-2014 104
Figure 53 – Pangsa pasar obligasi Cina menurut jenis obligasi, Des. 2014 104
Figure 54 – Daftar emisi obligasi Panda, 20151010-20160121 106
Figure 55 – Emisi obligasi CNY, 2008-2015 111
Figure 56 – Emisi obligasi CNH, 2008-2015 111
Figure 57 – Asset backed securities di Cina, 2005-2014 112
Figure 58 – Peristiwa bersejarah dan harga minyak mentah, 1861-2014 (US$/b) 121
Figure 59 – Harga minyak mentah Brent (US$), 20040102-20160106 123
Figure 60 – Kelebihan pasokan minyak mentah dunia, 2012q3-2015q3 123
Figure 61 – Distribusi ladang produksi minyak shale AS, April 2015 124
Figure 62 – Suku bunga deposito dan pembiayaan ulang ECB, 2008-Maret 2016 127
Figure 63 – Prediksi nilai tengah suku bunga Federal Funds, Des. 2015-2019 127
Figure 64 – Federal funds target rata (%), 1983-2015 128
Figure 65 – Federal funds rate, 1 Juli 1954-18 Feb. 2016 128
Figure 66 – Skema sumber pendanaan perusahaan 130
Figure 67 – Factors adding to reserves and off balance sheet securities lending program 137
Figure 68 – Multiplikasi Penciptaan Aset Fiktif 143
Figure 69 – Klasifikasi struktur aset, struktur finansil, dan struktur kapital 161


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the-danger-in-emerging-market-debt.pdf
the-danger-in-emerging-market-debt_Page3_Image1.jpg

Figure: China Foreign Exchange Reserves (US$ bn), 2000-2014
Sumber: Robert Huebscher, The Danger in Emerging Market Debt, Advisor Perspectives, Inc., 20160201.

Bank for International Settlements, International banking and financial market developments, BIS Quarterly Review, December 2015.

p.3
By the end of October, China’s foreign exchange reserves had fallen by over $450 billion from their peak in June 2014. And over one quarter of the reduction occurred in August and September 2015.

p.39
foreign exchange loans in China and Hong Kong, as well as net issuance of US dollar bonds by EMEs, raise the question of whether dollar borrowing outside the United States will continue to expand. Changing macroeconomic and financial conditions – in particular, a shift in relative funding costs that might emerge from a tightening of US monetary policy – could lead dollar borrowers to repay dollar debt, and dollar creditors to seek repayment. This in turn could lead to a reevaluation of the policy measures that have helped to shape these flows.

C15.
Easing has induced easing
Interview with Mr Claudio Borio, Head of the Monetary and Economic Department (MED), in Börsen-Zeitung, conducted by Mr Mark Schrörs and published on 25 August 2015.

Mr Borio, China is on everyone’s lips at the moment. There are increasing concerns about a “hard landing” of the economy and a bursting of the credit bubble. How worried are you about the recent developments? Do you see a risk that China could be the starting point of the next global recession or the next global financial crisis?
For quite some time now, a number of countries that escaped the global financial crisis largely unscathed have been exhibiting symptoms that are qualitatively similar to those that prevailed pre-crisis in those countries that would later be hardest hit by it: strong credit expansion and a strong increase in asset prices, especially property prices, on the back of high risk-taking and, for some, of the commodity price boom.
These are symptoms of a strong financial boom that typically leads to a bust, with possibly large macroeconomic costs. This is true in particular of a number of emerging market economies (EMEs), including some of the largest, but also, to a lesser extent, of some advanced economies. China is one of these countries. We have to watch this very closely.

So there is a reason to worry globally?
The EMEs’ heft in the global economy has increased substantially since the Asian financial crisis. So, should they run into trouble, the impact on the rest of the world would be larger. There are some positive developments suggesting that, in several respects, many EMEs are in a better shape than they were at the time.
They have better macroeconomic policies, including greater exchange rate flexibility, they have strengthened their financial infrastructure and financial regulation, notably through macroprudential measures, and they have greatly increased their foreign exchange reserves. But this is no panacea against crises.

Regarding China, some observers argue that the link between the Chinese financial system and the global financial system is weak and that, because of that, there is no risk of a global financial crisis as in 2007-08.
I don’t want to speculate about the next big crisis. But I would caution against underestimating the financial linkages. And, of course, China has a major impact on trade and commodity prices. Moreover, it is shared vulnerabilities that matter most.

You have mentioned greater exchange rate flexibility as an indicator of strength. Does that mean you welcome the new exchange rate regime in China? This has initially led to a depreciation of the renminbi – which has induced concerns about an intensified “currency war”.
The fact that China is structurally moving towards a more market-oriented exchange rate regime is without doubt a positive development. The more general question is how the depreciation of the renminbi fits into the bigger global picture we have been seeing for some time.

And what is your answer?
In general, exchange rates can redistribute growth – from faster-growing to slower-growing countries. When they do so, this is positive. It is also natural that the exchange rate has come to play a greater role in monetary policy since the financial crisis: in the countries that have been hardest-hit by it, and with interest rates pushed so low, domestic transmission channels have been impaired. But the problem is that, in general, currency appreciations have not been welcome. The consequence is that easing has induced easing.

And in the end there is competitive devaluation and a race to the bottom when it comes to interest rates
Some people argue that the world economy has been suffering for quite some time from a large deficiency of aggregate demand and hence that this exchange rate-induced generalised easing has been good for the world economy. At the BIS, we have a different view because we are more focused on medium-term financial booms and busts: instead of being a positive sum game, the process can be a negative sum game. The expansionary monetary policy has been transmitted to countries that did not need it, fuelling financial booms there.

The cooling-down of the Chinese economy and the depreciation of the renminbi have also led to concerns that global inflation, which is already very low, will be dampened further. What is your view on that?
Sometimes we seem to believe that we know more about the inflation process than we actually do – we do not fully understand what drives it. Having said this, at the BIS we are of the view that global factors have often been underestimated. We think that there are still significant disinflationary forces coming from technological progress and, above all, the globalisation of the world economy.
These secular factors are headwinds that have held inflation down despite very easy monetary policies. But these are welcome supply side forces, which support the economy. On top of that, there are some cyclical factors at the moment.

p.6
Since 2008, the basis has widened repeatedly in favour of the US dollar lender, ie there is a higher cost for borrowing in dollars than in other currencies even after hedging the corresponding foreign exchange risk – conventionally recorded on a negative basis (Graph 5, left-hand panel). As such, negative basis swap spreads indicate the absence of arbitrageurs to meet heightened demand for US dollar liquidity.2
The US dollar premium in FX swap markets widened substantially – in particular vis-à-vis the Japanese yen – after the odds of Fed tightening reached 70%. At the end of November, the basis swap spread of the Japanese yen versus the US dollar was minus 90 basis points, possibly reflecting in part the more than $300 billion US dollar funding gap at Japanese banks.

While funding continued to be available, such a large negative basis indicates potential market dislocations. And this may call into question how smoothly US dollar funding conditions will adjust in the event of an increase in US onshore interest rates. Similar pricing anomalies have also emerged in interest rate swap markets recently, raising related concerns (see box).

higher rates would be positive as they would confirm the strength of the US recovery. But higher rates would inter alia increase interest expenses for corporates. Low rates have helped to bolster high profit margins despite low earnings growth for US corporates in recent years (Graph 5, centre panel). Earnings in fact fell in the third quarter, by 0.6%. Historically, earnings shrinkage has signalled recessions, although few analysts now forecast such a development.
Markets also continued to be propped up by leveraged positions, which may be vulnerable to higher interest rates (Graph 5, right-hand panel). Although down from its August peak, margin debt in the US equity market remained within reach of previous record highs seen in the run-up to the dotcom bust more than 10 years ago.

Herwin Loman, China: turbulence on financial markets accompanied by fall of FX reserves, Country Report, 20160203, https://economics.rabobank.com/publications/2016/february/china-turbulence-on-financial-markets-accompanied-by-fall-of-fx-reserves/


Background information
China is the second-largest economy in the world in nominal GDP terms (estimated at USD 10.9 trillion in 2015) and the largest economy in PPP terms (estimated at USD 19.8 trillion in 2015). At the heart of China’s economic success has been its successful export- and investment-led growth model.
However, after 2008 growth relied to a great extent on rapid credit and (real estate and infrastructure) investment growth. Meanwhile, adverse side effects, such as a rapid rise in income inequality and major environmental problems have become too big to ignore. China’s growth model will have to be changed and become more consumption-driven instead of investment-driven.
Innovation will have to be nurtured, while environmental responsibility will have to gain in importance. The late-2013 Third Plenum addresses these issues, but implementing the plans correctly and timely will be a key challenge for Chinese authorities while major downside risks, such as a sharp economic slowdown or public unrest are present.

The People’s Republic of China, established in 1949, is a socialist one-party state ruled by the Chinese Communist Party (CCP). Power is centralized in the CCP whilst the support of the People’s Liberation Army and a well-developed internal security system safeguard political stability.
The availability of information is heavily controlled by the government. Press freedom and freedom of speech are heavily restricted, while the judiciary is not independent. Due to lack of transparency, developments in China, especially political ones, remain clouded and difficult to gauge. In recent years, President Xi Jinping has launched a far reaching anti-corruption campaign, which has helped him to increase his personal power.

Key developments
1. New bout of market turbulence accompanied by large-scale capital outflows
China’s stock and currency markets got off to a turbulent start in 2016, as both the currency and share price face strong downward pressure. Following heavy-handed government interventions some stability seems to have returned. The fall of share prices has stopped, but probably only after renewed large scale (indirect) government purchases.
The government also intervened heavily on currency markets, even on the offshore renminbi market, after the offshore renminbi had become substantially cheaper than the onshore renminbi. The government seems to have recognized that its poor communication and frequent policy U-turns had boosted instability, as it has created a new cabinet office to co-ordinate financial and economic policy. However, the fundamental tensions between more market forces and maintaining government control remain unresolved.

The turmoil has been accompanied by a sharp fall of China’s foreign exchange (FX) reserves from USD 3.69 trn in June 2015 (and 3.99tn in June 2014) to USD 3.33trn in December 2015. The decrease of FX reserves by a record USD 108bn in December implies net capital outflows of about USD 150bn.
Capital outflows are probably driven primarily by expectations of further currency depreciation, though the ungoing anti-corruption campaign and sentiment on stock and property markets might also contribute. The scale of the flows suggest that China’s capital controls are now quite leaky, which could increase financial stability risks.
While the pace of decline has been fast, the buffers left are still sizeable, even after taking into account that FX debt is estimated to be close to USD 1 trn. A sizeable part of the fall in FX reserves thereby appears to be caused by a Chinese companies and banks reducing their FX debt. Furthermore, China has a positive net international investment position (17% of GDP in 2014) and a sizeable current account surplus (of slightly more than 3% of GDP in 2015).
If outflows continued at the current pace, the government would attempt to tighten capital controls and could also allow greater depreciation.

2. Impact of turbulence on real economy seems limited, but challenges remain present
So far, the impact of the turmoil on the real economy seems to have been limited. According to the official first estimate, economic growth fell to 6.9% in 2015, down from 7.3% in 2014, but other economic indicators suggest a more pronounced slowdown, with growth falling to slightly below 5% in early 2015 and remaining at that level afterwards.
This big slowdown thus took place in 2015Q1, when the stock market was still booming, and was driven by much weaker growth of the industrial and construction sectors. In particular heavy industry has taken a hit, with steel production declining for the first time in recent history. According to most indicators growth in the service sector, which is the biggest and also the most labour intensive economic sector, has remained high.
Even excluding the high growth of the financial sector in 2015 (likely linked to the high trading levels on stock exchanges), service sector growth has remained relatively high. While there are no reliable unemployment data, most indicators suggest that the labour market has remained rather tight (though unemployment may be an issue in regions with a lot of heavy industry).

Macroeconomically much more important than the stock market is the real estate market. Construction grew extremely rapidly until early 2014, when both house prices and transaction numbers started to go down. Thanks to easing of lending, a recovery has taken place in the biggest (especially in so called tier I) cities, but much less in the tier-III cities and cities in the industrial north. Given the scale of construction in recent years, the real estate sector continues to pose risks.

Meanwhile, credit growth has continued to grow at a much higher pace than nominal GDP, which means that leverage has continued to increase. Despite relatively high consumption growth, the (household) saving rate remains high, which implies that high levels of investment continue to be needed to support growth.
While the control of the government over the financial sector and (though apparently increasingly leaky) capital controls mitigate risk, increasing leverage coupled with high levels of wasteful investment pose financial stability risks and are likely to result in a further slowdown of growth further in the future.

3. Impact of end of one child policy likely to be limited
In November the government abolished China’s one child policy. As China’s labour population has started to fall in recent years and will continue to do so as the population will start to age, a higher birth rate could help to raise long-term growth perspectives. However, the impact is likely to remain small.
An earlier easing of the one child policy for some groups did not result in a much higher birth rate, and birth rates in neighbouring countries such as Japan, South Korea and Taiwan are also very low. Furthermore, the costs of having children are high, especially in the big cities, and having just one child migh have become culturally ingrained.

wif.pdf
export earnings are not sufficient at present to finance the capital exodus. The gap is being bridged by the Chinese central bank selling its forex reserves.
three options: sudden, massive devaluation; gradual devaluation or clear restrictions on crossborder capital flows.
Sudden massive renminbi depreciation would make imports far more expensive, causing them to slump. As a result, production chains could be interrupted without any domestic substitutes being readily available. The outcome could be a severe recession. What is more, CNY exchange rates would no doubt overshoot, as the recession would make investment in Chinese assets more risky, thus forcing more capital out of the country. This in turn would trigger another round of depreciation.

Economic-Insight-6-reasons-monkey-economics-china-fev16.pdf
Triple policy trilemma.jpg
Sources: Euler Hermes

Corporate risk: Are ‘zombies’ back?
Corporate insolvencies increased by +25% in 2015 and are likely to grow by another +20% in 2016. Company DSO increased to 81 days in 2015 (from 77 in 2014) and is forecast at 84 days in 2016. Eased monetary policy helped drive credit costs low er but high debt stock and higher risk of nonpayment for banks limits loan expansion.
Corporate debt w as 160% of GDP in mid-2015. Bank lending conditions deteriorated. Commercial banks reported a rise in Non-Performing Loans to 1.59% in Q3 2015 (from 1.16% in Q3 2014), w hich amount to RMB1186bn (approximately USD180bn). Net profit grow th slow ed markedly to +2.2% YTD y/y in Q3 2015, compared w ith an increase of +13% in 2014 (see Figure 3).

High leverage is an issue for the longer term, particularly against a backdrop of profit decline. Using a panel of 2,900 listed companies in China, we analyzed the evolution of debt, equity and cash in China (see Figure 4). From 2012 to H1 2015, long-term borrow ing increased by RMB10tn pushing the debt-to-equity ratio to 114% (compared w ith 98% in 2012). How ever, net debt-to-equity (discounting available cash) w as only 63% in H1 2015, w hich confirms a sizeable, yet not inextricable, problem.

Looking at sectors (see Figure 5), the usual suspects (utilities, materials and industrials) show an increase in their gearing ratios – and declining profits. Unsurprisingly, in these sectors, payments terms also deteriorated over the period, w ith construction and manufacturing paying tw o w eeks later on average betw een 2012 and 2015.
Sectors closer to household final demand (consumer staples and discretionary) and sectors subject to government targets (including information technology and telecommunication services and transports) show a declining trend in their gearing.
indicators….. production, employment

Chinese exporters suffered from decreasing price competiveness as a result of continued currency appreciation (see Figure 10) in recent years, as labor costs increased. Combined w ith moderate grow th in external demand, it resulted in w eaker export performance. Another depreciation of the yuan w ill create further pressure on countries competing or trading extensively w ith China, leading to further decrease in their producer prices. This may be the case for countries like Japan, but also for Eurozone countries.

Recent yuan movements are also a consequence from less confidence in the outlook and associated large capital outflow s, further pressuring the currency. The current context calls for another round of depreciation:
(i) international pressure eased with the inclusion of the RMB in the SDR basket; (ii) economic activity is fragile and export performance weakened; (iii) monetary tightening in the U.S. exerts dow nward pressure on the RMB/USD parity; (iv) deflationary pressures are elevated w ith the GDP deflator contracting by -0.8% y/y in Q4 2015; and (v) freer RMB could help reduce the use of foreign exchange reserves, which were depleted markedly in 2015 (see Figure 11).
All in all, Euler Hermes expects the RMB will depreciate to 6.8-7 RMB to 1 USD. If communicated effectively, this currency depreciation may not have a negative effect on stock markets. Miscommunicated, as we have seen so far, it w ill be yet another nudge for the Chinese economy.

Eswar Prasad, China’s Efforts to Expand the International Use of the Renminbi, Report to U.S.-China Economic and Security Review Commission, Brookings Institution, 20160204.
RMBReportFinal.pdf
RMB per unit of 3 foreign currencies.jpg

Gregor Irwin, The ‘Chinese Put’, Global Counsel, London, 20150721.
Global_Counsel_The_Chinese_Put_0.pdf
The Shenzhen and Shanghai stock markets were flat in the first half of last year. In the second half they increased 28% and 58% respectively, with most of the gains coming towards the end of the year. It was this year, however, that both markets really took off. From the start of the year until their peak on 12 June the Shenzhen and Shanghai markets rose 122% and 60% respectively.

This is in part explained as a side effect of the monetary easing by the People’s Bank of China that began in November last year, which meant more funds chasing higher returns in the country’s equity market.
In addition, financial innovation and the increasing use of margin finance provided by both official brokers and informal lenders meant a surge in leveraged stock investments. This was despite the fact that the Chinese economy had been cooling and underperforming against expectations for much of this period.

stock prices increasingly bore little resemblance to fundamentals raises concerns that
leveraged investors would be very exposed if the market turned sour and investors had to close out their positions. And that is exactly what happened. In less than four weeks from 12 June the Shenzhen and Shanghai markets lost 40% and 32% respectively, accelerating the pace of margin calls, triggering the automatic suspension of an increasing number of stocks, and panicking officials who feared they had lost control of the market.

At the end of June 2015 the PBOC again loosened monetary policy and proposals were published to allow national pension funds to invest in equities. At the start of July the China Securities Finance Corporation (CSFC) was given additional funds to help stabilise the market both through direct purchases and by lending on to official brokers. At the same time, 21 of the main brokers announced the creation of a joint market stabilisation fund.
Soon after, IPOs were suspended and both the extent and range of instruments used for direct intervention in the markets by the CSFC and other state-backed groups was increased. Finally on 8 July the authorities announced a package of measures that included a ban on share sales by senior executives and large shareholders and an instruction to state-owned enterprises to maintain or increase their shareholdings.
The PBOC also coordinated financial support to the CSFC from China’s state-owned banks reported to total more than $200bn.

The interventions appear to be working for now and to have succeeded in limiting the losses for private investors.
But what are the broader implications of this episode for market reforms and systemic risk in China?
interventions of this sort may create moral hazard, this is hardly a new concern in China.

the prices of Chinese stocks now look artificially high, having been propped up a combination of trading suspensions, large scale interventions and restrictions on divestments.
This means a further correction may be required before prices move into line with fundamentals.

the private sector is always a lower-priority for the state-owned banks when it comes to the allocation of credit.
more market discipline to state-owned enterprises through governance reforms and partial private ownership.
The irony is that many SOEs are helping to prop up the stock market, just when they are supposed to be broadening their ownership by issuing shares onto the market.

interventions to prop up the stock market are a reminder that the imperative of social and political stability in China means the system’s tolerance of private losses remains very low. The result is what might be termed as the ‘Chinese put’ – by which substantial downside risk from investment is implicitly absorbed by the state.
This phenomenon is not only a feature of equity markets. It is much broader and applies to other parts of the financial system too, as is illustrated by the continuing reluctance by the state to allow either failing investment trusts to fold or firms to default on corporate bonds.

This creates a conundrum. Whenever reforms create new risk-taking opportunities – as they must if they are to be meaningful – individuals have an incentive to maximise their exposure, knowing there is a good chance the state will bail them out.
Moreover, the likelihood of a bailout is increased when individuals take on risks that are correlated with the risks taken by others, given the state’s particularly low tolerance for systemic risks. This behavioural pattern makes it more likely that reforms create systemic risks, which is why the process of reform is itself both slow and subject to reversal.

The authorities in China have not yet solved this conundrum. Until they do the system of capital allocation is likely to remain largely directive with the state-owned banks continuing to play a dominant role. The same clash between individual incentives and the actions of the state applies to reforms in all areas of the financial sector, including the banking sector.
While progress has been made in some areas, including towards interest rate liberalisation, this is incremental. This means risk in general, but especially credit risk, will continue to be under-priced from a social perspective.
At best this means the system of capital allocation is inefficient. At worst it is inherently unstable as the failure to reform means a build-up of slower burning risks as the balance sheets of the banks, many corporates, and different parts of the state, including local government, could deteriorate quickly if the credibility of the Chinese put is ever called into question.
The problem is not that the authorities are unaware of the risks – they are and they also know what should be done about them, at least in principle. The difficulty is instead that the reforms that are required themselves entail risks that are both more immediate and intolerable. This means that stability now may come at the cost of a much bigger crisis in future.

Mahamoud Islam and Ludovic Subran, China: Great Wall, Great Mall, Great Fall? Not really…, Euler Hermes, 20150909.
Economic-Insight-China-Sept15.pdf
Table 4: Indonesian export exposure to China (share of the sector in a country’s total exports to China)
Energy (36%), logam (non-ferrous) (21%), pertanian pangan (15%), kimia (10%)

re-read again
Andrew Labelle, China’s economy is entering a slower, riskier phase (and policy options are running thin), Special Report, TD Economics, 20150723.
ChinaSlowerGrowthAndReforms.pdf
growth has been too dependent on credit-fuelled stimulus. Non-financial sector debt has risen to roughly 250% of GDP. This rise in debt presents serious risks.
According to the two best indicators to help gauge banking crises risks by the Bank of International Settlements (BIS), China is above the threshold signaling financial vulnerability.
credit-to-GDP gap, its long-term trend, and DSR. A DSR above 6% is deemed by the BIS to be a “very strong indication that a crisis may be imminent”.5

the trade-off between near-term growth and long-term reform
As its economy matures, economic growth is slowing. In the first quarter of 2015, China’s economy slowed to its weakest pace since the financial crisis.

Policymakers responded to the slowdown by announcing a dizzying array of additional stimulus. In effect, it chose additional near-term growth, at the cost of higher financial vulnerability risks down the road.
While these initiatives appear to have had some success in temporarily lifting economic growth, high debt levels limit both the magnitude and effectiveness of the policy response.

Chart – Chinese outstanding debt has grown significantly since financial crisis

its labor force growth slows due to population aging and a low birth rate.

Following the financial crisis in 2008-09 and again as growth flagged in 2011 and 2012, China undertook large-scale credit-fuelled stimulus in order to boost its economy.

local government financing vehicles (LGFVs) to finance their budgets and massive expansions in infrastructure spending

QE n EMP vs TMP
China’s growth figures have come under question, again
China’s GDP figures are too much smooth on the year-over-year profile.
GDP is reported on a two weeks basis, after the quarter ends, compared to roughly 4 weeks for the U.S. and the UK, 6 weeks for Germany, 7 weeks for Japan and two months for Canada
The Keqiang index has some drawbacks as it overly exposes heavy industry, rather than the services sector. And China’s economy is slowly shifting to a services-based one.
alternative indicators of Chinese economic activity, including construction in floor space terms, air passenger traffic, total freight transportation, electricity generation/consumption, and motor vehicle sales.

Bagan – some alternative indicators of economic growth point to a greater slowdown
Source: China National Bureau of Statistics, People’s Bank of China, China Electricity Council. *Weighted combination of electricity consumption, freight volume, and bank

Nargiza Salidjanova, Lauren Gloudeman, Katherine Koleski, Matthew Snyder, Sean O’Connor, Economics and Trade Bulletin, The U.S.-China Economic and Security Review Commission, 20160205.
February 2016 Trade Bulletin.pdf

Table 1: U.S. Trade with China: Top Five Exports and Imports (US$ millions)
Source: U.S. Census Bureau. http://censtats.census.gov/naic3_6/naics3_6.shtml.

Table – ATP Trade through December 2015 (US$ millions)
Source: U.S. Census Bureau. http://www.census.gov/foreign-trade/statistics/product/atp/2015/12/ctryatp/atp5700.html

Advanced Technology Products
The U.S. trade deficit with China in advanced technology products (ATP) reached $120.7 billion in 2015, a $3 billion decline form 2014 (see Table 2). An in the previous years, imports of information and communication products (ICT) were the main contributor to the deficit. Excluding ICT, the United States ran a $13 billion ATP surplus on the strength of aerospace exports.

Industry overcapacity—a new addition to the survey in 2016—was the fifth most cited challenge for U.S. firms.

electricity, rail freight, supply of raw materials, and retail sales, as proxies for measuring China’s GDP.
less sensitive to political pressures

Beijing Highlights “Supply-Side” Reforms
the bigger risk to its economy—the quality and structure of Chinese debt

Stock Market Volatility Continues into 2016
Six months after its widely felt crash, the Chinese stock market experienced further declines in January, with the Shanghai Composite Index (SCI), China’s main exchange, falling 22.6 percent.41 The slide was triggered in part by the devaluation of the renminbi (RMB) against the U.S. dollar in early January, sparking concerns over the strength of the Chinese economy.42
Since reaching its June 12 peak, the SCI has fallen 46.8 percent, while Shenzhen, the smaller, technology-dominated exchange, has fallen 45 percent.43 Volatility continued despite a new circuit breaker mechanism implemented at the start of the year intended to prevent dramatic falls in the market.*
The mechanism was designed to suspend trading for 15 minutes when the benchmark CSI300—an index that tracks the largest listed companies in Shanghai and Shenzhen—dropped 5 percent. If the index dropped an additional 2 percent, markets would close for the remainder of the day.44 However, the system had the opposite of its intended effect, speeding up stock declines as investors scrambled to sell before trading was suspended.45
On January 4, the first day the system was implemented, the CSI300 dropped 7 percent, activating the circuit breaker and ending trading for the day 80 minutes early.46 On January 7, the market once again fell 7 percent, this time after they had been open for less than 30 minutes.47 The same day, the China Securities Regulatory Commission (CSRC) suspended the circuit breaker, citing its negative effects.48
Since the circuit breaker was suspended, markets have continued to decline, with the SCI dropping below the key 3,000 mark, an indicator of sentiment (see Figure 15). To limit further market volatility, the CSRC announced on January 6 that large shareholders—defined as those holding 5 percent or more of shares in listed companies—will be prohibited from selling over 1 percent of their total shares for the next three months.49 The CRSC also set a requirement that large shareholders must disclose share reduction plans 15 trading sessions in advance of taking action.50

A review of recent trade figures between China and Hong Kong revealed that Chinese citizens get money out of the country by over-invoicing imports and under-invoicing exports.54 A comparison of China’s imports from Hong Kong and Hong Kong’s exports to China—figures that should match—revealed that according to Chinese numbers, imports from Hong Kong were $142.5 billion higher than reported by the corresponding numbers from Hong Kong.55
In December 2015, China’s General Administration of Customs reported $164.1 billion (1.05 trillion RMB) worth of imported goods from Hong Kong, while Hong Kong’s Census and Statistics Department reported $21.57 billion (HK$168.13 billion) in exports to China.56
capital outflows totaled $436.8 billion in the first three quarters of 2015 (see Figure 16).57 Capital outflows accelerated in the last few months of 2015 based on unofficial estimates. The Institute of International Finance calculated $676 billion in total capital outflows for 2015.58 Bloomberg Intelligence measured nearly $1 trillion in outflows for 2015 compared with $134.3 billion in 2014.59

The significant rise in capital outflows reflects both anxiety about the Chinese market and pursuit of higher returns abroad. Main drivers of China’s capital outflows include:
• Loosening of Capital Controls: Over the last year, China has been gradually and selectively loosening its controls on capital inflows and outflows—a key component of its financial reform agenda and broader goals for the internationalization of the RMB.*
As controls have been slowly relaxed, Chinese investors have moved money abroad to take advantage of higher returns and diversify their portfolios.60 But an annual $50,000 cap on the purchase of U.S. dollars for Chinese citizens remains in place, prompting illicit capital outflows.61
• Debt Repayment: Chinese firms borrowed heavily in U.S. dollar-denominated debt, taking advantage of the appreciating value of the RMB and low U.S. interest rates following the global financial crisis. The sudden devaluation of the RMB in August 2015 raised the cost of servicing their foreign debt by approximately $15 billion.62
The U.S. Federal Reserve’s interest rate hikes in December 2015 strengthened the value of the U.S. dollar and made borrowing more expensive, further incentivizing Chinese firms to reduce their existing dollar-denominated debt.63
• Depreciation of the RMB: Chinese citizens and global investors are seeking to move their assets abroad before a depreciation of the RMB erodes the value of their assets. After years of steady appreciation, investor expectations are shifting toward a weakening value of the RMB.64 Goldman Sachs expects a 6 percent depreciation in the RMB in 2016.65
Several other hedge funds, such as Hayman Capital Management, Greenlight Capital Inc., and PointState Capital LP, are betting the RMB’s value will fall.66
• Concern over the State of China’s Economy: In 2015, China’s economic growth slowed to its lowest pace in a quarter of a century at 6.9 percent (for more information on the slowdown, see “Growth Hits 25-Year Low” section).67 In addition, the Chinese government’s muddled responses to the volatility of the stock market and the sudden devaluation of the RMB in August 2015 have shaken investors’ confidence in the ability of the Chinese government to run the economy.68
• Surge in Outbound Mergers and Acquisitions: Based on data from the research consultancy Rhodium Group, Chinese companies spent around $1 trillion on outbound mergers and acquisitions in 2015, a 16 percent increase from 2014.69 Outbound acquisitions by Chinese firms are accelerating.
According to international financial software firm Dealogic, announced acquisitions in 2016 already total $12.5 billion, the fastest start to a year on record.70
• Increasing Numbers of Chinese Citizens Traveling and Studying Overseas: China has rapidly become the world’s largest source of outbound international tourists and tourism-related expenditures. 71
Chinese international travel grew from 10 million departures per year in 2000 to 98 million in 2013, and Chinese spending abroad has also increased at a faster rate than any other country in the world, growing 28 percent from 2013 to 2014.72 In addition, increasing numbers of Chinese students are studying abroad. In 2014 alone, more than 350,000 Chinese students traveled to the United States.73

Continuing current policies runs in opposition to the “impossible trinity” that a central bank cannot simultaneously maintain an independent monetary policy, a fixed exchange rate, and free capital borders. If capital outflows continue to grow, it will place pressure on the RMB to depreciate, forcing the People’s Bank of China (PBOC) to either allow the currency to depreciate or defend the currency with its reserves. Thus far, the Chinese government has sought to maintain both the value of the RMB and last year’s incremental reforms to loosen capital controls.75

Private equity and hedge funds have taken out loans in RMB that become easier to pay off as the RMB devalues.
The PBOC has sought to stem the outflow of foreign reserves by increasing the cost of betting the RMB will weaken.80 To prevent such a devaluation, the PBOC is squeezing liquidity in Hong Kong—a major center for onshore and offshore RMB trading.
On January 25, the PBOC expanded reserve requirements on Hong Kong-based RMB deposits from just mainland banks to all offshore banks, thus reducing the availability of RMB funds by around $23 billion (150 billion RMB).81
The PBOC has pressured mainland banks to raise interest rates for Hong Kong-based bank loans, effectively killing the offshore RMB-lending business with higher borrowing costs.82 In addition, the PBOC has prohibited foreign asset managers such as private equity and hedge funds from raising RMB-based funds for overseas investments.83
Beyond regulatory and administrative measures, the Chinese government has signaled its unwillingness to allow the RMB to depreciate further. After billionaire investor George Soros predicted “a hard landing” for China’s economy, China’s state-run media made veiled threats that “radical speculators” would “suffer huge losses” from trying to bet against the RMB.84

James Marple, Maria Solovieva, and Admir Kolaj, China’s Renminbi will not threaten the dollar’s reserve currency status, Special Report, TD Economics, 20150811.
China_Reserve_Currency.pdf
China’s “Managed Convertibility” Programs: Part 1 (Inbound Investment)
Qualified Foreign Institutional Investor (QFII)
QFII, launched in 2002, was the first program allowing foreign institutional investors access to capital markets in China. Investors (financial or credit institutions) must apply for qualification to the China Securities Regulatory Commission (CSRC) and investment quota to State Administration of Foreign Exchange (SAFE).
Once approved, the QFII opens a foreign exchange account and an RMB account with its designated trustee and a securities account in the China Securities Depository and Clearing Company. Through these accounts, foreign currency exchange is administered and securities are invested.
With the minimum quota set at $50 million and maximum at $ 1 billion, QFII is allowed to invest in equities, open and closed-end funds, ETFs, stock index futures (for hedging purposes only), bonds and fixed income products traded in interbank bond market, options, placements in small and medium enterprise (SME) bonds, and other investments approved by CSRC and PBoC.
In terms of asset allocation, there are general guidelines of at least 50% allocation to equities and not more than 20% to cash. Minimum lock-up periods applies and is subject to SAFE approval; monthly fund remittance (weekly for open-ended funds) should not exceed 20% of the QFII’s total assets.

Renminbi Qualified Foreign Institutional Investor (RQFFI)
RQFII provides access to mainland securities for overseas investors using offshore Renminbi. The pilot RQFII started in December 2011 in Hong Kong. In October 2013, London became the first RQFII-eligible jurisdiction outside of China. The application process is similar to QFII, where the potential investor must seek approval from CSRC and obtain the investment quota from SAFE.
Once the approval is granted, the RQFII must authorize a QFII custodian to transact on its behalf. As of June 2015, there are 132 RQFIIs with the total approved quota of RMB 391 billion and the total ceiling of RMB 920 billion. One of the main advantages of RQFII is the ability to invest without capital flow or asset allocation restrictions.
RQFII fund holders have the ability to establish investment funds and make investment decisions according to their firm’s skill set and risk-reward strategies without implementing costly synthetic fund structures and exposure to counterparty risks. Even though the program is less than 50% utilized, it is expected to grow over time with potential expansion of the ceiling.

China’s “Managed Convertibility” Programs: Part 2 (Outbound Investment)
Qualified Domestic Institutional Investor (QDII)
The QDII program, launched in April 2006, allows licensed domestic fund management and securities companies to use funds raised in China to invest overseas. As with the QFII/RQFIIs, domestic institutions must apply for an investment quota with SAFE and set up an overseas custodian account for transactions and settlements.
Once the funds are raised, the QDII may invest in a range of financial instruments, such as government and corporate bonds, equities, funds, structured products and financial derivatives. However, direct investment in real estate, precious metals, and commodities as well as securities financing (except financial derivatives) and short selling activities are prohibited. Additionally, there are limitations on geography and asset allocation.

Qualified Domestic Individual Investor (QDII2)
The so-called QDII2 program, which is expected to be rolled out within the next year, aims to address capital inconvertibility for domestic high-net worth individuals. Media reports cite 6 pilot cities: Shanghai, Tianjin, Chongqing, Wuhan, Shenzhen, and Wenzhou.
Residents of these cities with a minimum of RMB 1 million of net financial assets will be allowed to purchase financial, real estate and industrial investments overseas. Annual foreign exchange conversion limit of USD 50,000 is expected to be relaxed for purposes of QDII2.

Appendix: China’s “Managed Convertibility” Programs: Part 3 (Other programs)
Shanghai-Hong Kong Stock Connect
The Shanghai-Hong Kong Stock Connect program, introduced in 2014, establishes access between onshore (Shanghai) and offshore (Hong Kong) stock markets. At the initial stage, only “A” shares (shares listed in Shanghai and denominated in RMB) that have a corresponding “H” shares (shares of mainland companies listed in Hong Kong and denominated in Hong Kong dollars) are available for trading.
Trading activities are subject to daily and aggregate quota set on a “net buy” basis, which means that unlimited sell orders are permitted. The aggregate quota is set at RMB 300 billion for “northbound” (to Shanghai) and at 250 billion for “southbound” (to Hong Kong).
As of July 2015, total northbound trading turnover (buy+ sell) was equal to approximately RMB 196 billion, while southbound trading turnover stood at HKD 93 billion. It is important to note that no day trading is allowed in the onshore market; while short selling is limited to the covered type and margin trading is restricted to margin trading-eligible securities.

Pilot Free Trade Zones
The China Pilot Free Trade Zone (FTZ) was first launched in Shanghai in September 2013 and expanded to three more areas in December 2014. It permits offshore investing for Chinese nationals living within the FTZ and onshore investing for foreign individuals working in the FTZ. The program also offers cross-border lending, allowing FTZ-based companies to borrow from offshore banks.
However, authorities have set up restrictions on RMB borrowing capacity and funds utilization, which make this feature somewhat limiting. Mainland-Hong Kong Mutual Recognition of Funds
Mainland-Hong Kong Mutual Recognition of Funds was implemented on July 1, 2015 and allows eligible Mainland and Hong Kong funds to be distributed in each other’s market.
Equity, bond, mixed funds and index-linked ETFs with a minimum size of RMB 200 million operating for at least one year are eligible, while gold ETFs, fund of funds and structured funds are not. There is a program utilization quota of RMB 300 billion and a maximum requirement for the investment and subscribers in the “host” (vs. “home”) market.

As a result of the trade settlement program, offshore holdings of RMB has grown from virtually nothing in 2009 to RMB 1.7 trillion in May 2015. Roughly half of these deposits are in Hong Kong, with most of the remainder in Taiwan and Singapore, and Korea. However, over the last two years, settlement centers have expanded to include a number of international cities.
London, Frankfurt, Seoul, Paris, Luxembourg, Doha, Sydney and Toronto were announced as new offshore RMB clearing centers in 2014, followed by Kuala Lumpur and Bangkok in 2015. The opening of these settlement centers, in addition to currency swap agreements between the PBoC and foreign central banks to provide access to RMB liquidity is likely to lead to further growth in RMB trade settlement.

Mainland Chinese citizens’ ability to invest abroad also remains restricted. The main program for mainland investors is of similar structure to the foreigner program. The Qualified Domestic Institutional Investor (QDII) program allows domestic financial institutions to invest in select offshore securities.

Joining the IMF’s official reserve currency club a key motivator for easing RMB restrictions
The main reason that China has accelerated its efforts to increase the use of the RMB is its desire to have it added to the IMF’s special drawing right (SDR) basket, putting it in a small group of recognized reserve currencies. The IMF makes its decision on the composition of this basket every five years and is expected to do so before the end of 2015.

Before we get into China’s motivation for joining the SDR, we must explain what it is.
SDRs are an interest-bearing reserve asset originally created by the IMF in 1969 to help maintain the Bretton Woods fixed-exchange rate system. The motivation for their creation was to meet the demand for reserve assets without having to create additional U.S. dollars, which had the byproduct of driving up the market price for gold and making it increasingly difficult to maintain the $35 an ounce dollar peg.
The SDR was intended to play a significant role in foreign exchange reserves, but with the collapse of the dollar-gold peg in 1971, it has remained marginal. The SDR is not a currency, but rather a claim on the freely convertible currencies of IMF members. Its value is determined by the weighted market exchange rates of the currencies in its basket.
The last weightings were decided in 2010 and put into effect on January 1, 2011. The dollar makes up 41.9% of the SDR basket, the euro 37.4%, the pound 11.3% and the yen 9.4%. The IMF allocates SDRs solely to countries (private entities cannot hold them). To date there has been a cumulative allocation of 204 billion SDR, which, is worth about $285 billion dollars. This represents 2.5% of the world’s total currency reserves.
SDRs still play a relatively small role in reserves for two main reasons. Firstly, there aren’t very many of them and new ones are only created on an ad-hoc basis – the last major allocation was in the aftermath of the 2009 global financial crisis. Moreover, the majority of countries who hold them are developed countries that have little need for them.
Secondly, SDRs can only be exchanged with other governments or the IMF itself. They cannot be used to settle trade, but only as a means to acquire actual currency from other IMF members. So, why does China want the RMB to join the SDR? Perhaps most pertinently because it will tell the world that its currency is worth holding in reserve and is safe to do so.
The IMF’s criteria for inclusion in the SDR basket is that it be freely usable, which the IMF defines as “a currency that is widely used for international payments and is widely traded.” China’s progress on the payments front is undeniable, but as discussed above, it still has some way to go to make the currency fully convertible for investment.
A second reason that China is interested in the SDR is its desire for it to play a more important role in global reserves than it currently does. This would require significant changes to its structure – allowing it to be held and traded by private entities for example and dramatically increasing its allocation. This is likely a long way off, but including the RMB in the basket is one step in the direction of a more representative global reserve asset.
The IMF has noted the deficiencies in the RMB’s convertibility, referencing the spread between onshore and offshore values of the RMB, a lack of transparency in financial data, and caps on deposit rates, among other things.
Still, the IMF has affirmed that China is taking the steps to remedy these deficiencies and may therefore decide that the RMB is freely usable enough. Regardless of this year’s decision, China’s growing importance on the international stage suggests that it is likely only a matter of time before it is allowed to join the club.
When it does, China will also likely disclose its reserve holdings to the IMF, which would reduce the ‘unallocated’ portion of reserves significantly and provide more clarity on the world’s allocation of foreign exchange reserves.4

RMB’s inclusion in the sDR is not a game changer
Given the SDR’s minor role in international reserves, the addition of the RMB to the SDR is more of recognition for the efforts that China has made to internationalize its currency, than it is itself a game changer. Importantly, the share of a currency in the SDR does not guarantee a requisite share in overall foreign exchange reserves.
The U.S. dollar’s share of total currency reserves is much higher than its 41.9% SDR share. Total claims in U.S. dollars represent 65% of allocated reserves reported to the IMF. The euro’s share is a fair bit lower at 21%, while the yen and pound sterling are relatively small players at just 4.1% and 3.9% respectively (see Chart 1 on page 2).

A crucial limiting factor to growing the RMB’s share in global reserves is how quickly China removes the remaining restrictions on investment flows to and from the country. However ingenious China’s efforts to improve the flexibility of the “people’s currency” in global capital markets have been, regulatory restrictions and frequent government intervention weigh down its utilization in comparison to fully tradable currencies.
The PBoC’s surprise announcement of a 1.9% devaluation of its currency peg is illustrative of this
point. While the move telegraphed as necessary to bring it in line with market rates, the market’s reaction was to follow the PBoC’s peg downward. The context of the move – a slowdown in economic growth and flagging exports – was not lost on market participants, and the response appears to suggest further depreciation is forthcoming.
The reaction of policymakers to the Chinese equity market nosedive also showed the instincts of authorities to control the outcomes of financial markets when they are not to their liking. As stock prices fell, more than half of market trading was suspended; forcing liquidity seekers to sell other assets, like interbank bonds, which cascaded losses into those markets.
Additional restrictions on short selling, futures trading and IPOs restrained domestic risk hedging and raised the price of options and futures tied to Chinese stocks in international markets. Such experiences provide much needed information on the spectrum of risks involved when investing in a state-controlled market that may diminish its attractiveness to foreign investors.
China is moving the dial incrementally, but it has a long way to go in building credibility and liquidity within its financial system to match the sophistication of the U.S. and others. Another challenge to the RMB becoming a major reserve currency is the orientation of its economy towards exports and investment.
The role of a major reserve currency comes with responsibilities as well as privileges. One of these is that if your currency is going to be stored by others in reserve, foreigners must have a way to accumulate it. This requires either buying more foreign goods than are produced domestically – running a current account deficit as the U.S. does – or lending and investing more in the rest of the world.
Chinese authorities have for decades done the opposite. The exchange rate has been used as a means to make exports competitive and capital has been restricted from leaving the country. This has resulted in the accumulation of $4 trillion in foreign exchange reserves – equivalent to roughly 40% of China’s GDP.
The growth in China’s foreign reserves – of which 65% or so is estimated to be in dollar-denominated assets – illustrates one of the elements that support the dollar’s role as a global reserve currency. In addition to insurance against capital flight, countries build dollar reserves in order to
gain a competitive advantage and sell more goods to the world’s largest importer.
This works because the U.S. is a consumption-based economy. China, on the other hand, is not. Consumption is less than 40% of China’s economy. Chinese economic reforms are aimed at making this transition, but for authorities that have for decades used the value of the currency as a means to drive growth, a stronger RMB may not be such a welcome development.
The recent devaluation is a reminder of this perception. Indeed, the drive to internationalize the RMB is coming at the same time that there are increasing signs that the Chinese economy is slowing dramatically and capital is leaving the country. In announcing its devaluation, the PBoC was careful to state that it was necessary in order to move to a more market-based system and still consistent with its financial liberalization goals.
Still, further depreciation would not be surprising. Given the dollar’s swift appreciation over the last year, the price of maintaining the RMB’s managed float with the dollar has been a significant loss of competiveness against a majority of its trading partners. Achieving adequate economic growth and avoiding capital outflows may not always be congruous with its goal of becoming a major reserve currency.

070611_ACUS_GBE_MapEconFinFuture.pdf

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