Courtesy of Patrick Chovanec
As the year comes to a close, and we look forward to 2012, I continue the tradition I started last year and offer a brief look at the top stories that shaped China’s business and economic climate in 2011:
1. High-Speed Rail. It was the best of times, it was the worst of times — China’s ambitious high-speed rail program embodied the highest highs and the lowest lows the country experienced this year. In January, President Obama cited the planned 20,000km network in his annual State of the Union address as a prime example of how America need to catch up to the Chinese. As if to prove his point, June saw the grand opening of the much-heralded Beijing-Shanghai line, timed to coincide with the Communist Party’s 90th anniversary celebrations. But even before then, there were signs of trouble on the horizon, starting in February when the powerful head of China’s railway ministry — the project’s godfather — was abruptly fired as part of a massive corruption scandal. Then a crash on a line near Wenzhou, in which at least 35 people were killed, unleashed a wave of fury on the Chinese internet, forcing the government to re-think the entire project amid charges of cover-up and sloppy construction. By November, with high-speed trains running at chronically low capacity and construction debts piling up, the railway ministry was asking Beijing for a rumored RMB 800 billion (US$ 126 billion) bailout just to pay the money it owed suppliers.
2. Inflation. Few issues preoccupied the average Chinese citizen — or Chinese policymakers — this year as much as rapidly rising prices. The consumer inflation rate, which began the year just shy of 5%,rose to 6.5% by July. The increase was led by food prices, particularly pork – a staple part of the Chinese diet — which skyrocketed by more than 50%. Keenly aware of the potential for popular unrest, Beijing made containing prices its top economic priority — even if that meant reining in growth. Throughout the year, the central bank repeatedly raised interest rates and bank reserve requirements, in an effort to bring the pace of credit expansion back under control. The powerful state planning bureau leaned heavily on Chinese companies not to raise prices, and even hit consumer goods giant Unilever with a stiff antitrust fine for publicly discussing possible price hikes. While CPI did decline to 4.2% by November, China still did not see a single month in 2011 in which inflation did not exceed the government’s 4% target for the year.
3. Real Estate Downturn. This fall, something strange began to happen. Real estate prices in cities all across China, which have risen phenomenally in recent years, began to drop. Property developers — who had borrowed heavily to pile up large amounts of unsold inventory, in the face of tightening credit conditions – began offering steep discounts (30, 40, even 50%) to get their hands on much-needed cash. Recent homebuyers, furious at having paid full price, demanded refunds and in some cases trashed developer showrooms. One property agency estimated that new home prices in Beijing plummeted 35% in November alone. Transactions volumes in cities across China have stalled, and local governments — dependent on land sales to fund their operating budgets and repay debt — arestarting to panic. Chinese investors, many of them holding several empty units as a form of savings, are looking on anxiously, wondering whether the bubble has popped, hoping the government will somehow engineer a rebound in 2012.
4. Wenzhou Credit Crisis. In September, reports began circulating in the Chinese media that dozens of business owners in the southeastern coastal city of Wenzhou had fled for parts unknown, leaving behind a shambles of unpaid debts and ruined companies. Two had even killed themselves by jumping from their office towers. Facing pressure from rising wages and input costs, as well as a less competitive Renminbi, these entrepreneurs had apparently gotten themselves enmeshed in informal lending schemes that had gone belly up — China’s own version of a “subprime” crisis. After Premier Wen arrived on the scene and directed local banks to extend emergency loans, many were quick to call it an isolated instance of Wenzhou’s trademark brand of seat-of-the-pants entrepreneurship gone awry. But others saw it as an alarming example of a much larger trend: an explosion in risky, off-books ”shadow” lending as a way around the government’s efforts to rein in runaway bank lending, a hidden, casino-like money market Fitch estimated at RMB 10 trillion (US$ 1.5 trillion). If so, they argued, Wenzhou’s woes could be just the tip of the iceberg.
5. Muddy Waters. When research firm Muddy Waters, founded by former journalist Carson Block, accused Chinese timber company Sino-Forest of exaggerating its land holdings and profits, it set off an avalanche. Not only did it cost hedge fund manager John Paulson — famous for betting against U.S. subprime mortgages – up to $500 million after the stock plunged over 85%. It also sparked a widespread hunt to identify — and sell short – other overseas-listed Chinese firms that might have something to hide, particularly “backdoor” or “reverse merger” listings which had avoided prior scrutiny. It signified a sea change in market sentiment: investors who, absent any direct knowledge, once assumed that all China stocks were winners, now feared they were all outright frauds. In November, when Muddy Waters turned its guns on Chinese advertising seller Focus Media, the stock plunged 66% at one point due to short-selling, leaving Chinese overseas-listed firms feeling bruised and battered, and wondering which of them could be in the cross-hairs next.
6. RMB Internationalization. This year saw numerous high-profile predictions that China’s currency, the yuan (CNY) or Renminbi (RMB), is destined to supplant the dollar as the world’s leading reserve currency. As if to realize this aim, the Chinese government embarked upon a number of steps intended to increase the use of the RMB beyond China’s borders. It expanded its currency swap arrangements with other countries, authorized more dim sum and panda bonds to be issued in RMB, and encouraged Chinese exporters and importers to settle their trade bills in yuan. One result was a dramatic expansion in holdings of offshore RMB in Hong Kong (CNH), which doubled to RMB 620 billion by October. Critics, however, counter that the yuan is still a long way from free convertibility — a prerequisite for any truly international currency — and point to a late-year fall-off in CNH deposits as evidence that willingness to hold yuan was primarily driven by short-term speculative interest, rather than longer-term faith in the RMB.
7. Eurozone Crisis. The frantic efforts by European leaders to stave off a debt meltdown and save the Euro may have unfolded in Athens and Frankfurt, but all eyes were on Beijing. After an emergency summit in October agreed to expand the Eurozone bailout fund to €1 trillion, the head of that fund flew immediately to Beijing, hat in hand, to ask the Chinese to chip in from their massive foreign reserve holdings — a move some said marked China’s emergence as the world’s top economic power. Earlier, Italy had floated the idea that China’s sovereign wealth fund would step in and rescue its bond market, and make much-needed investments in its economy. The Chinese, while undoubtedly flattered, in the end were cool to the notion of “saving the world,” insisting they had their hands full with their own problems. Among them: fears that a renewed downturn in Europe would hurt demand for Chinese exports, and slow China’s growth. By the end of the year, however, China did make at least one major acquisition in Europe, when its Three Gorges power company bought the Portuguese government’s 21% stake in Energia de Portugal (EDP) for $3.5 billion.
8. U.S. Currency Threats. Despite the fact that China’s currency steadily appreciated throughout 2011, ending the year up nearly 5% against the dollar, the sluggish U.S. job market ensured that the exchange rate remained firmly in Congress’ political crosshairs. In October, the U.S. Senate finally passed a long-threatened bill to impose wide-ranging trade sanctions on China in retaliation for its currency policies, by a vote of 63-35. Chinese spokesmen reacted with predictable fury, but Speaker Boehner prevented the bill from reaching a vote in the House, saving President Obama from an awkward election-year veto decision. While Boehner called the bill “dangerous,” the front-runner for the Republican presidential nomination, Mitt Romney, racheting up his rhetoric on China, promising to declare China a “currency manipulator” on his first day in office – all of which suggests a rocky road for US-China relations as the U.S. enters next year’s election season.
9. National Social Insurance Law. Last November (2010), China passed a national social insurance law – a major milestone that replaces a confusing and inadequate hodgepodge of local programs and taxes. However, when the law went into effect this July, foreign businesses in China had an unwelcome surprise: a little-noticed clause that required foreign expats to pay into the system — despite the fact that no collection mechanism had been set up, despite the fact that in most cases it would be all-but-impossible for them to collect any benefits. Then the northeastern city of Dalian — at the prompting of China’s Ministry of Finance — suggested it planned to lift the cap on income subject to payroll taxes, effectively subjecting foreign expats and other MNC employees to a 30% tax on top of China’s 45% income tax rate. So far, appeals to modify the policy have gone unanswered, even though more labor-intensive foreign-run businesses, like international schools and hospitals, say it is a deal-killer for operating in China. The new taxes, along with a secret circular restricting the ability to foreign firms to reinvest profits within China (which has since been scrapped), and an apparent crackdown on a commonly-used investment structure known as Variable Interest Entities (VIEs) all have contributed to a climate of growing concern and uncertainty that may help explain, at least in part, the recent decline in Foreign Direct Investment (FDI) into China.
10. Telecom Antitrust Investigation. In November, China’s two state-owned telecom giants, China Telecom and China Unicom, admitted fault and reached a settlement with antitrust regulators in an investigation into price-fixing and other anticompetitive practices in their broadband internet access business. The case, which was brought by the powerful National Development and Reform Commission (NDRC) — and according to earlier reports involved billions in potential fines — was the first under the country’s new Anti-Monopoly Law (AML) that targeted a Chinese state-owned enterprise (SOE). Previous cases had uniformly focused — many argued unfairly — on acquisitions or pricing behavior of foreign firms, despite the fact that Chinese SOEs often occupy semi-monopolistic positions in protected markets. The investigation and its outcome, which the NDRC says will save consumers money, raises the encouraging prospect that Chinese regulators may — at least in some circumstances — be willing to impose discipline on powerful state companies, which often behave as a law unto themselves.