Q&A: Matthew Crabbe on how to read Chinese economic data A failure to clean up dirty land could threaten urbanization Chasing the cloud Chasing the cloud Microsoft and Amazon battle it out Microsoft and Amazon battle it out 中经评论:营销大趋势 中经评论:营销大趋势 www.chinaeconomicreview.com JULY 2014 VOL. 25, NO. 7 BUSINESS EDUCATION
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Q&A: Matthew Crabbe on how to read Chinese economic data
A failure to clean up dirty land could threaten urbanization
Chasing the cloudChasing the cloudMicrosoft and Amazon battle it outMicrosoft and Amazon battle it out
MONTH IN REVIEW06 NEWS BRIEF | Th e biggest China news stories in June
COVER STORY16 GRAND DREAMS | Can foreign companies crack the Chinese cloud computing market?
MARKETS & FINANCE29 CASTING LIGHT ON SHADOWS | Stringent regulations to curb informal lending could end up hurting the economy
ECONOMICS & POLICY24 GROUND WASH | With almost 20% of its arable land contaminated China can’t aff ord to look the other way, but the country is struggling to put the incentives in place to start cleaning up27 SELLING THE STATE | China shuffl es the deckchairs of state ownership with Citic Group’s backdoor listing
Q&A AND COLUMNS
08 LIES, DAMNED LIES AND CHINESE STATISTICS | Understanding the Chinese economy requires a healthy dose of skepticism of all and any data coming from the government 10 DON’T OVERESTIMATE EUROPE’S DIVISIONS | Europe’s economic crises make it look weak to the Chinese but Beijing should not underestimate how united the 27-nation bloc actually is12 FORESEEING TROUBLE | Foreign brands shouldn’t wait for a crisis to starting thinking about crisis communications14 STRENGTH OF THE NATION | Th e success of internet giants Jingdong Mall and Alibaba shows that Chinese companies can develop into world leading businesses
THE HOUSE VIEW04 SOULLESS HOMES | Chinese culture all but forgotten in the rush to urbanize
Ta n g d y n a s t y p o e t H e Zhizhang returned from a long sojourn abroad balding
and as a stranger to his children. A contemporary poet in China might lament a homecoming strange, disori-enting, even alien.
“Where is your memory? You will one day return to your hometown without recognizing anything. How do you call this place your hometown?” Qiao Runling, a deputy director at the National Development and Reform Commission, said in April at a real es-tate forum in Shanghai.
Qiao wasn’t reciting poetry, but his comment captures the problem with urbanization in China today. The framework planners have used during the past 30 years to build cit-ies has been overly simplistic, void of creativity and without consideration for local culture. The same drab style of concrete and steel has risen in hun-dreds of urban centers. The results are wide boulevards that bisect tall apart-ment blocks for as far as the eye can see. Even the street names are inter-changeable between cities.
“Most cities look alike. Most cities have similar buildings,” Qiao said. “If you walk around China, we see more and more similarities rather than dif-ferences.”
From a random street corner in any given medium-sized city, distin-guishing it from the next one can be a difficult task.
Perhaps the most devastating as-pect of this dull urban expansion is the lack of demand for it. Planners have drawn up master designs for their cit-ies with little regard for who might come to live in them. At a talk at the European Chamber of Commerce last month, Paul Procee, lead urban spe-cialist at the World Bank, drew a pic-ture of how Chinese cities were shap-ing up without heed to market forces.
“The government builds these 10 roads next to each other, perfectly
squared with humongous apartment buildings in between,” Procee said. Yet, at the same time, “on the fringes [of the cities] you see these informal three-story buildings coming up in a completely random way, and the gov-ernment is not really paying attention to that.”
“What is being built in lots of these small counties are buildings that are for the middle class. And you really wonder, who are going to be the ones occupying this?”
In many of China’s more than 600 official cities, the answer could be no one. The middle classes already dwell in apartment buildings. Many of them will upgrade to bigger cities, particu-larly the first-tier cites.
But for the county-level cities, where urbanization is currently fo-cused, there are limited buyers for these flats. Such real estate isn’t priced for migrant workers, the heart of China’s urbanization process, Procee says. That’s why a market for informal housing on the outskirts of town is booming.
This model for urbanization is broken. In fact, from the perspective of many economists, the Chinese gov-ernment never had it quite right.
Policymakers for decades have called urbanization the driving force of growth in the Chinese economy. This theory casts migrant workers – once they have made the leap from vil-lage to metropolis – as urban consum-ers who will buy cars and apartments upon arrival.
The Chinese government has it backwards, however. Towns cannot be built from scratch and the masses expected just to flock there; emerg-ing urban areas need to demonstrate growth, innovation and develop new industries to attract a steady stream of people looking for work. For each migrant that enters a city, healthcare and education should be made avail-able. Local governments must also
Soulless homesprovide subsidized housing. All of this is a huge cost to the state.
“Urbanization, in other words, is a consequence of rising wealth and can accommodate it,” Michael Pettis, an economics professor at Peking Uni-versity, wrote in his blog last year. “It is not a cause of rising wealth.”
Ignoring the real source of demand for housing and confusing the drivers of urbanization have produced China’s infamous “ghost cities” – new, sprawl-ing urban areas with few residents. This stubborn central planning is also rendering the bulk of Chinese cities cultural wastelands.
Where, then, is the real demand? And where is the real China among the myriad of faceless cities? The an-swer could be one and the same, says Qiao at the NDRC.
As China continues to urban-ize, local governments and property developers must start taking into ac-count local culture. Traditional Chi-nese painting and poetry often depicts quaint river towns with a slow, leisure-ly pace of life.
Such art might romanticize the notion of a peaceful lifestyle, but Qiao says the Chinese people yearn for a more culturally enriched experience. Small towns, ones that reflect the local culture and history of the region they are based in, could be the future of ur-banization in China.
The past 30 years has been spent wiping these places off the map. The small river towns that have survived are more akin to tourist attractions than living spaces.
“Actually, conventional urbaniza-tion is the elimination of local culture. That is a very harsh statement,” Qiao said. “Chinese people have demand for peaceful lifestyles. They want this kind of residential environment but the market cannot provide it now. So the next step is building peaceful, small towns. This will be the next step in urbanization and a new opportunity.”
Chinese culture all but forgotten in the rush to urbanize
THE HOUSE VIE W
China Economic Review | July 201404
NE WS ROUNDUP
MONTH IN REVIEWEconomyChina’s exports gained 7% in May from a year earlier, Bloomberg reported, citing a statement by China customs. The gain, which surpassed analysts’ median estimate of 6.7% in a Bloomberg News survey, helped to cushion a slowdown in China’s economy amid a 1.6% fall in imports – a drop that was not forecast by any economists in a survey that had a median projection for a 6% gain. The trade surplus widened to US$35.92 billion. Stronger exports may con-vince Chinese leaders that a bigger stimulus package for the economy isn’t necessary.
China’s economic development slowed further this quarter as capi-tal spending showed weakness and fewer companies applied for credit, Bloomberg reported, citing a quar-terly report by China Beige Book International. Fewer than half of businesses reported higher invest-ment, the smallest proportion and sharpest drop since the survey began
ten quarters ago. The slowdown hurt hiring and wages, and interest rates offered by shadow lenders fell below those offered by banks. For the first time since the survey began, no sector showed improvement compared with the previous quarter.
Chinese Premier Li Keqiang is con-fident that China will meet its annu-al growth target of 7.5% for 2014, Reuters reported. Writing in Britain’s The Times newspaper on the eve of his visit to London, Li said slowing growth in the world’s second-larg-est economy was normal and not a problem. “China’s economy needs to grow at a proper rate, expected to be around 7.5% this year,” Li wrote. “It is slower than the past, but normal.” Li also wrote that the Chinese gov-ernment was ready to adjust policy to make sure it does hit the target.
FinanceChina needs to make the yuan more flexible to cope with rising capital flows, Reuters reported, citing Ma Jun, the chief economist at the cen-tral bank’s research bureau. Ma said that capital inflows into China’s bond market could increase as domestic bond yields are higher relative to over-seas markets and that as China’s capi-tal account is already partially open, there could be “a substantial increase” in outbound foreign direct investment if China further loosens its grip on capital flows. As part of its ambitions to turn the yuan into a global curren-cy, China plans to free up its capital account though authorities have said some restrictions will be kept in place.
Direct trading of the yuan and pound started in the UK in mid-June as London stole a march on European rivals seeking to deal in the world’s second-largest trade currency after the US dollar, Bloomberg reported. While four other nations had already signed such accords with China, the UK’s deal made it the first Euro-pean country to do so. London has been competing with cities including Frankfurt to become Europe’s off-shore yuan hub. China is seeking to strengthen commercial relations with European countries.
WE’LL GROW: Ahead of a vist to London in June Premier
Li Keqiang said China would meet its 7.5% GDP target
CHINA BY NUMBERS
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Size of stake Alibaba Group is buying in Guangzhou Evergrande Football Club
Ratio of vacant homes in China’s urban areas in 2013, a survey showed
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134Number of environmental courts set up local governments
$2.06bnValue of China South City’s investment in e-commerce push with Tencent
China Economic Review | July 201406
The People’s Bank of China has suspended the launch of the coun-try’s first asset-backed security, South China Morning Post reported. Ping An Bank filed an application in May to sell a credit-backed product worth RMB2.8 billion (US$481 million) to the Shanghai stock exchange, which operates under the China Securities Regulatory Commission, without informing PBOC. PBOC insisted the suspension was in compliance with government directives, as institu-tions are required to file ABS issuance plans to the central bank before list-ing. Market observers said the power struggle among regulators is a major obstacle to reforming China’s finance industry.
Politics and societyUS-China cooperation on cyber-crime has stalled since the US indict-ment of Chinese officials on hack-ing charges, while Chinese hacking efforts have continued unabated, Reuters reported, citing comments from a senior US security official. In May, the Justice Department charged five Chinese military members with hacking US companies to steal trade secrets, prompting Beijing to sus-
pend a Sino-US working group on cyber issues including money laun-dering, child pornography and drug trafficking. The indictments, the first criminal hacking charge the US has filed against specific foreign officials, strained US-China commercial rela-tions and created troubles for US technology companies in China.
China plans to build a school on the disputed Paracel Islands, BBC News reported, without citing a source. The move would boost China’s presence in waters also claimed by Taiwan and Vietnam. China calls the island Yongxing and has been building up a settlement there for the last two years. The school is expected to serve just 40 children, whose parents all work on the tiny island. In May, Chinese and Vietnamese ships clashed over a drilling rig that China has placed near the islands. Beijing claims a U-shaped swathe of the South China Sea.
BusinessChinese telecoms equipment maker Huawei Technologies plans to add 5,500 employees in Europe over the next five years, Bloomberg report-ed, citing Chief Strategy Market-ing Officer William Xu. Shenzhen-based Huawei now has about 7,700 employees in Europe. The company is adding workers as it competes for business in the region against rivals including Alcatel-Lucent and Erics-son. Huawei has said it is focusing investment on countries where it has been accepted, after lingering sus-picions in the US that its gear may give Chinese intelligence services the opportunity to tamper with networks for spying.
General Motors announced in a fil-ing with US safety regulators that a defective ignition switch was man-
ufactured by Chinese-based Dalian Alps Electronics, Reuters reported. The switch was used in nearly 3.4 million Chevrolet Impala and Monte Carlo, Buick LaCrosse and Lucerne, and Cadillac DeVille and DTS cars that were recalled on June 16, mark-ing the second time this year an auto manufacturer has discovered a problem with a China-made part. In February, British car maker Aston Martin recalled most of its sports cars built since 2007 after discovering a Chinese sub-supplier was using coun-terfeit plastic.
Uganda plans to invite six Chinese companies this month to bid for up to US$8b worth of rail project con-tracts, Bloomberg reported. “Bid-ding documents will be ready by July 10 and we are inviting only Chinese companies,” Uganda Works Minister John Byabagambi said. “We shall sign engineering, procurement and con-struction contracts with the winners.” The first phase of Uganda’s planned railway construction covers 1,000 kil-ometers, stretching from the country’s border with Kenya to Rwanda and a town near the border with the Demo-cratic Republic of Congo, Byabag-ambi said. Work on an extension will take place later.
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China Economic Review | July 2014 07
Q&A: READING ECONOMIC DATA
Lies, damned lies and Chinese statistics
Given its sheer size the Chi-nese economy
is closely scrutinized by the world. But a lack of transparent economic data makes this job dif-ficult, and is a source of much ire among foreign observers. They’re not the only ones struggling, however, says Matthew
Crabbe, Asia Pacific research direc-tor at consumer insights firm Mintel. The Chinese government is as much in the dark as anybody when it comes to Chinese numbers. In an interview with China Economic Review, Crab-be, who is also author of the recently published book Myth-Busting China’s Numbers, gives his thoughts on proxy measures for China’s economy and explains why we should pay more attention to consumer data.
There is a lot of skepticism among foreign observers of official Chinese data. It can’t all be unreliable, can it?I don’t think any statistic is ever en-tirely accurate; it’s just the best esti-mate. I think one of the things about China is that it’s growing so fast that the expectation that the data could be accurate in such a situation is probably a false one. And I think the problem China presents is that common west-ern expectation is that if the figures are published, that they therefore must be true. So yes there are problems in the data but it’s by order of degrees. As with anywhere, there will be slight inaccuracies in gathering data, and of course in China those get amplified as you go up the different levels towards the national picture.
Yes, there are problems with the GDP figures. But I think there are other common assumptions that I hear such as that the Chinese govern-ment knows what the real figures are and they don’t like to publish them. I think the Chinese government is as much as in the dark about what the real numbers as anybody else. If you think about it, the Chinese govern-ment needs an accurate picture as pos-sible. They need to tax the economy so they can provide social services as a government. But the depth of that coverage remains very thin. It still needs a lot more money. The only way they can pay for that is tax from the economy, but without accurate figures it’s very difficult to do that.
How should we read economic data given regional disparities in report-ing numbers?Well, here are what we think is a common problem. We often look at a figure, and we assume that’s true. You read the figure, but you don’t in-vestigate it. I think what you have to do is that you have investigate it, and not assume that figure says it what it is. One of the key things with a statistic is investigating how it was created it, why it was created, what the problems might be, what the definitions are. Before we agree on these numbers we have to know where they came from.
Investment banks are constantly try-ing to forecast the country’s growth figures, and in so doing, have relied on an ever-changing array of proxy statistics such as rail freight volume. What are the most reliable proxy statistics for GDP now?As the economy shifts away from ex-port manufacturing, more towards domestic consumption, the range of proxies definitely have to shift. Before, statistics on cement, power genera-tion had always been useful. Figures on construction and heavy industrial inputs are proxies for how industry is doing, and just looking at that now, its quite limiting. You need to under-stand what’s happening in consumer markets. You could look at retailers. I know some investment banks that are looking at the growth of KFC and cer-tain retail companies. That could give you an idea of where the consumer market is going. Household spending indicators that come from the govern-ment - the rural and urban household consumptions surveys are quite inter-esting. These figures might be skewed
Understanding the Chinese economy requires a healthy dose of skepticism of all and any data coming from the government and a willingness to dig very deep
“I don’t think any statistic is ever entirely accurate; it’s just the best estimate. I think one of the things about China is that it’s growing so fast that the expectation that the data could be accurate in such a situation is probably a false one ... So yes there are problems in the data”
China Economic Review | July 201408
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Matthew Crabbe
but they give you a good indication of trends. Now, you’ve got big data in the form of the trends that are generated by online retail sales, which can be more time-sensitive and more current. These can be quite useful indicators and proxies as well.
Economists have complained that accurately measuring China’s serv-ices economy is close to impossible. How can we go about measuring it, or at the very least, improve methods of measuring it?I know the National Bureau of Sta-tistics is staring to try and measure services much more than in the past. It might take a while to really develop the figures. The way I did it with retail was to do it from the bottom up. And, in the end, I think that’s the only way you can do it. Split services into their component parts and research each one individually, and get the picture from the bottom. Services is different from retail because retail is volume of sales, whereas services is value-added, in terms of the value of human service, so for example you need to look at wages in the different services sectors to get an idea of growth and the rela-tive strength of different services.
By clamping down on corruption at state-owned enterprises the gov-ernment could be looking for a way to get better information on corpo-rate revenues. Do you think there is some truth to this?The government has social security net spending duties to fulfill and to be honest the money has not been enough to cover what it really needs to cover. The only way they’re going to get that [money] is if they can get true figures from companies, and particu-larly state-owned enterprises. A few months ago, the national oil corpora-tion was caught for under-declaring its profits and not paying enough tax. If flagship state-owned enterprises are avoiding tax, what’s the picture under-neath that? Of course, it’s widespread. That’s a real problem, because this is money that should be going to the government coffers. But the money isn’t there. I think its part of clamping down on this rife tax avoidance.
What are the mistakes that foreign companies make when using data to enter or expand in China and how can they try and avoid them?One of the main mistakes that for-eign companies make is reading a figure and believing it. If you really want to operate in China, you’ve re-ally got to know it. It comes back to forensic due diligence into the figures and understanding the granular and the micro markets that you’re dealing with. Ask: What do consumers really want to buy? Not just assuming what people are buying, when that might be because that’s all there is available to buy. It’s about getting that much better understanding and not assuming what you’re told is true.
If you could have any complete eco-nomic data set, what would it be?Services are the one grey area that peo-ple really need to work on. What do people rent? Who do they hire? What do they spend doing rather than buy-ing? I think there’s a big shift in the consumer market more towards buying experiences rather than buying things. It’s about quality of life. We think this kind of thing is becoming much more important, it’s how you use your time, your life to your best advantage. It’s “I don’t want to spend hours doing the laundry, I want to have somebody else do it, or have somebody else collect it, wash it, and then send it back to me”. That’s the kind of thing people want. It’s that lifestyle efficiency if you like.
Services are only going to grow and grow. If we have a better measure on that, we’ll have a much better measure on the real economy.
What are your biggest headaches when developing data on China?I think it’s just that you have to cover so much. It’s such big numbers. Be-cause it’s such a big country, the mar-gins of error can be amplified greatly. I think that’s the real issue with China, the sheer size of it and the fact that it keeps changing. You can’t go back and assume the figures you had last year were correct. You have to pretty much start from scratch every time, so that you can revise upwards, well, usually upwards. It’s just hard work.
What’s your most significant discov-ery about China data from writing the book?We all know China has grown big and fast. But I think the one thing that surprised me is the fragility of the economy, still. The fact that there are problems with corruption, a lack of a social security net, a lack of labor mobility, a lack of rule of law in cer-tain aspects of the economy and also the amount of debt there is. In 2012, it was something like 205% of GDP. According to Standard Chartered, in the first quarter of this year total debt amounted to around 250% of GDP. So, it’s getting worse. It’s that fragility that frightens me, and something that continues to concern me.
Q&A: READING ECONOMIC DATA
China Economic Review | July 2014 09
WE DON’T KNOW IT ALL: Crabbe says that a healthy dose of skepticism should be applied to all num-
bers on China, not only the offi cial data produced by the National Bureau of Statistics (pictured)
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China Economic Review | July 201410
Q&A: EUROPE AND CHINA
Stonger together
Barely two years ago a severe financial crisis unfolding in Europe saw many Chinese
commentators predict the end of the union and its continued decline in the global order. But internal divisions have been exaggerated, says Nicholas Veron, a senior fellow at Bruegel, the EU’s eminent economic think tank. The Chinese should not underesti-mate the political and economic unity that still exists on the continent.
Retaliatory tariffs continue to be a problem between the two regions. Will it continue to be a viable policy tool even when the China is making overtures to a possible bilateral free trade deal with the EU?There are disputes all the time at the WTO. The rules are clear, and the dispute resolution mechanisms are clear. That shouldn’t prevent China
Europe's economic crises make it look weak to the Chinese but Beijing should not underestimate how united the 27-nation bloc actually is
and other jurisdictions including the EU from negotiating free trade agree-ments, but if one of the parties doesn’t play by the rules, it’s perfectly normal that the other party should enter into a dispute process. I know that not everybody in China is happy about the rulings of the dispute settlement mechanism within the WTO, but the [fact that] China has decided to sub-mit itself into the WTO, therefore I think it is now part of the established framework, and it certainly shouldn’t prevent China from negotiating other, deeper trade negotiations with other jurisdictions and not only the EU.
What is the likelihood of a China-EU free trade agreement, consider-ing that the EU has a chronic trade deficit with China?I don’t think that’s a problem. Ob-viously, some member states of the
EU are more enthusiastic about the China-EU free trade agreement than others. I don’t think that’s primarily linked to the question of the deficit; I think it’s more about general attitudes to globalization. It’s a well-known fact that some countries are more comfort-able with globalization than others. To be specific, France and Italy have mis-givings about globalization that other member states of the EU don’t neces-sarily share.
So you have a political process in-side the EU that is going to affect the prospect for China-EU trade negotia-tions. And, of course, it will be affected to a large extent by components in the international landscape, includ-ing, not least, whether or not there is the prospect of China participating in agreements such as the TPP [Trans-Pacific Partnership] or not. At this point, there isn’t much chance of such a prospect, but I can imagine scenarios where that would change.
Obviously a China-EU free trade agreement is not a completely straightforward proposition from a political standpoint. It’s a trade agree-ment more difficult to achieve than Iceland or Switzerland, both of which are outside the EU. As we know, the EU has signed an agreement with [South] Korea. If China is willing to enter the same sort of discipline that its smaller neighbor in the east did, you could imagine, in principle, there would be openness on the side of the EU. The politics is complicated, be-cause the EU is complicated, since there are different member states with different sensitivities.
China appears to play European nations off against each other to pre-vent collective EU action in trade disputes?Well, I think you’re right. It’s simple. When they’re divided, they’re weak; when they’re united, they’re strong. So
UNITED FRONT: German Chancellor Angela Merkel poses with French President Francois Hollande
China Economic Review | July 2014 11
Q&A: EUROPE AND CHINA
it’s not a very good idea to play divided in this game, and there is no question, as you said, that China has on a num-ber of issues, not just economic issues but also more diplomatic issues, typi-cally looked at Europe as a collection of countries and felt more comfort-able dealing with individual countries, at the risk of sometimes creating the feeling at EU institutions that China was a attempting to undermine the authority of EU institutions. I think that’s a correct description of what we’ve seen in recent years.
What does it mean for the EU that China will become the world’s larg-est economy, and how should the continent position itself for this eventuality? China is a very large economy; the US is a very large economy. The fact that China is a bit smaller or a bit bigger than the US in my view is not a big factor. I think what is a big factor is China becoming such a big part of the world economy. But that’s not particu-larly new.
In fairness, there are people in the EU who haven’t adapted to this real-ity, who continue to have this very old thinking, looking a bit down at China and feeling a sense that Europe, be-ing part of the West, has a form of economic superiority. I think this is completely outdated, misguided and counterproductive. But it is true that you have that mindset in some corners, I hope backwater corners, in EU insti-tutions. To the extent it still exists is deteriorating rapidly. In a word, China gets a lot of respect from Europe, and properly so.
As China stakes out its own place in the world it sometimes clashes with the international rules established by western nations post-World War II. How can Europe get China to be a more engaged and responsible player in the global system?My observation is that in the econom-ic area, not talking about the rocks in the South China Sea, China has gen-erally adapted itself to the internation-al framework. It is a member of the WTO and the IMF; it is compliant with Basel III and all these interna-
tional financial standards. Well, they’re not perfectly compliant, in accounting there’s a difference between interna-tional reporting and Chinese account-ing standards. But if you compare this with the US, China is more compli-ant with the ISRS. In general, it seems to me China, in economic norms and standards, has been willing to adopt a framework that was largely shaped by Western nations. Now it’s changing, of course. Emerging countries and China first among them are having a bigger impact on these global institutions.
There is a widespread feeling, however, that it’s a fairly different logic in the minds of these Chinese leaders. So they are basically separating eco-nomic integration from geopolitical, or at least, regional thinking. Now obviously if you play through certain escalation or even conflicts, that would establish a link between all these dif-ferent barriers. And we see that, for example, in the case of Russia and Ukraine, geopolitical confrontation can lead to reversals in the economic area, but fortunately, China has not so far come near the point where you would have this sort of overlap.
The Eurozone crisis has deeply diminished many normal Chinese people’s views about Europe as a global economic and political actor. Is it possible to reverse this decline in perception of the continent, or is it doomed to second-tier status?The euro crisis has been very difficult for Europe, and Europe has lost wealth and influence in this crisis. So there is no denying this. Having said that, I think my impression when I’m in Asia, and its not just in China, is that per-haps the number of observers in Asia have overreacted and perceive Europe as even weaker than it really is. So I think it’s important to really monitor what is happening in Europe, even if it’s very complicated, and often very boring. To be blunt, two years ago, the overwhelming consensus in Asia was that Greece would leave the Eurozone, and possibly the Eurozone would break up, and this hasn’t happened. So there is often an underestimation of those strengths that still exist
both from an economic and political perspective. So maybe there is a bias perceiving Europe as less cohesive and decisive, and less able to make joint decisions than the reality.
London, Frankfurt and Luxem-bourg are all establishing renminbi-clearing hubs in Europe. How does this play into the internationaliza-tion of the renminbi? Financial centers, which deal with the renminbi transactions, will perhaps have a big influence on the pace of the yuan’s liberalization. But the most important factor remains the thinking within the Chinese government; at this point I think we’re still far from a true internationalization of the ren-minbi for financial transactions. Of course there’s a lot that has been al-ready completed for trade transactions, but that’s a differ-ent thing.
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Foreseeing trouble
What PR trends are you seeing in China?The concept of SoLoMo, which stands for social, local and mobile and was coined by John Doerr in 2011, nicely explains what I see the PR trends are like in China. China currently has 618 million internet us-ers, 500 million mobile internet users, 281 microblog users and 355 million users of WeChat [a mobile messag-ing app].
With such a huge number of ne-tizens, social media and digital com-munications is a key trend if you want to communicate effectively in China. Traditional media, such as television, radio and print media remain impor-
Claudia Choi, vice president of Greater China at EBA Communications, gives her thoughts on PR in China and why foreign brands shouldn’t wait for a crisis to start thinking about crisis communications
tant though. The adoption of smart-phones and tablets, as well as the in-troduction of 4G telecommunication standard enable seamless communi-cations via mobile.
When we talk about PR in China, we talk much about local. To reso-nate, PR practitioners have to identi-fy local news angles to do storytelling appealing to the local audiences. It is also important that a company is per-ceived to be committed to the China market and actively contributing to local society. On the other hand, PR companies should also realize the potential of local companies who are actively going and looking to go in-ternational. Agencies are required to help their local clients to go global.
Can you give some examples of your work for clients in China?More and more clients come to EBA for integrated communications. It is to support them from setting up marketing communications strat-egy, developing message framework, training local spokesperson, media relations, social media, event man-agement and measurements.
PR is a creative industry. We must be able to anticipate and to create. The challenges are hence to stay up-to-date on the local politi-cal, economic and social matters and to anticipate the upcoming commu-nications channels and how differ-ent audiences react to these com-munications channels to find the best way to be agile.
Do Chinese and foreign firms h a v e b i g d i f f e r e n c e s i n
requirements? If so, what are they?
Both Chinese and for-eign companies are get-ting more aware of the
importance of building, reinforcing or reinventing their brands and are taking actions to step up their com-munications efforts. I will say that it is to do with the aspiration for trans-parency from the general public and market competition.
Do you advise on crisis PR? What advice do you have for foreign companies that can be the target of media scrutiny like McDonalds and Apple?In most cases, a crisis arises or gets escalated because of poor communi-cations.
EBA does crisis communications. This is a service which we are doing very well and seeing more and more interest from clients. We help clients to set up crisis communication strat-egy, guidelines and procedures and processes to mitigate risks, minimize damage or even turn around a crisis to enhance the image as a good cor-porate citizen. In short, companies should not wait till a crisis comes to start thinking of
“My message to foreign companies is that they should never be perceived to apply double standards between their home country and in China. They need to show long-term commitment to the China market”
China Economic Review | July 201412
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Q&A: PR IN CHINA
crisis communications.My message to the foreign com-
panies is that they should never be perceived to apply double standards between their home country and in China. They need to show long-term commitment to the China market.
How do you see the Chinese market developing? What sorts of PR serv-ices do you see companies operat-ing in China needing in the future?I started doing communications in China dating back to 1993. I am amazed by how much China has achieved. In the old days, communi-cations was more focused on product promotion. It was used to support sale and business development. Com-panies are becoming more committed to reputation management. It also leads to a blue ocean for PR practitio-ners and it is CSR [corporate social responsibilities] communications.
As mentioned above, integrated communications is a key driver in the PR industry globally and in particu-larly in China. Most Chinese compa-nies have just started seriously doing communication. They need to heav-ily invest in the groundwork. That is strategy, message development, crisis
communications, communications training and the cultural difference between China and any of the mar-kets Chinese companies want to go to. I am pleased to see that Chinese companies are getting more confident and be willing to communicate.
One very interesting thing I can see is that many companies are put-
ting focus on internal communica-tions. It is to engage and embrace their employees. Talent acquisition and staff retention is a major chal-lenge too.
To effectively communicate, people go back to the basics. Con-tent is more recognized as the king [in communication]. Channel comes second. PR practitioners must be able to generate content, both written and non-written, to reach the people who matter via the different and evolving communications channels. Mobile communications also enable commu-nications in a global scale. It brings out the importance of visual content like videos, photos and infographics.
What is the challenge that you face from local PR companies?I see lots of opportunities for PR companies in China. I am also pleased to see that local PR companies are competing with their international counterparts. I always think that EBA sits in the middle of local and international companies as our ori-gin was from Hong Kong. We know both sides of the fence well. It is also our unique selling point that we can bridge the East and the West.
“Most Chinese companies have just started seriously doing communication. They need to heavily invest in the groundwork. That is strategy, message development, crisis communications, comms training and the cultural difference between China and the world”
China Economic Review | July 2014 13
Q&A: PR IN CHINA
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UNDER FIRE: Choi says that foreign companies in China shouldn’t wait until a crisis to start thinking about crisis communications
COLUMN: INTERNET GIANTS
Strength of the nation
In late May Chi-na’s largest online direct sales com-
pany, Jingdong Mall, raised US$1.8 billion in an IPO on the Nas-daq. Coming soon, its domestic rival Alibaba Group, the largest e-commerce company in China as well as in the world, will also list
in New York. It is expected that the IPO will raise US$20 billion, surpass-ing the total generated by Facebook and making it the biggest internet firm in the world by market value.
This fantastic figure has caused uproar on Wall Street. The coverage in the English-language media is over-whelming. Some people have gone so far as to ask, with astonishment, “When has a Chinese company ever been the world’s No.1?”
It is indeed rare for Chinese com-panies to become global leaders in any industry, especially one as advanced as technology. But Alibaba has done so. Reports show that Alibaba’s web-sites had a turnover of US$248 billion in 2013, more than the sum of both eBay and Amazon combined. Leaving other data aside, this alone is enough to declare its No.1 position in the field of e-commerce.
In order for China to really express her global economic power it is not necessary for the country to rank first by GDP size or to have skyscrapers bloom in cities everywhere. Instead, China should boast a large number of invincible multinational companies across the globe. Today, the compre-hensive ability of a domestic com-pany is a symbol of the international strength of a country, and it serves as an indication of the resilience of a na-tion’s backbone.
Alibaba landing in US capital markets and likely rewriting the fi-
nancial records for international inter-net companies would announce to the world that if all companies begin from
the same starting line, Chinese firms can also come to the fore.
Currently in more traditional in-dustries, when Chinese companies compete against their giant US peers such as Coca-Cola, Boeing, General Electric, Procter & Gamble, Pfizer and Apple, the gap between them is evident both in global and their home markets. There are many deep-seated reasons for this phenomenon.
To begin with, most major US companies have a long history; some even have a history of well over a century. In other words, when China was in the latter end of the feudal era known as the Qing Dynasty (1644-1911), and its people were struggling just to meet the requirements for basic survival, many of these US companies were already in existence and thriving.
Second, the properties and man-agement mechanisms of the largest Chinese state-owned enterprises, or SOEs, are also primary factors which constrain development and growth. SOEs are usually the biggest com-panies in China by scale and assets,
The success of internet giants Jingdong Mall and Alibaba shows that Chinese companies can develop into world leading businesses
“In order for China to really express her global economic power it is not necessary for the country to rank first by GDP size or to have skyscrapers bloom everywhere. Instead, China should boast a large number of invincible multinational companies across the globe”
SOMETHING TO BE PROUD OF: Zhao says globally competitive Chinese multinationals, not GDP
fi gures or a forest of skyscrapers, are how China should express its power to the world
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China Economic Review | July 201414
priddGeit
G Bin Zhao
but they are shielded by national poli-cies or are reliant on their monopoly positions and lack comprehensive strength.
As a relatively new phenomenon, the internet industry is different to tra-ditional sectors, giving Chinese firms a more even playing field on which to compete. The internet has been able to prosper in China at a time when the domestic economy has really been booming, the overall business environ-ment has been improving and venture capital funding has really emerged as an important source of funding for start-ups.
The most basic business ele-ments, which are commonly found in US companies, have gradually been formed in China, enabling Chinese in-ternet companies and their US coun-terparts to basically stand together at the same starting line. And it should never be forgotten that US companies are generally more advanced in inno-vation and technology.
In addition, the development pro-cess for Chinese e-commerce provid-ers and internet companies, represent-ed by Alibaba, can be traced back to a process in which foreign rivals initially staked out the leading positions, main-ly by virtue of their more advanced technology, but then eventually went into a period of decline.
As time elapses, history has shown that Chinese companies can grow and gradually penetrate the market, pushing the foreign companies aside. For example, Google has almost been completely squeezed out of China. As another example, Yahoo!, one of the primary shareholders in Alibaba, now falls far behind the Chinese company that its investments helped to nurture.
The US media and American tech companies themselves have blamed their failings on the Chinese govern-ment’s strict supervision of and in-terference in their China operations. Even if this is partly true, it cannot be the only explanation.
“Many attribute the American company failures to government reg-ulations or favoritism. While these played a part in their failure, there were other more relevant reasons related to
the companies themselves,” accord-ing to Kaifu Lee, former president of Google China. And besides, why can other US firms, especially those men-tioned above in other industries, man-age to find success in China?
Meanwhile, China’s top internet companies are only going to get stron-ger. According to a recent study con-ducted by the World Bank, Chinese purchasing power will soon overtake that of the US, making it the world’s largest economy.
Despite the fact that an elephant is huge, it is most often the lion or tiger
that has the final say in the wild. The success of enterprises like Alibaba can be likened to the concept of genetic variation – only when there are a wide variety of successful companies will China’s voice be compared to the true roar of the dragon.
COLUMN: INTERNET GIANTS
GOING FOR THE TOP: Leading Chinese tech companies are getting multi-billion valuations in the US
Mr. Zhao is executive editor at China's Economy & Policy, and co-founder of Gateway Interna-tional Group, a global China con-sulting firm.
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China Economic Review | July 2014 15
CAN FOREIGN COMPANIES CRACK THE CHINESE CLOUD COMPUTING MARKET?CAN FOREIGN COMPANIES CRACK THE CHINESE CLOUD COMPUTING MARKET?
Grand dreamsGrand dreams
FIT IT ALL IN: Cloud computing offers endless possibilities for companies to outsource IT and internet functions, but Chinese companies are stil unsure about it all
Almost all of the six hundred and twenty mil-lion Chinese people and the hundreds of thousands of domestic firms that connect to
the internet daily store some form of content online. Social media platforms such as Sina Weibo and file sharing services are increasingly a part of daily life.
For the firms that provide these online servic-es, start-up and operating costs can be high. The hardware and software that keep their businesses alive don’t come cheap. But as cloud computing gains traction in China business expenses are coming down. “We are able to quickly deploy a lot of services without spending an enormous sum of money in the early stage,” says Yue Pengyu, director of operations and maintenance at NQ Mobile, a Chinese mobile internet company that focuses on security and privacy products.
NQ Mobile is a client of Amazon Web Services, which entered the domestic market in December 2013 with a limited offering. Amazon is one of the main foreign players, along with Microsoft and IBM, that are driving the development of the cloud computing market in China. If they can be successful they will earn huge revenues and deliver the benefits that businesses in North America are already realiz-ing. In their way stand national security issues, regu-latory hurdles and a lack of market trust.
The next internet boom“The market itself, even without the foreign players, has exploded in the last year,” says Steve Mushero, CEO of ChinaNetCloud, a foreign-owned sever management and cloud computing company based in Shanghai. When ChinaNetCloud started running cloud services in 2008, there was virtually no com-petition, and even until last year, Mushero says, the industry had very few significant players.
COVER STORY: CLOUD COMPUTING
China Economic Review | July 2014 17
Growth in China is coming from an explosion of data, digital media and web-based applications in a country with 618 million internet users as of the end of last year. Inter-net behemoths like Alibaba Group, Baidu and Tencent Holdings are pulling people online. China is the world’s largest smartphone market.
Cloud computing is reshaping how people live, work and do busi-ness. People increasingly use the cloud for everything from social net-working to online shopping to file-sharing. Companies access cloud services for tasks ranging from doc-ument editing and data backup to advertising, sales, and customer rela-tionship management. A survey by North Bridge Venture Partners found that 75% of American companies were using cloud services in 2013.
Understanding the size and scope of the market is complicated by dif-fering definitions. Broadly speak-ing, cloud computing can be defined as the practice of storing data and running software over the internet. This includes cloud software, such as internet apps that allow companies to
COVER STORY: CLOUD COMPUTING
track sales, and hardware, for instance the data centers that store informa-tion. Then there are “public clouds” that anyone can sign up to use and “private clouds” that are built by com-panies to keep others out.
Consequently, market valua-tions can vary wildly. Research firm Zero2IPO estimates that China’s cloud computing market will grow at an annual rate of 50% over the next few years and surpass RMB13.6 bil-lion (US$2.19 billion) by the end of 2015. Wang Feng, manager of China Telecom’s cloud computing unit, sees market growth of 26% per year between 2013 and 2017, with a market value of RMB13.4 billion already at the end of 2013. State-run China Software Industry Association estimates the cloud computing value chain, a much wider definition, could be worth RMB1 trillion by 2015.
Global players are following Amazon and rushing in. Microsoft launched its Azure cloud computing platform in China in March while IBM recently entered the sector with its SmartCloud Enterprise+ system, serving mainly enterprise and gov-
ernment customers. Intel and Ora-cle have either launched their own or bought into existing cloud services in the country.
Foreign knowledgeAmazon, Microsoft and IBM in China all offer what is known as ‘infrastructure as a service,’ one of three service models in cloud com-puting. It provides virtualized hard-ware, or in other words computing infrastructure. Yet they each have a differing approach.
AWS is a platform designed to run on economies of scale, which will gives clients the ability to provide services at the best available prices, said Justin Mallen, founder and CEO of Silk Road Telecommunications, a Hangzhou-based corporate tele-com services provider. IBM is much more focused on the corporate cloud, while Microsoft is all about Microsoft products.
Amazon is the world’s largest provider of public cloud computing services. It currently offers a limited range of its AWS in China, allowing companies to purchase its comput-
AIMING HIGH: Microsoft has done its homework for cloud computing in China, following the rules closely and securing strong partnerships
China Economic Review | July 201418
ing, database and storage services by invitation only. AWS has partnered with the regional authorities in Bei-jing and Ningxia. Under this arrange-ment, Amazon supplies the software, while Chinese partners provide local data centers, bandwidth and content delivery.
Microsoft has a stronger foothold in the Chinese market with its Azure service, which launched as a limited preview last June and went fully live this March. “We pride ourselves as the only multinational company that has a true public cloud service here in China,” George Yan, who man-ages Microsoft’s China cloud busi-ness, told China Economic Review in an interview in early June. Azure’s key selling point as a global provider is that any individual or company can sign up for the service, in contrast with AWS, which is not yet fully public. Amazon declined to comment
COVER STORY: CLOUD COMPUTING
for this story.Yan claims that Azure’s success
lies in its unique partnership model. Microsoft’s partner, Chinese tech firm 21Vianet Group, operates the service, running data centers in Shanghai and Beijing that deliver Azure, while Microsoft licenses the software. The Shanghai municipal government is also a party to the deal. Microsoft claims to have had big success in China so far. Among Azure’s customers are Coca-Cola China, which uses the platform for digital advertising, mobile games company LineKong Entertainment, which hosts top games on Azure, and state-run China Network Television, which will use Azure for this year’s webcast of the Spring Festival Gala, the most-watched TV show on earth.
IBM is also partnering with 21 Vianet Group, but unlike Microsoft’s public cloud it is working with the
Chinese internet data service pro-vider to host its managed private cloud service. A flagship project for the company is the development of a smart logistics center in the coast-al port city of Ningbo, which once complete will enable more than 5,000 firms at the site to share data across the cloud.
In addition to providing services locally, the companies are also work-ing with Chinese firms operating overseas. AWS already serves 5,000 Chinese customers outside of China.
The growing popularity of cloud services hasn’t gone unnoticed by local technology players. E-commerce giant Alibaba has launched Aliyun, the biggest cloud service in China, Tencent offers Q-Cloud and former Tencent executives have formed start-up UCloud. With their local knowl-edge, strong ties to Chinese business-es through existing internet services and cost competitiveness they come to the market in a solid position.
Yet foreign companies have their own advantages that can’t be dis-counted. “The key strength of major global players are the richness of their product offerings, as well as the qual-ity and experience servicing large scale clients,” said Charlie Dai, an ana-lyst at Forrester Research in Beijing. “The entry of global players will fur-ther impact, and actually has already impacted, the Chinese market.”
Heavy cloudThese are exciting times for foreign cloud providers, but can they suc-ceed in what looks like becoming an increasingly difficult marketplace?
Global vendors face a range of challenges in China – lagging infra-structure, a complex regulatory envi-ronment, a shortage of skilled person-nel and geopolitical tensions. It’s also not clear that Chinese businesses will adopt cloud services on a large scale, let alone those provided by foreign firms. Whether Amazon, Microsoft and others can thrive will depend on their ability to navigate these obsta-cles as well as the willingness of Chi-nese companies to entrust their data to the cloud.
Microsoft is the only global
For SMEs and startups, cloud services remove a huge headache
Cloud computing is booming in de-
veloped markets thanks to demand
from small and medium enterprises,
or SMEs. With IT and the internet
critical parts of almost any company
these days, a service that can reduce
costs is going to be welcomed.
By signing up to public cloud pro-
viders such as Microsoft’s Azure or
Amazon Web Services, SMEs no lon-
ger need to buy servers or manage
software and can outsource the ex-
pense and headache of maintaining
a technical team to someone else.
Ireland-based O’Reilly Media esti-
mates that fi rms can save up to 30%
on IT costs over a three year period by
employing cloud services rather than
using on-site equipment.
The global market has exploded.
Almost one in three US fi rms use
some form of cloud. China is catch-
ing up, albeit slowly. Microsoft says a
large portion of the SME clients using
Azure in the Chinese market are de-
velopers. Tech costs, paid incremen-
tally and moved to operational costs,
are no longer a barrier to innova-
tion. Chinese e-commerce fi rm Kuke
Industry says that using Alibaba’s
cloud unit is “much faster than our
own server, and has saved us lots of
money on tech and personnel.”
Technology startups in China, a
growing scene in Beijing and Shen-
zhen, are huge users of clouds. These
services give clients instant access to
server power and enable them to in-
stantly expand or shrink their pool of
machines, paying only for what they
need at any given point. All this makes
it possible to launch a serious startup
without serious capital. Whereas in
the past new companies had to invest
in expensive equipment in order to
get off the ground, “the biggest line
items in these companies now is rent
and food... A decade ago, I don’t think
you could write a line of code for less
than US$1 million,” former Google
executive Chris Sacca said in a media
interview in 2010.
China Economic Review | July 2014 19
COVER STORY: CLOUD COMPUTING
company that has managed to offer a completely public cloud service in China. This hints at the knotty legal and regulatory tangles that foreign firms must cut through in order to do business in a sensitive sector. For-eign companies looking to set up data centers or cloud services in China must establish a joint venture with a local firm. Not only do they have to take pains to avoid hosting ille-gal content, such as pornography and politically sensitive speech, they also have to contend with heavy-handed government measures, like the occa-sional “lockdown” in which com-panies are prohibited from moving hardware into or out of internet data centers. The most recent such lock-down lasted for 22 days in February and March, while big political meet-ings took place in Beijing.
Another issue for cloud companies in China is personnel. In an industry still in its infancy, companies have a hard time finding people with the requisite skills to operate a cutting-edge cloud service. “Running a data center is relatively easy,” says Mushe-ro. “Running a cloud is much more operationally difficult; even Aliyun has had problems with that. Long-term that’s going to be a challenge.”
The government’s preoccupation with “internet sovereignty” poses a particular challenge for cloud service providers. Multinationals are find-ing that the only way to enter the Chinese market may be to completely segregate local from global opera-tions. “What we have done in China is basically we have carved out an island of services that exist in China, that’s exactly the same as the rest of the world, but they don’t talk to each other,” says Microsoft’s Yan. “We purposely disconnected the China services from the rest of the world because of the rules and regulations here.”
In the past two months the issue of “internet sovereignty” has become entangled with a diplomatic flare-up that could make life much harder for foreign, especially US, technology companies than it already is. The US government in May publicly named five members of China’s armed forc-
es as suspected perpetrators of cyber crimes against US companies. Beijing reacted with fury. In a vaguely word-ed notice, state media said China will review all foreign IT products sold domestically and block any that fail to pass a new “cyber security vetting system” designed to weed out secret spying and surveillance activities. Only a few weeks earlier the gov-ernment banned state agencies from using Microsoft’s Windows 8 operat-ing system, without making it clear why. Reports, which have not been
confirmed, also surfaced saying that state companies are being told not to use IBM’s servers.
The speed with which the above measures were rolled out and the lack of clarity on implementation mean that the possible impact on the cloud computing sector is hard to predict at the moment. However, the way in which foreign companies provide cloud computing services in China may make them less susceptible to any sharp or aggressive changes in government regulations.
As Mallen notes, Amazon and Microsoft are the middle layer in the cloud computing chain – they are nei-ther service providers nor data cent-ers. Such functions are sensitive and restricted to foreigners. Non-Chi-nese companies operating in cloud computing must have a local partner to do business in China. Amazon, Microsoft and IBM all offer services through licenses, partnerships and relationships with local entities. They do not run the entire cloud comput-ing value chain. In the Microsoft partnership 21 Vianet is the contract holder responsible for protecting cli-ent data, something that Yan says the company has made very clear to the media and government.
BRAIN POWER: Servers such as these in data centers across the country power the Chinese cloud
system. Foreign companies like Amazon, however, do not deal with the hardware
China Economic Review | July 201420
“What we have done in China is basically we have carved out an island of services that exist in China, that’s exactly the same as the rest of the world, but they don’t talk to each other”- George Yan, Microsoft China
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COVER STORY: CLOUD COMPUTING
China’s dreams of IT dominance start in the cloud
It’s hard to see what rice wine has
in common with big data. But poor,
mountainous Guizhou province in
southwestern China, mainly known
for the traditional liquor Maotai, is
vying to be China’s main hub for data
centers and cloud computing. Accord-
ing to Chinese media, the country’s
big three state-owned telecom car-
riers have moved into the Guian New
District, a development zone near the
provincial capital Guiyang, since last
October to set up data centers. These
are clusters of networked computer
servers that store and process vast
amounts of digital information.
Joining them are over 100 high-
tech fi rms, including internet heavy-
weights Baidu, Sina and Sohu as well
as e-commerce giant Alibaba. Lured
by Guizhou’s manufacturing indus-
try, low electricity prices and mild
climate – which makes it cheaper to
keep buildings full of humming serv-
ers cool – plus a host of tax and other
incentives rolled out by provincial au-
thorities, these companies are looking
to cash in on the explosive growth of
China’s digital ecosystem.
A data center boom is sweeping the
nation. State-owned telecom provider
China Unicom recently launched two
huge data centers in Inner Mongolia’s
Hohhot and Hebei’s Langfang, in addi-
tion to the facility currently under con-
struction in Guizhou. The facilities will
host a cloud service for government
and enterprise customers, called Wo-
Cloud, which the company rolled out
last December. China Telecom, too, is
building a data center capacity in In-
ner Mongolia. News reports indicate
that the facility will have 2 million
servers, making it the largest data
center of its kind in Asia.
In the meantime, Alibaba unit Ali-
yun, the largest cloud computing pro-
vider in China, is expanding at a rapid
clip. Aliyun in June opened its fi rst
data center in Beijing, boasting 10,000
servers. Foreign companies, too, are
seeking a piece of the action. IBM an-
nounced in 2011 that it would build a
goliath information center in conjunc-
tion with Chinese tech fi rm Range
Technology. Expected to be completed
in 2016, the project in Langfang, serv-
ing local governments and foreign en-
terprises, will be nearly the size of the
Pentagon at 6.2 million square feet.
Beijing recognized the potential of
cloud computing for the fi rst time in
the Twelfth Five-Year Guideline (2011-
2015), in which it was marked as a
“strategic emerging industry.” This
economic blueprint is an important
tool with which to direct investment
in key sectors. All of the above ties
into the Chinese government’s goal
of turning China into a global IT pow-
erhouse. The endgame, as outlined
in ambitious government plans, is to
make the country an “innovation-driv-
en country” by the 2020s and a world
power in science and technology by
2050. “Efforts should be made to build
our country into a cyber power,” Pres-
ident Xi Jinping said in February, after
setting up a central leading group for
“internet security and informatiza-
tion” that he will preside over.
POWERING MOBILES: Lu Zhaoxi (3rd right), CEO of Alibaba, attends the launch ceremony last year for yunos.com and six smartphones that run on the
Aliyun cloud computing system developed by Alibaba
China Economic Review | July 2014 21
Nevertheless more needs to be done to overcome pre-existing anxieties in the local market about uploading company data to foreign-run clouds. “We won’t do that now because we don’t know if it is safe to do that for our data,” a spokesperson for Kuke Industry, a Shanghai-based e-commerce firm with annual rev-enues of US$1 million, told China Economic Review. “It is so hard to handle and control the situation if something unfair happens to us [when] working with a foreign com-pany.”
The question of trust runs much deeper than just worries about for-eign companies. In the West, govern-ments and companies are more open to working with cloud providers. Last October AWS won a US$600 mil-lion contract with the US Central Intelligence Agency to build a cloud network. China appears to be less ready, partly out of a lack of expe-rience or faith in outsourcing such functions.
“Yes, we do have worries [about cloud computing], such as if they are going to sell our customers’ data to others or if they are going to control us because we have to use their serv-ice,” said Kuke Industry.
“I don’t yet know that that’s some-thing that people here are comfort-able with,” says Mallen. “The big internet players in China like to build their own networks, they like to build their own data centers, they like to build their own systems. Where a Netflix will host on Amazon, I don’t know that a Youku would ever host on Amazon.” Youku Tudou is Chi-na’s largest online video provider.
Going skywardIf global companies can figure out how to win the trust of the govern-ment and local companies, they will transform the industry. Indeed, the entry of big foreign brands is already shaking up the market, bringing healthy competition and global stand-ards to a fast-evolving sector. Mushe-ro sees the trend as a huge positive. “The more competition, the lower prices, the better features, the higher standards, just the better off China
is in general,” he says. “It also allows Chinese companies to use global standard tools and clouds, which
means then they can go global.”The spread of the cloud also ben-
efits Chinese companies, particularly small and medium enterprises. Busi-nesses can use the cloud not only to store their data, but also to run their core management systems. To Mal-len, the value proposition of cloud computing is “as simple as it gets.” The cloud frees firms from having to buy their own IT infrastructure and hire their own technicians to run, maintain and troubleshoot all that hardware and software. Instead of spending many thousands of dollars on servers, a company might sub-scribe to cloud services for a few hun-dred renminbi per month.
Mallen says that cloud comput-ing services can relieve the headache of upfront capital, server and serv-ice maintenance and staff problems. “Your headache of what happens when it’s broken and you don’t have
COVER STORY: CLOUD COMPUTING
China Economic Review | July 201422
“I think the only key tectonic shift that ever may happen is if once again the Alibabas and the Baidus of the world decide to outsource their infrastructure” - Justin Mallen, CEO and founder, Silk Road Telecommunications
COVER STORY: CLOUD COMPUTING
the right expertise in-house – gone. One phone call and you fix every-thing.” By lowering the cost of criti-cal infrastructure and making it more flexible and easier to use, cloud com-puting also promotes innovation. “You also get more niche things,” says Mushero, “not only innovation, but [apps] that don’t make a lot of money and aren’t mainstream but are useful to some people.”
Yue at NQ Mobile acknowledges the cost savings. “Although we dou-bled the number of servers, we didn’t double manpower. We do massive operations by ourselves based on AWS. Basically, all we have to do is to press one button to complete the deployment of a group of servers. We don’t worry about where the servers are and what the configuration is, we are concerned only about its services. Product research and development is the only thing we have to do.”
It previously took NQ Mobile around 15 days to start providing services to an overseas client, or three days if they were super quick. The job can now be completed in 20 minutes with AWS, Yue says.
Making it rainCloud computing is still at its rela-tive infancy in China. The demand fundamentals are seemingly there to forecast growth at similar levels to North America. Big foreign play-ers have moved quickly to enter the country and are well positioned to influence the development of the local market.
Where analysts see more work needed is in firming up local offerings and having the flexibility to adjust to changing conditions.
AWS arrived in China first, but it hasn’t tailored its products care-fully enough to meet domestic
requirements and still has to define its Chinese partners. Microsoft has built smart partnerships and over-come regulatory hurdles, noted Dai from Forrester Research, but faces the challenge of extending and enabling its partner ecosystem to have techni-cal consistency.
Influencing the biggest change necessary for the market to achieve its full potential is likely beyond the ability of foreign firms. Deals with big companies offer the largest rev-enues, but they are fewer in number, said Microsoft’s Yan. A number of multinationals who use Microsoft’s Azure services in China are already global clients.
But the big money lies in provid-ing services to huge Chinese firms.
Many of these are state run. The challenge in winning their business is two-fold: State-owned enterprises are slow to adapt to technological inno-vation and extremely protective of their data.
Until recently they were not allowed to sign contracts with outsourced data center services. Although they might soon be permit-ted to buy computing as a service, there is no guarantee they would opt for a foreign provider. SOEs are often obliged to ink deals with Chinese firms, usually other SOEs.
If large emerging private-sector companies, especially in technology and internet, can be persuaded of the benefits of public clouds instead of hosting themselves, then the market could move decisively. That would benefit the likes of Microsoft and Amazon.
“I think the only key tectonic shift that ever may happen is if once again the Alibabas and the Baidus and the Tencents of the world decide to out-source their infrastructure, said Mal-len. “[However] I don’t see that hap-pening anytime soon.”
“Maybe a Youku will do it first, maybe not. They’ve got a lot of legacy infrastructure already built in place that I’m sure they’re goning to keep using. But I’d say if mid-tier inter-net companies decide to shift to the cloud, that’ll be tectonic for the cloud business.”
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ECONOMICS & POLICY: CLEANING CHINA
Ground wash
Sweeping problems under the rug can make them disappear from sight for while. Chinese lead-
ers, like their developed world peers, have felt a good grip on the broom for years. However, as they start to do more house cleaning of the economy, many nasty surprises are in store.
In this latest stage of develop-ment the heavy industries such as power generation and steel that cre-ated huge economic zones on the east coast are heading inland. As those factories move away, they leave with them a legacy of torrid environmental degradation. Poor agricultural prac-tices from the overuse of pesticides have also laid waste to much terrain.
According to a major recent official survey, up to 16% of soil is polluted and almost 20% of arable land is con-taminated,
About 8 million acres has been declared polluted beyond agricul-tural use – an area roughly the size of Belgium. With China supporting a fifth of the world’s population on only around 8% of its arable land, the country needs every last bit of farm-land it has to feed its people. Land must also be cleaned up to accom-modate new homes and residential communities springing up across the country in the wake of a frenzied pace of urbanization.
Beijing is waking up to this prob-
lem and realizing it can’t overcome it alone. The state is responding with new policies and increased invest-ment, attracting foreign companies with much needed experience and advanced solutions. But the domestic soil remediation industry is not only lacking in terms of technology, there is an absence of rules and regulations: The required policy simply does not exist yet. Until that is done, and ways are found to get more private and public money into cleaning farmland, major social and health risks will stick around.
An invisible disasterTo most observers the filthy air that
With a fi fth of its arable land contaminated China can’t afford to look the other way, but the country is struggling to put the incentives in place to start cleaning up
UNDER THE SURFACE: Remediation is going to be big business with so much land to decontaminate and is crucial to China’s urbanization
China Economic Review | July 201424
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ECONOMICS & POLICY: CLEANING CHINA
clogs major cities and rafts of dead fish cluttering waterways are the obvi-ous signs of three decades of break-neck development. Toxic sludge pits are pretty illustrating as well. By con-trast, soil pollution is often invisible – and in many ways worse.
Damaging contaminants have leaked into the soil across much of China. Among the most often found in tests is cadmium, which is known to cause lung and liver disease and may increase the risk of cancer. Pesti-cides from agricultural production are another major pollutant.
China’s food supply is under threat. Contaminants leech into riv-ers and aquifers, tainting the water supply. Cadmium doses in the soil are highest in regions that house min-ing and smelting industries, which often happen to be major agricultur-al regions too, Greenpeace noted in a recent report. Last year the gov-ernment of Guangdong province shocked the public by declaring that 44% of rice samples had excessive lev-els of cadmium. Greenpeace warns of “arsenic rice.”
Acknowledging the severity of the problems is the first step for the gov-ernment to come up with viable ways to tackle them. The official survey, conducted jointly by the environ-mental protection and land resources ministries, went some way to doing that. Never before had they publicly released data on this field that could be classified as a “state secret.”
Then there are signs that great-er policy support for action is in the works, a key trigger for things to get done. Environmental authorities in March passed a plan to tackle soil pollution. But it’s still far too soon to expect brown fields to turn green in the near future.
Technical challengesSoil pollution is not only hidden from the eye; it’s hard for advanced equipment to detect and even worse to map. The degree of contamina-tion can differ dramatically from one square meter to the next, requiring extensive testing to understand a sin-gle site, experts said.
The sheer scale of China compli-cates the viability of solutions.“The
average [remediation] project size in China is estimated to be about 150,000 tonnes [of soil],” said Stephen Clarke, vice president of business development at West Mountain Capital, a Canadian firm specializing in pesticide contamina-tion that is working on remediation projects in China. “The largest site to have ever been remediated in Cana-da… was 125,000 tonnes. And there was only one of those.”
There are estimated to be 300,000 contaminated sites of widely varying size in China, said Clarke, who has seen proposed projects that exceed one million tonnes.
Treating this problem is simply beyond China’s current capabili-ties in a way that potentially inflates the problem. Soil remediation can be done on-site or off-site. Chi-nese companies usually go with the former, which involves digging up all the soil, trucking it somewhere, and typically burying or burning it. At minimum, this involves moving tens of thousands of truckloads of dirty soil, which invites spillage accidents. Burying may simply result in mov-ing the problem, and while burning can be done safely under the right controls, it can easily dump pollutants into the air if not managed correctly.
Foreign companies with decades of experience cleaning up their own homes first come with a different solution. Typically they either exca-vate, process and replace dirty soil on site, or undertake in situ treat-ment without displacing the earth at all. West Mountain Capital’s cur-rent project in Hangzhou, which is remediating the site of a former pes-ticide plant slated for urban devel-opment, involves on-site excavation. The company is importing custom-ized machines to do the job. While Clarke maintains that it’s tough to know what a standard project looks like in such an infant industry, the Hangzhou site is certainly not uncommon.
The inability of China to clean up its own mess is a boon for interna-tional operators. The country already represents more than 90% of revenue for West Mountain Capital. Demand is only going to grow, and if Beijing
pumps more cash into it, the returns could look even better. Separate esti-mates from Japan’s environmental agency and the state-run China Secu-rities Journal value the Chinese reme-diation market at around US$18-19 billion per year by 2020.
A localized problemCleaning up the soil will require more from foreign firms that just shipping over machines, however. They need to dig in for the long haul to have any real impact.
The technical challenges posed in China mean that a company has to to develop its local operations on a project-by-project basis. Every soil remediation project is essentially a local project: Soil and pollutants dif-fer from site to site, and continent to continent. “There is a need to develop specific solutions because the soil and the land is different,” said Oliver Wu, president of Liaoning Huafu Group. Huafu is working on a pilot remedia-tion project with a Canadian firm.
Being forced to work on the ground has its benefits – it could lower the chance of intellectual prop-erty theft. This is particularly relevant to industries such as remediation that require advanced proprietary technol-ogy and equipment. Major interna-tional manufacturers of trains, autos and solar panels have seen local firms overtake them after copying their technologies used in joint projects.
“The intellectual property rests on how the remediation strategy is applied and managed, and how the unexpected is addressed. That’s criti-cal,” says Bengt von Schwerin, Asia Pacific managing director of environ-mental services for AECOM, a lead-ing global company in soil remedia-tion. “It’s the experience that makes the difference. From a remediation perspective, that’s the difference between making money and losing the company.”
Von Schwerin also emphasized that implementing the all-valuable experience itself depends on a high degree of cooperation with Chi-nese firms and experts. Local players already understand the indigenous soil characteristics as well as the busi-ness and political scene – necessary
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ECONOMICS & POLICY: CLEANING CHINA
components to a profitable project. All this impacts the way com-
panies do business in this space. AECOM’s offices operate as a wholly foreign-owned enterprise in China, but projects are often done as partner-ships. At times AECOM takes the lead, at other times it assumes a sup-porting role. As von Schwerin says, it’s “horses for courses,” and in fact not all that different from doing busi-ness elsewhere in the world. Compa-nies should adapt to the local condi-tions, soil and otherwise.
Only the largest foreign firms will have the resources to get through such a process. And yet despite their scale they have nowhere near enough capacity to take on an area the size of a small European nation, which some experts see as only the tip of iceberg of contamination.
More policies, pleaseChina is not alone in facing the chal-lenges of a major post-industrial economy. The US, Canada and Aus-tralia, at least in terms of geographical scale, faced similar problems.
“If you take the US Superfund mechanism for example, initially it created a lot of money for lawyers, but didn’t really remediate any sites,” said von Schwerin, referring to a pro-gram set up in the 1980s that allows the authorities to clean up polluted areas and also force responsible par-ties to act. “China has the benefit of understanding what getting it wrong
up front means.” Whether policymakers are learn-
ing from those historical lessons isn’t clear. China still lacks a solid policy framework to cover remediation. The cleanup plan presented by the Minis-try of Environmental Protection ear-lier this year still has to be approved by the State Council. Until it is there are only patchwork policies in place in addition to vague promises by offi-cials. Beijing has been pledging to clean up the environment since the late 1980s. Critics are still waiting.
Some industry insiders are more optimistic. Von Schwerin sees reme-diation guidelines being developed and applied for rigorously in the next five years, and more strict enforce-ment happening in the next ten – seemingly a long time, but much shorter than the decades it took to build adequate systems in other coun-tries. Until then, firms are free to try their hand at cleaning up.
“There aren’t that many clear bar-riers from the government right now, just a lot of encouragement,” notes Huafa Group’s Wu.
Such freedom won’t do much to help address soil pollution through a systematic process, which is real-ly what is needed. Under-regulated sectors are prone to breaking rules. Clarke from West Mountain Capital pointed out that companies can offer a variety of remediation services in China across different price points. But without set standards it is hard
to know whether a site that has been cleaned up is in fact actually safe for end use – especially when “safe” dif-fers considerably from land that will support apartment blocks to land that will support crops.
The money flowWithout policy and financial support from Beijing it will be a challenge to direct investment in remediation to agricultural land. But in order for that to happen, some serious conflicts that already exist between the central and local governments will need to find resolution.
As industry is pushed away from urban centers, land is being freed up for other use, mainly luxury and commercial development in cash-strapped cities, says Charlie Welsh, founder of XportReporter, an intel-ligence company. Local governments rely heavily on sales of land-use rights for their income. Overall, the economy is unhealthily dependent on property.
“There is a profit motive for them to actually invest there and get that land properly treated, as opposed to believing that ‘we must improve the farmland’,” said Welsh. “Anything that results in improving somebody’s bottom line is where you see the real investment taking place.”
The importance of tackling resi-dential development sites shouldn’t be underestimated, especially given the continued push for urbanization. But fixing up farmland is a bigger public health issue, one that will need to be fixed, at least initially, with govern-ment cash and not private investment.
Who pays is debatable. Amid all the talk of state support for the sec-tor there is little clarity on where the burden lies. Local authorities already shoulder much of China’s social wel-fare spending and can hardly afford to carry more.
Yet some public financing is starting to trickle through, says von Schwerin, although like any other major funding program it takes time to get to the actual remediation.
“It is a constant battle between land use and financing,” said Clarke. “The challenge is large enough to be considered generational.”NEW PASTURES: Cleaning up brownfi eld sites could give China more arable land to farm
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ECONOMICS & POLICY: SOE REFORM
China shuffl es the deckchairs of state ownership with Citic Group’s backdoor listing
Bosses at top state-owned enter-prises, or SOEs, are all about control. On the occasions that
they have had to let go, such as when big firms were listed on capital mar-kets in the early 1990s, they fought hard to ensure outside investors got little say in management.
This is one of the biggest obstacles to shaking up governance and own-ership of top SOEs, which the cur-rent administration is pursuing with a vigor not seen since those days. Back then President Jiang Zemin and his reform-minded Premier Zhu Rongji broke up thousands of state factories as they decisively smashed China’s “iron rice bowl.”
Nobody is anticipating a similarly brutal tactic during this latest round
of reform to be deployed on the SOEs that survived that blood bath. Experts have come to expect tactical, nuanced moves that bring in capital or expertise but retain state control.
A landmark deal involving Chi-na’s first SOE to be run on market-like principles has been heralded as a blueprint for state enterprise reform in the Xi Jinping-Li Keqiang era. Shareholders in Hong Kong-listed Citic Pacific recently approved the company’s plan to buy the key operat-ing assets of parent Citic Group for US$36 billion. These include lucra-tive stakes in financial services provid-ers such as Citic Securities and Citic Bank.
“Listing most state owned assets in domestic and overseas exchange
[without relinquishing state control points to] the direction for future SOE reform,” Kai Hu, a senior ana-lyst with ratings agency Moody’s in Hong Kong, told China Economic Review.
As the largest ever capital injection by an SOE into an overseas-listed unit, observers ponder the Citic deal’s significance. They note that Citic Group was at the forefront of Chi-nese economic reforms. Under the guidance of Rong Yiren, an illustri-ous “red capitalist” who won the trust of the Communist Party, the com-pany spearheaded China’s first efforts to attract foreign investment within Deng Xiaoping’s plan to let market forces into a then undeveloped econ-omy. Now it is the biggest finan-
Selling the stateA GIANT MOVES: The group that was at the heart of China’s opening up is being thrown into the limelight again, this time as a model for SOE reform
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ECONOMICS & POLICY: SOE REFORM
cial conglomerate in China.Experts see several positive out-
comes from the news. The inclu-sion of private shareholders into Citic Group’s assets “will [also] at least improve its transparency,” noted Hu – not something SOEs enter into willingly. Listing in Hong Kong will also mean the assets are subject to more stringent disclosure require-ments and better governance.
High profile institutional investors that bought into a share offering from Citic Pacific to fund the deal should also add a counterbalance to the state’s control. In the event that Chi-nese policymakers support projects that could “destroy the value of the company … there will be pressure from [its] financial shareholders,” Hu said. These include influential gov-ernment bodies such as the National Social Security Fund.
The unique nature of the backdoor listing of Citic Group through the
asset injection, which is the practical result of the transaction, suggests this could be a model for future shakeups in the ownership of state enterprises.
So, is this the answer to arguably the biggest economic question facing the government since the 2008 finan-cial crisis: How to retain a heavy gov-ernment hand in SOEs even while making them more market-oriented? Or in other words, how can the state spread prosperity without giving up control of China’s economy?
Leaders appear to think it is, at least for now. Many large SOEs including China Mobile and Sinopec have listed in Hong Kong and New York over the past two decades as part of government-designed restruc-turing and fundraising. The rebirth of capital markets on the mainland in the 1990s wasn’t designed to improve governance or profit investors.
With the economy sputtering poli-cymakers recognize the benefits of
unlocking growth in SOEs that sit on juicy, strategic assets from energy to utilities. The language of the Third Plenum talked of the market having a “decisive” role in SOEs; this year more and more state projects have been opened up. But the need for public control remains critical.
Beijing has decided that state firms will continue to be the backbone of China’s economy, ratings agency Fitch said in a report in late May, and therefore “there is a low likelihood of the state relinquishing its control over the large and strategic SOEs in this round of reforms.” In fact, the central government will “solidify their status as linchpins of the economy” through preferential policies, an age-old habit that is dying hard.
The Citic Group transaction not only retains state control of Citic Pacific, but will actually increase it. Beijing’s stake in the listed unit will rise from 58% at present to 82% upon completion. This doesn’t look much like reform anymore.
Critics of the state sector say it is inefficient. The purpose of opening up ownership to private, and even-tually foreign, investors is to maxi-mize returns on assets. Governance of state giants must also be tightened to prevent catastrophic financial losses. Citic Pacific burned US$2 billion in 2008 after an executive made unau-thorized currency derivatives trans-actions. Flabbergasted investors had believed that supposedly responsible management at a listed firm would reduce the risk of such an event.
This deal does not look like it will achieve either – or that it is even try-ing to. Neither will the market be given a chance to price SOEs fairly. Beijing forbids state assets to be sold at below book value, regardless of the trading price of the firms that control them. State investors in Citic Pacific, such as the social security fund don’t like to lose money, but they are also operated at the behest of the state and are unable to ignore the directives coming from Beijing.
What initially appeared to be a step towards change now looks more likely a clever illusion as the arms of the state continue to grip hard onto government companies.
DOING IT OUT WAY: Selling shares in SOEs in Hong Kong won’t make them play by market rules
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MARKETS & F INANCE: SHADOW BANKING
Stringent regulations to curb informal lending could end up hurting the economy
New regulations announced since early May seek to impose some semblance
of order in China’s murky world of informal lending. Beijing wants shad-ow banking activities to be curbed to ease financial risks and push more money into the real economy.
But getting Chinese banks to fol-low instructions is an uphill struggle for regulators. Bankers like the profits they get from lending to desperate borrowers including private enterpris-es, local governments and property developers. Many of those loans look unstable. China had about US$30 trillion in shadow banking assets at the end of 2013, a third of which is risky and may pose problems, accord-ing to ratings agency Moody’s.
Even if lenders paid more heed to regulatory announcements, the most
recent measures alone are not enough to curb risky practices. And if they were, they could do more harm to the economy than good by stemming a vital flow of credit into the system.
Recent rules issued by China’s financial regulators have focused on the interbank market, a conduit for dodgy off-the-balance sheet loans.
In the West, interbank loans ensure banks hold enough capital to meet reserve requirements by the end of each day. Such loans in China, however, are a way for banks to get past strict caps on deposit-to-loan ratios.
By disguising corporate loans as interbank loans, Chinese banks can hold on to less capital while lend-ing more. In other words, they raise leverage, and thus profits. Interbank assets in China surged 140% between
2010 and 2013. Smaller banks have become large net borrowers in the interbank market, expanding more quickly than their deposit bases would normally allow, thereby becoming more exposed to wholesale funding markets and a liquidity crunch.
Lenders have been able to get away with it because the interbank market is less regulated compared to other financial areas as such loans are seen as safer than corporate lending. Chinese bankers use them to make high-risk but high-interest paying loans to property developers, small and medium enterprises and local government financing vehicles – enti-ties that are otherwise unable to bor-row directly from banks.
Previous efforts to regulate have been ineffective. Late last year the China Banking Regulatory Com-
Out of the shadowsHIDDEN FROM VIEW: Banks are adept at obscuring their loan deals to circumvent lending quotas. This time interbank lending is the conduit of choice
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MARKETS & F INANCE: SHADOW BANKING
mission (CBRC) sought to close the existing loophole with Document No. 9, under which new rules would cap the volume of interbank loans by imposing stringent capital require-ments. That could have led to an unwinding of interbank investments in shadow loan products, Standard Chartered said in a report.
Interbank lending continued una-bated. Document No. 9 was not a set of regulations itself and, as such, had no teeth, said Sara Hsu, an econom-ics professor at State University of New York New Paltz. Their prof-itable shadow banking operations under threat, bankers complained and pushed the document quickly into the background, she said.
China’s central bank, frustrated by the banking regulator’s unwillingness to rein in rampant shadow lending, fought a series of turf wars with the CBRC for greater regulatory control over the area, eventually winning out. On May 16, the central bank and four other financial regulators jointly issued Document No. 127.
Although in the end a watered-down version of rules discussed by regulators last autumn, Document No. 127 nonetheless issued a set of concrete limits on interbank lending. Interbank loans cannot account for more than a third of banks’ liabilities. Bank-to-bank loans must be included in banks’ official loan quotas, record-ing them on their balance sheets.
The results have been felt immedi-ately. “With increased regulation and supervision, off-balance sheet shadow banking credit creation remained sub-dued” in May, UBS said in a report. Meanwhile, more money is being cre-ated via normal channels to fill the gap.
But other analysts worry that Doc-ument No.127 is not enough to curb shadow lending. Most of the inter-bank loans of big Chinese banks fall easily within the new lending caps so will not be affected. The contribution of interbank lending to overall shad-ow banking activity is also overstat-ed, said Andrew Collier, managing director of Orient Capital Research in Hong Kong, noting there are many other sources of shadow financing.
Wealth management and trust
products are by far the biggest chan-nels of shadow lending, together worth RMB20 trillion (US$3.2 tril-lion), according to Hsu’s calculations. These investments are sourced from a large range of credits, including bro-kerages and insurers. Banks listed in Hong Kong only hold RMB2.3 tril-lion of such products, or 2.4% of their total assets, according to a note by Deutsche Bank. China’s main banks are all listed in the territory.
It is these shadow products that need to be regulated for financial risks to be better contained. In April the government ordered lending institu-tions to build up capital or scale back business in case of potential losses, but that hasn’t stopped the trust and wealth management industry from handing out loans to high-risk bor-rowers, said Hsu.
Wealth management and trust products are effectively free to charge higher interest rates to borrowers than banks are. But only companies that have poor credit ratings or have been banned from borrowing from banks would accept such high interest rates.
Ironically, this high-risk lending has shielded these products from nosy regulators. A significant portion of trust and wealth management lend-ing is made to local governments that have provided much of the backbone of China’s investment-led growth in the last decade.
After the central government clamped down on the practice of banks directly lending to local gov-ernments, officials started to instead borrow from trust companies. By 2013, shadow banking provided 27.8% of the RMB7.13 trillion bor-rowed by local governments, up from nothing in 2010.
Resistance from banks to limits on shadow banking, as well as regulatory in-fighting between officials at the CBRC and central bank, will likely delay any effective efforts to control wealth management and trust prod-ucts, despite new guidelines. New rules are often watered-down: The caps on interbank lending were lower than many in the market expected.
Still, any moves to tighten shadow lending further could hurt credit crea-
tion, which would ripple through-out the economy. Developers, local governments and small businesses depend on such flows to stay afloat. Total credit growth decelerated in May on new shadow banking curbs, despite a strong pickup in bank lend-ing.
“China’s credit system is becom-ing increasingly more sensitized to the risks posed by a … credit event in the shadow credit market or regula-tory tightening,” UBS noted in a June report.“As such, we continue to see heightened liquidity and credit vola-tility risks, particularly with regard to the latest new interbank business regulation.”
“The trouble is that the crack-down risks choking off credit to pri-vate firms, which rely disproportion-ately on shadow channels to finance their growth,” Thomas Gatley, an analyst at GavekalDragonomics, said in a June note. “China desper-ately needs more private investment to offset the slowdown in capex by inefficient state-owned enterprises in excess capacity industries” that until now has been an important driver of growth.
Real estate offers another danger. Developers under pressure from fall-ing house prices might not be able to make loan repayments to trust prod-ucts, which still have significant expo-sure to property.
Investors that once overlooked the risk of shadow banking products for higher returns could pull out their money and tighten liquidity. Collier warns this could precipitate a fur-ther “deflation in property prices that underpin most of the economic activ-ity in China.”
A weakening property market and insolvent developers threaten local government finances. Local govern-ment income is highly dependent on land sales, which, in turn, are decided by housing demand and housing pric-es. The fear that local governments might default on their debt means regulators are forced to tread lightly, said Collier.
Overzealous regulators could force a “bankruptcy of a municipal-ity.” Central leaders in Beijing are not expected to countenance that.
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