Is affordable art the next big Chinese consumer trend? Q&A: China still "gambling on stupid" in stock markets Outward bound Outward bound Opening the door will unleash Opening the door will unleash mainland investment in H-shares mainland investment in H-shares 中经评论:管控新金融 中经评论:管控新金融 www.chinaeconomicreview.com MAY 2014 VOL. 25, NO. 5
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
Is affordable art the next big Chinese consumer trend?
Q&A: China still "gambling on stupid" in stock markets
Outward boundOutward boundOpening the door will unleash Opening the door will unleash
mainland investment in H-sharesmainland investment in H-shares
MONTH IN REVIEW06 NEWS BRIEF | Th e biggest China news stories in April
COVER STORY16 CHANGE OF DIRECTION | China takes a dubious shortcut onto the global fi nancial market
MARKETS & FINANCE33 SURGING AHEAD | China’s fi rst batch of IPO stocks in over a year have skyrocketed
BUSINESS 28 WALKING THE WALK | Insights from a property tycoon on how to succeed in a murky market30 AFFORDABLE ART | Is art for the middle classes the next big consumer trend in China?
ECONOMICS & POLICY22 GDP PANGS | Trying to decipher the meaning and signifi cance of the growth fi gures for China’s economy is no easy task24 EXPORT SLOWDOWN | Trade data disappoints again25 CHINA’S CRUMBLING HOUSING | A serious problem with roots in a growth model that has run its course26 CONFLICT CROPS | Rising tensions in Ukraine fl ag risks for Beijing’s grain import policy
Q&A AND COLUMNS08 CHINA IS STILL “GAMBLING ON STUPIDITY” IN THE
STOCK MARKETS | An expert discusses fi nancial reform10 REASONABLE EXPECTATIONS | Beijing is likely to take only modest steps to reform in 201412 ESCAPING NOSTALGIA | A chat with Shanghai Tang about building a luxury Chinese fashion brand14 A DELICATE BALANCE | Th e tradeoff for growth
THE HOUSE VIEW04 PROFITS AND PROTECTION | Principles and lost opportunities weigh on the minds of Hong Kong’s IPO rule makers
THE HOUSE VIE W
Charles Li, the chief executive of the company that runs the Hong Kong stock exchange, can’t seem
to drop the Alibaba topic. As the com-pany gears up for its US$15 billion listing in New York, Li has re-opened the dis-cussion on why the tech giant didn’t make the offering in his city and how the Hong Kong exchange can avoid missing out on major IPOs again in the future.
The debate comes down to whether Hong Kong should change its listing rules to capture demand for IPOs from the growing number of technology firms from the mainland. Or should it stand firm and stick with a widely respected principle that protects investors?
Last year, Alibaba officially announced that it was seeking a public listing. Hong Kong and New York, popular with Chi-nese firms that float overseas, duked it out for the business. With estimates valuing the company at around US$140 billion, the prize at stake is lucrative.
But the listing comes with strings at-tached. Alibaba’s 28 partners, who hold 10-13% of the company according to various estimates, want to retain the right to ap-point managers and retain its partnership structure. They say this is vital to protect the long-term strategy and vision that they have for the company.
This is incompatible with Hong Kong’s “one shareholder, one vote” princi-ple that is designed to protect public inves-tors through equality of ownership. Talks between the two parties to fit Alibaba’s request fell apart last September. In late October, Nasdaq and the New York Stock
Exchange both said they would allow it.Hong Kong was right not to alter its
rules for the sake of one company. In a region full of complex, opaque ownership structures and boardrooms where investor rights are a secondary consideration, the city has a valuable reputation for reliability.
Giving in to Alibaba would have set a dangerous precedent for other similarly important rules to be changed for firms looking to list there. Rushing the consulta-tion process to ensure Alibaba’s IPO took place in Hong Kong would have given off the harmful perception that the city was willing to drop due process and financial regulations to attract big business. Worse, regulators could get entangled in a “race to the bottom,” Syren Johnstone, a Hong Kong University law professor, told China Economic Review in March after Aliba-
Profi ts and protectionPrinciples and
lost opportu-
nities weigh
on the minds
of Hong
Kong’s IPO
rule makers
China will be mired in a period of am-
biguous and unending reform until
governments central and local bin
the GDP targets that have forced the
country to grow at excessive rates for
more than a decade, Hu Shuli, the in-
fl uential editor of business magazine
Caixin, wrote in an editorial in March.
That day is a long way off. The
central government has fi xed a GDP
target of 7.5% for this year and as
economic data continue to disappoint
and defaults emerge in sensitive sec-
tors such as housing, chances are in-
creasing that nervous policymakers
will try to spend their way to reach
that goal.
The tone for 2014 is strikingly
similar to last year. At a meeting with
provincial leaders in early April, Pre-
mier Li Keqiang said economic growth
must remain in an “appropriate zone,”
which analysts have pegged at above
7% annual GDP growth. The phrasing
is different but the signifi cance is the
same as Li’s “bottom line” in 2013,
an undeclared fl oor believed to be 7%
that couldn’t be fallen through.
It’s clear that ambitious reform
will subdue GDP growth while rapid
expansion will edge out hopes for re-
structuring the way China’s economy
runs. How the premier will proceed to
balance fi nancial and market reforms
with economic growth in the medium
term is up for debate.
To massage the economy, Beijing opts for a lighter touch
BIG TRADE: The Hong Kong Stock Exchange must continue to
protect investors, but it also needs to be able to win the biggest IPOs
China Economic Review | May 201404
ba’s decision.But Hong Kong is in a precarious
position. Its economy is heavily reliant on financial services, an industry in which it is super-competitive; for four of the past five years, it has been the world’s largest IPO market, accord-ing to Dealogic. A sign of its pulling power are the big upcoming billion-dollar listings of retailer Watson and pork producer WH Group.
Yet while it can win large conven-tional businesses, as well as huge com-modity trades thanks to its proxim-ity to mainland China, many people including Charles Li and investment bankers fear it is missing out on the most lucrative IPO trend – tech stocks.
Such firms excite investors and of-ten attract massive valuations. Main-
land China rivals Silicon Valley in churning out the biggest tech firms in the world by number of users. How-ever, despite Chinese firms’ prefer-ence for Hong Kong, tech companies have tended to list in New York. Since 2009, nine of the 10 biggest IPOs by Chinese internet companies have been in the US, according to Dealogic. Ten-cent is the only big Chinese tech firm listed in Hong Kong.
If Hong Kong cannot adjust, it stands to lose out in the new economy, some critics argue. It is already un-der pressure from the US, which has allowed dual-class and other share structures for almost two decades. Furthermore, the central government in Beijing wants to turn Shanghai into a global financial hub, which will in-
evitably come at the expense of Hong Kong. Much of the city’s IPO business is from mainland Chinese companies.
The city needs to move forward. As Charles Li noted, “inaction [on this issue] appears to have helped nobody in Hong Kong, but it does hurt Hong Kong’s competitiveness in attracting new economy companies.” He claims that investors in the US have not been negatively affected by the unconven-tional ownership structures of Google and Facebook. Hong Kong, he writes, could adopt special rules to give tech companies the structures they request.
But Li’s argument ignores what opponents of change cite as their big-gest concern: Investor protection. US investors can hold misbehaving firms to account through class action law-suits. Hong Kong’s Common Law system does not allow for this. It is too expensive for ordinary retail investors in the city to seek redress by them-selves as they must pay for lawsuits upfront. Changes to the legal system haven’t been part of the dialogue.
Li is correct to call for a “more rational and open discussion about weighted voting rights and our [Hong Kong’s] future competitiveness.” But reforms to the system cannot be lim-ited to the securities industry alone. A much larger framework meant to protect investors, including judicial re-form, must be included in that effort if Hong Kong wants to be on par with New York. The city cannot cut itself off from a huge new market for IPOs, but neither can it abandon its principle in pursuit of profit. Now is the time to let the talks start.
The likelihood this year of a ma-
jor stimulus package on par with the
US$586 billion monster in 2009 is
low – practically impossible, some
analysts say. Even if the government
could muster the money this year, it
would undermine all confi dence in the
reform promises made by China’s new
leaders.
Beijing will no doubt engage in
some “fi ne tuning” of the economy in
2014. The question now is what areas
will be stimulated and what industries
will feel the touch. In several places,
efforts to pull the economy out of an
early rut are already well underway.
State spending is already fl owing
into the economy; last year’s target
stimulus wasn’t announced in a single
statement or pushed through in one
transaction. It is already clear that this
year will be the same unless the situa-
tion escalates out of control.
On the policy side, this is a much
lighter touch than in the past. But
major stimulus may not just be un-
desirable, it could be infeasible. “The
scale of the credit expansion over
the past few years has been so large
that delivering a renewed accelera-
tion in credit growth would require
increasingly implausible volumes of
new lending,” GaveKal Dragonomics
said in a report. In 2014, “fi ne tuning”
could be the government’s only op-
tion to keep growth on track.
THE HOUSE VIE W
China Economic Review | May 2014 05
NE WS ROUNDUP
MONTH IN REVIEWECONOMYChina posted better-than-expected first quarter GDP growth of 7.4%, according to official data. But it was a slowdown from 7.7% growth in the final quarter of last year. Other data released showed industrial output ris-ing 8.8% in March from one year ago. Last year, China set its growth tar-get for 2014 at 7.5%. China’s growth data is closely watched around the world. A slowdown could hurt Asian economies, especially those which export commodities and industrial components to the world’s second-largest economy.
Economic growth in China’s Hebei province slowed to 4.2% in the first quarter from 9.2% a year earlier as its steel industry took a hit from newly introduced pollution curbs, Bloomb-erg reported. The central government has ordered many of Hebei’s pollut-ing steel factories to reduce capac-ity, in effect, closing them down. The slowdown in Hebei’s expansion underscores the impact of the govern-
ment’s campaign to reduce industrial overcapacity and pollution. Hebei is the country’s biggest steelmaking region.
China’s State Administration of For-eign Exchange is relaxing some cur-rency controls for multinational com-panies, The Wall Street Journal report-ed. The new rules, which expand on a trial program started in December 2012, would allow domestic and for-eign firms with at least US$100 mil-lion in foreign-exchange income in the past year to transfer capital more freely. China for years has maintained a “closed” capital account, strictly controlling the movement of money in and out of the country. SAFE said the latest move will take effect June 1.
FINANCEThe China Securities Regulatory Commission has announced a list of 28 companies that have disclosed IPO plans, suggesting the regulator is ready to end a two-month pause on new-share sales, The Wall Street Journal reported. Beijing ended a 14-month-long moratorium on initial public offerings in January, allowing 48 companies to list in the first two months of this year. But the new issues halted abruptly in March, when authorities stopped granting approvals.
The Shanghai Stock Exchange will delist Nanjing Tanker after four consecutive years of losses, The Wall Street Journal reported. The money-losing state-run shipping business will become the first company delisted
from China’s main stock exchange in seven years, an action seen as a sig-nal of Beijing’s intent to improve its stock market, cut financial risks and reduce industrial overcapacity. Nan-jing Tanker’s stock will be removed from the bourse in mid-May.
China announced a trial program to allow cross-market stock trading by mainland and Hong Kong investors, The Wall Street Journal reported. The program will allow mainland inves-tors to buy up to US$1.7 billion (RMB 10.5 billion) a day of shares
BRIGHT DAWN: Historically, the H-share market
has outperformed its mainland counterpart
CHINA BY NUMBERS
Cre
dit
: P
ayt
on
Ch
un
g
Cre
dit
: T
ha
ng
ara
j K
um
ara
vel
US$5 bln
Bond program set up by Tencent
Number of public infrastructure projects opened to private investment
80
2Percentage point cut in the RRR for rural commercial banks
RMB49,287
Average price of premium housing in Beijing in Q1 per square meter
China Economic Review | May 201406
of selected companies listed in Hong Kong, while permitting Hong Kong investors to plow up to US$2.1 billion a day into A-shares. The move is also designed to push forward the interna-tionalization of the yuan.
POLITICS & SOCIETY
Up to 16% of China’s soil is heav-ily contaminated, Reuters reported, citing survey results released by the Ministry of Environmental Protec-tion. China is desperate to tackle the impact of rapid industrialization and
urbanization on its food supplies, with the aim of maintaining self-sufficiency and reducing its depend-ence on grain imports amid soaring demand. The report blamed agricul-tural production and other “human activities” for the contamination, which it said had been accumulated over the long term. The ministry said China is working on a series of meas-ures to help resolve the problem of soil pollution.
Japanese shipping line Mitsui OSK paid US$28 million to the Shang-hai Maritime Court to free an ore carrier impounded in a dispute that dates back to the Second World War, Financial Times reported. The ship had been ferrying Australian iron ore to China’s flagship steel mill Baos-teel. The Chinese foreign ministry called the case “a common commer-cial contract dispute.” For many years, China discouraged wartime claims by its citizens against Japan, but no longer does so amid escalating ten-sions between the two countries.
BUSINESSWeibo, the microblogging service owned by Beijing-based Sina, jumped 19% in its first day of trading after pricing its IPO at the low end of the marketed range. The shares climbed US$3.24 to US$21.24 in New York on April 18, after they were priced at US$17 each. Weibo, which also counts Alibaba Group among its backers, raised US$285.6 million in the IPO. The stock was trading at US$19.21 per share at market close on April 25.
Chinese authorities blamed French utility Veolia Environnement for dangerous levels of benzene in the tap water in the northwestern city
of Lanzhou. Benzene, a cancer-inducing chemical, had been found in tap water supplied by the firm at 20 times above national safety levels, forcing the city to turn off supplies in one district and warn other residents not to drink tap water for the next 24 hours. State-run China National Radio quoted a Lanzhou government spokesman saying “there were super-vision problems within Veolia Water Company related to water quality and safety.” Veolia said it had no ben-zene and was helping to search for the source of the chemical.
US beverage giant Coca-Cola’s reported revenue for the first quar-ter beat expectations, driven in part by sales in China, Reuters report-ed. Coke does not break out China sales separately, but it said global case volumes rose 2% in the quarter, while those in China rose 12% due to increased marketing and advertis-ing around the Chinese New Year. In 2013, the Asia-Pacific region accounted for 13% of the company’s overall sales. Coke plans to invest US$8 billion in China over the five years through 2017 as it focuses on emerging markets to boost revenue.
NE WS ROUNDUP
Cre
dit
: M
ike
Be
hn
ke
n
Cre
dit
: S
oil
Scie
nce
Cre
dit
: C
hri
sto
ph
er
232,000
Number of cars BMW said it was planning to recall in China20%
Size of stake cinema company IMAX sold to Chinese investors
Increase in China sales for Yum! Brands in Q1
9%7,000Visitors came to the Monet exhibition in Shanghai on opening weekend
China Economic Review | May 2014 07
Q&A: PROBLEMS WITH A-SHARES
China Economic Review | May 201408
China is still “gambling on stupidity” in the stock markets
Ch i n a ’ s c a p i -t a l m a r k e t s r e o p e n e d t o
IPOs this year after a 14-month hiatus but the process has been cha-otic, further entrench-ing investor skepticism of A-shares. In an inter-view with China Eco-nomic Review, Zhou Chunsheng, a professor
of finance at Cheung Kong Graduate School of Business in Beijing, gives his thoughts on the challenges in building a functioning system. First, before regulators can successfully push through real reform, investors will have to, among other things, stop “betting on stupid,” which, as Zhou describes, is a quick race to the bot-tom.
Looking at the way the mainland market has performed since IPOs restarted in January, how would you appraise its performance? What has changed?Frankly, I’m not very positive on the performance of the capital markets in China. China set up the Shanghai and Shenzhen markets more than 20 years ago but the two markets didn’t do well. From a financing perspective, sometimes they say ‘no refinancing, no IPOs because we have to stabilize the secondary market.’ But on the other hand, especially retail inves-tors, most of them lost money for a long time, for years. Possibly, you can make more money by investing in financial products from banks.
Do you think pausing IPOs for a year has had a positive impact on the market?I don’t think so. They shouldn’t do that: Pause then reopen. The market
can make its own decision. Now it’s a bear market, it’s going down. So I will not try to IPO now. I will wait. If the capital markets in China are really market oriented, investors, enterprises and corporations, they can make their own correct decisions. The CSRC may think that if the market is in a downward trend then we must help the market by reducing the amount of financing, such as pausing IPOs or slowing down IPOs.
Part of it was trying to improve liquidity in the market as well, right?Yes. Some investors say, ‘Well the CSRC is making the right decision because they are trying to stabilize the market.’ I don’t think this kind of policy works in the long run.
Why?When you say we suspended or pause IPOs, in the future you have to reopen it. This will bring some negative impact to the market.
Is the CSRC sending signals that they are preparing for a registra-tion-based IPO system? From my
perspective, it seems like regulation has been increased on some of the latest listings.Possibly, you are right. They say, in the future we will change the IPO system to a registration system. This is market oriented reform. But right now the CSRC is not doing that, for whatever reason.
What do you think some of those reasons are?The CSRC, in China, this is a gov-ernment agency. So, [CSRC head] Xiao Gang [and other leaders], they have quite a few vice chairmen or vice presidents or whatever. They are all government officials. They pay a lot of attention to the comments of their bosses.
So there’s a bureaucracy problem?Yes. Also, they pay attention to the investors as well, to cater to the preferences of investors’ short-term needs.
So as the CSRC transitions toward the registration-based system – and they have said they will do this...That’s true. They have said they plan to do this.
So what kind of obstacles will the CSRC run into as they try to do this? You’ve already mentioned one, which is bureaucracy. Are there others?Sure. I think before we do that we have to strengthen our legal sys-tem, and the trust of the people, the investors, in the system. Even in the current situation, the market is highly regulated by the CSRC, but there are still a lot of wrongdoings by investors, inside trading or whatever.
Also we know that accounting information of public companies is
I1poiovnC
Zhou Chunsheng
“We call that a trust problem. It’s a social issue in China. It’s not just a stock market issue in China. It’s a social phenomenon that exists in the whole society. It exists in food safety issues. We have fake medicines”
Q&A: PROBLEMS WITH A-SHARES
China Economic Review | May 2014 09
not that reliable, even though the CSRC tries to improve the qual-ity. We try to improve the quality of information disclosure but after so many years it’s still a serious prob-lem. That’s why there are many peo-ple who say, ‘Chinese investors are very speculative. Why?’ Because they don’t trust the public companies.
There’s a Chinese word called ‘bosha.’ I’ll explain: I’m an idiot but you are an idiot as well. So I bought a bad stock but I can pass it to you at a higher price. Then I can make money [even though it was a bad investment to start with] … It means to gamble on stupidity, or someone being stupider than you.
Interesting phrase. Has any progress been made in dealing with these kinds of problems?Sure. I think the CSRC has made some progress. But we call that a trust [problem]. It’s a social issue in China. It’s not just a stock market issue in China. It’s a social phenomenon that exists in the whole society. It exists in food safety issues. We have fake med-ications. We can also see this kind of issue in the stock market. If we can-not solve this issue... I mean, these
issues exist everywhere, in Hong Kong and the US and London stock exchange. But it’s not so widespread.
I think in China the situation is more serious. If we cannot solve this, if we cannot improve the quality of information disclosure, if we cannot effectively punish the wrongdoings in the stock market, then the stock mar-ket in China will not perform very well, will not be trusted by long-term investors. That’s why many measures that have been taken by the CSRC have not been very effective. Because they have not solved the fundamental problem.
And this is a cultural problem?Well, it’s related to culture but I strongly believe that it’s related to the whole legal system and enforcement of the law. Sometimes, in China, [for example] I know you. You are the regulator or you have the power. I won’t catch you; I’ll catch someone else. We call that ‘selective enforce-ment.’ You know what I’m saying. This is a social issue. So the reform of the Chinese stock market is closely related to the reform of our social sys-tem, our legal system.
We are making progress. We are
making very good progress in many aspects. But these kinds of issues, we need more time to deal with this.
Okay. So my final question is about how, when people talk about the implementation of a registration-based system, there needs to be a legal follow-up to that.That’s true.
Because if you suddenly give a list of requirements, and any company can list as long as they meet those requirements, then there needs to be a strong legal follow-up. So the question is: How coordinated is capital markets reform with legal reform? Is there strong coordination right now?I should say there is coordination right now but I don’t believe the coordination is so strong. CSRC is a government agency. It only takes care of the capital market. It’s not very powerful in the bureaucratic system. The Supreme Court and the People’s Congress, of course they are much more powerful. So I guess we have to make good preparations before we do this kind of thing, or else some companies will cook up their num-bers, saying they make a lot of profit and that they have a very good busi-ness model. They encourage inves-tors to buy their stocks and then they take the money away. China has such a huge population. China has mil-lions of companies. Do you know the number of companies in China?
I have no idea. What’s the number?If we count all the companies, includ-ing small and micro businesses, we have possibly 30 million businesses or enterprises. This number is bigger than the population of some Euro-pean countries. That’s why China is somehow different from other coun-tries. Such a large population. Such a large number of businesses. That’s why it’s very difficult for regulators to monitor all of them and for inves-tors to get to know them. So you can imagine that if we switched to the registration system, it’s very difficult … This is possibly the correct way to go but it takes time.
LET DOWN: Zhou says that Chinese regulators take a selective approach to enforcement of mainland
companies, many of which have disappointed investors
Q&A: CHINA’S ECONOMY
Reasonable expectations
Recent economic data have trou-b l ed marke t s
and analysts about the direction of the Chi-nese economy. China Economic Review caught up with Bill Adams, senior interna-tional economist at US-based PNC Financial Services Group and co-
author of the book “In Line Behind a Billion People: How Scarcity Will Define China’s Ascent in the Next Decade,” to get his thoughts.
Q1 GDP data show China’s econ-omy continues to slow. Do you believe lower growth rates give the government more room to push through with rebalancing?China’s slower growth in the first quarter is a direct consequence of steps that the government has already taken to address some of the imbalances in the economy. We’ve seen a big slowdown in investment activity, in part because of direct controls on the quantity of credit growth, but also because of more market-determined interest rates, which are higher interest rates and have dampened the rate of credit growth. So five or 10 years ago, eve-ryone was talking about how China needed more market-determined cost of capital to make investment more efficient over the long run. And now we’re starting to see some of the financial reforms necessary for that to happen come into place.
Where do you stand on the debate over whether Beijing should roll out more stimulus measures to meet growth targets?My read of Chinese economic policy right now comes from the premier’s effectively forward guidance out of
the [Government] Work Report at the National People’s Congress. As long as growth is strong enough to maintain full employment, the gov-ernment does not see a need for a substantial stimulus program. And looking at the latest wage growth data which were released with the first-quarter GDP report, it looks like China’s wage growth is reflect-ing a still relatively tight labor mar-ket, meaning a labor market that’s close to full employment. So I think the pace of growth that China’s experiencing right now is sufficient from the government’s perspective. The concern for China in 2014 is not so much the pace of growth, but uncertainty over the resolution of the excessive credit growth during the years immediately following the global recession.
The Chinese leadership has prom-ised to allow a more “decisive” role for market forces in the economy. Is this commitment sincere, and if so, are there possible dangers to this approach?I think Chinese policymakers under-stand the obstacles to growth posed by vested interests in the Chinese economy and system, so the analysis is there. But how exactly to go about changing the system is very compli-cated. The other thing to say about it is that it’s quite possible that one consequence of China’s current anti-corruption drive, which is coming down especially hard on state-owned enterprises and sectors of the econo-my that are heavily regulated, could be opening those sectors to more participation by privately owned par-ticipants.
Premier Li Keqiang recently called for reform of the state-owned enterprise sector to allow more private capital investment. How
urgent is the need for liberalization of private investment, and how far will Beijing allow private investors to go?China’s private sector has provid-ed most of the country’s new jobs since the turn of the century. But for the last few years, an appreciating currency has meant that privately owned export-oriented manufactur-ers in labor-intensive sectors have been struggling, if not declining. And regulatory barriers make it dif-ficult for private entrepreneurs to set up businesses that capitalize on domestic market opportunities in the way that they built factories to capitalize on robust foreign demand prior to the Great Recession. The Chinese government has pledged to allow a large role for market forc-es in sectors that are dominated by state-owned firms, but this pledge has been made many times before and the reality has historically fallen short of the promise. The most rea-sonable expectations for the liberali-zation of heavily regulated sectors in 2014 would be modest ones.
China’s weak manufacturing PMI worries many analysts. Given that manufacturing makes up only 41% of China’s economy today, while the service sector accounts for 49%, do you think this focus on factory production as a gauge of China’s economic health is missing the point?The manufacturing PMIs are excel-lent indicators: They monitor an important sector, they are reported in a consistent and easily interpret-ed way, and they trend with Chi-na’s overall business cycle. Now, in 2014, defaults on loans made dur-ing the years after the Great Reces-sion, when credit rained from the sky in China, are the bigger risk to the economy. But Chinese data on
The Chinese government understands the obstacles to growth posed by vested interests but progress on reform in 2014 is likely to be modest at best
China Economic Review | May 201410
adnEcAtbS
Bill Adams
defaults and debt restructuring isn’t as timely or comprehensive as data on growth, so economists are forced to track the problem through other means.
How will a scarcity of natural resources impact the success of China’s transition or rebalancing to a service and consumer economy?When we talk about China’s rebal-ancing to a more sustainable model of growth, we are usually talking about a transition to an economy that is more directed toward con-sumer demand and less reliant on exports or ever-rising property pric-es. A more consumer-oriented econ-omy is sustainable in the sense that growth is less likely to be interrupted by an asset bubble collapsing or a global recession, but it would not necessarily be less resource-intensive. Think about it – what would the Chinese economy make if it were
more oriented toward domestic consumer demand? What do Chi-nese consumers want more of? Big-ger houses, new cars, roads to drive their cars on, and electronic devices to play with while they are stuck in traffic – resource-intensive stuff.
Beyond headline economic and industrial data, what else should our readers look out for when trying to understand the direction of the Chinese economy?Today, hundreds of millions of Chinese people live middle class lifestyles, but lack access to the clean air, clean water, safe food, and other amenities that middle class consumers in most developed coun-tries take for granted. I am watch-ing for the growth of industries to fill in Chinese consumer demand for these things that China’s break-neck growth has so far not deliv-ered.
Could you speak about your cur-rent areas of research and interest regarding the Chinese economy? What are you currently working on that you think is important?I’ve recently been looking at the global links in China’s food supply chain. Whenever trade with China comes up in conversation in the US, Americans tend to lament that eve-rything we buy is made in China, but China doesn’t need anything that the US makes – not realizing that one-fifth of the feed grain used to raise Chinese pork, chicken and beef is imported, or that the US is one of China’s biggest grain suppliers. This international dimension is why pork prices are always the first part of the Chinese CPI basket to shoot up dur-ing a spike in global inflation: Pork is raised on feed grain, much of it imported, and so the cost structure of producing it follows global price trends that Beijing doesn’t control.
Q&A: CHINA’S ECONOMY
China Economic Review | May 2014 11
China Economic Review | May 201412
Q&A: BUILDING A LUXURY CHINESE BRAND
Escaping nostalgia
Luxury fashion is about gaining acceptance; what you wear and how you wear it is a projection
of who you are as a person and how you want to be seen. The garments that fill your wardrobe are therefore heavily influenced by your social circle. Getting a professional office worker in Shanghai to sport a manda-rin collar instead of necktie is no easy task – no matter how premium the product on offer.
The mandarin collar is low, unfolded and can be buttoned to fit snugly around the neck, conjuring the image of a Qing dynasty scholar. For less conspicuous wear, it can be unfastened into a V-neck as Raphael le Masne De Chermont, executive chairman of Shanghai Tang, a Hong Kong-based clothing company, pre-fers to wear it. Since the mid-1990s, Shanghai Tang has been known for its apparel with a strikingly tra-ditional Chinese influence. For the past several years, however, as it bids for the attention of wealthy Chinese consumers who disdain dragons on their jackets, the brand is remaking its image with a far lighter Chinese touch. The change in ideology is not without its challenges.
De Chermont refuses to wear neckties and demands that others take theirs off. “It’s the leash of the corporate animal,” he says on the sidelines of a luxury brand forum in Shanghai on March 22, before exhorting this reporter to unknot his own. As an ideological statement, Shanghai Tang does not sell neck-ties despite the huge mainland mar-ket for them. The decidedly Chi-nese collar isn’t just about comfort or fashion. It’s a cultural statement, playing ever so slightly on the sen-timents of the country’s illustrious past while also hoping to sidestep the twinge of unpleasant moments in history. The brand is positioned at a
A chat with Shanghai Tang about building a luxury Chinese fashion brand
confluence of national and fashion-able confidence in China – whether it wants to be or not. Finding equal footing on this untrodden ground will be a challenge for De Chermont as the brand looks to capture a grow-ing share of sales from mainland-ers, of whom few today dare flaunt a mandarin collar.
Don’t dwell too long on the tradi-tional Chinese elements of the brand, the chairman says. De Chermont’s pitch to the world as Shanghai Tang expands on the mainland and abroad is that the company sits at the fore-front of “Chinese chic,” a representa-tive of all that’s new in Chinese fash-ion, not a throwback to the past.
“We are not nostalgic. We are not going back. Some people think Shanghai Tang is all qipao, all chang-shan. It’s not,” he says, referring to two traditional Chinese outfits. The qipao is an embroidered vest worn by women; a changshan is a long but-ton-up shirt once commonly sported by men in imperial China. “I dress in Shanghai Tang every day.” He couldn’t always, though. When Swiss holding company Compagnie Finan-ciere Richemont, which also boasts the likes of Dunhill and Piaget in its stable of luxury brands, took over the company in 1998 from Hong Kong tailor and businessman David Tang,
De Chermont said Shanghai Tang was unsuitable for casual wear. The design looked like something out of ancient China. “Everything was too costumey. It was like Western peo-ple dressing like Chinese,” he said. Chinese cringed at the sight; many were embarrassed to even set foot in the shops. At the time, the brand’s main customers were tourists passing through Hong Kong. Though finely crafted, Shanghai Tang’s shirts and jackets carried little more than souve-nir value.
An advertisement from the 1990s shows a blonde-headed Westerner suspended midair in a kungfu-style kick, his Shanghai Tang jacket flying back behind him.
De Chermont has taken the brand far beyond those days; besides the mandarin collar, his dark blue coat has nominal Chinese influence. Still, the past is hard to ignore, especially for a company that calls itself Chi-na’s first – and possibly only – luxury brand. European luxury brands often tout their heritage, and Shanghai Tang, established in 1994 by Tang, traces its style to the vibrant metrop-olis of the 1930s after which it is named.
De Chermont described the Shanghai of that era as a color-ful party where Eastern culture and fashion were running head on with the West. At the time, the city was carved up into concessions overseen by various imperial powers. Many Chinese citizens were relegated to a small, poor area of the city but within the concessions an elite, international crowd enjoyed a lifestyle on par with London or Paris; the decadence was so full-on that Shanghai acquired the unfortunate nickname of “Whore of the Orient” among party–loving Europeans.
A burgeoning tailor business catered to the upper class and con-
“We are not nostalgic. We are not going back. Some people think Shanghai Tang is all qipao, all changshan. It’s not ... “I dress in Shanghai Tang every day.”
China Economic Review | May 2014 13
Q&A: BUILDING A LUXURY CHINESE BRAND
centrated the most talented stitching knowhow in the country within city limits.
That ended abruptly with the communist takeover in 1949. “No more party; no more equality in the way you express yourself,” De Cher-mont says. The tailors fled to British-controlled Hong Kong as refugees and formed a tailors’ guild that, in some form, has survived among their sons and grandsons. David Tang was one of them.
De Chermont estimates that Shanghai Tang employs up to 70% of those descendents today, giving the brand a strong claim to the legacy of China’s tailoring prowess.
The 1930s were an indisputably robust era for the city. Yet some Chi-nese historians refer to that time as being an important part of China’s “century of humiliation.”
That is a dilemma for the brand: Its heritage and the foundations of its style are rooted in a period of time that, in history books and in the heart of the country’s elder generation, is synonymous with ignominy. Shang-hai Tang is trying to break away from notions such as these while at the same time retaining its story and her-itage.
“China was not confident for a while,” De Chermont says. “They are
the big players of the economy and will soon be the first. They have a lot to catch up. They don’t want people to remind them of their misery in the past.” When asked if Chinese people want Chinese characteristics in their clothing, he responds with an unhesi-tant “no.”
Perhaps the brand’s slogan “Re-orient yourself” is also its business model.
Shanghai Tang is doing well at ditching the past and in the same step attracting Chinese shoppers. In 2010, only 9% of sales came from mainland customers, according to figures pro-vided by De Chermont. In 2013, that share had jumped to 22%.
The gain in Chinese buyers comes at a crucial period for luxury brands on the mainland. China’s central government began clamping down on conspicuous consumption among party officials at the end of 2012 and the effects on international luxury brands that dominate the luxury seg-ment have been profound.
Bain & Co said luxury sales slowed from 12% annual growth in 2012 to just 2% last year; 2014 will likely see a similar slowdown.
Shanghai Tang has relished the backlash against graft, however. “It’s very good for us. We’re growing very fast. Much faster since the corruption
campaign took place,” De Chermont said.
He claims that Shanghai Tang is “politically correct.” As a Chinese brand, it has moved under the radar of the corruption crackdown, avoid-ing the characterization as Euro-pean luxury. Price also comes into play. Shanghai Tang costs less than its European peers. During the cor-ruption crackdown, lower-cost luxury and premium brands have taken in solid growth as China’s anti-graft watchdog has sought out the officials in pricey Hermes blazers.
The crackdown might be one trend that has boosted sales at the company but there are other changes in the economy that Shanghai Tang has yet to leverage.
Luxury sales in second-tier cit-ies in China are booming. In fact, consultancy McKinsey said last year that sales in these cities are driving luxury consumption on the mainland. As shopping malls fill with West-ern brands in cities such as Chong-qing, Chengdu and Harbin, Shanghai Tang’s presence there is still “little,” De Chermont says. That’s under-standable. Chinese brands in these markets will likely be at a disadvan-tage for now.
While luxury consumers in Chi-na’s first-tier cities are increasingly sophisticated, often shopping for sub-tler designs without large labels, buy-ers outside of Shanghai, Guangzhou and Beijing still want to show off.
They appraise products based on price and want friends to know they can afford expensive European brands. A Chinese brand may not suffice in impressing colleagues, at least until consumers in those areas become more refined.
Shanghai Tang does have shops in several second-tier cities but they are in airports, catering to the same travel retail crowd as a decade ago.
That’s just one more challenge in being a Chinese luxury brand. Shang-hai Tang is still mulling how to lever-age its heritage and tradition – which cultural characteristics to highlight and which ones to forget.
That could very well determine its success or failure on the mainland.
NOT INTERESTED: Wealthy mainland Chinese have had a hard time coming to accept Shanghai Tang as
a luxury fashion brand worthy of their money, but the company believes it can change attitudes
Cre
dit
: J
on
ath
an
Ko
s-R
ea
d
China Economic Review | May 201414
COLUMN: GROW TH TRADEOFF
A delicate balance
China’s transi-tion from a cen-trally planned to
a market economy has neither been easy nor linear. The government has tried to liberal-ize some of the sectors, although not all, priva-tize some industries, but certainly not all. Overall, one can argue that the dominance of the state-owned sectors has been maintained with a spe-cial emphasis since the 2008 global crisis. Such strategic choice is also behind the continuation of an investment driven growth model. The cost of such a model, howev-er, cannot be underesti-mated. Resource misal-location, overcapacity in
the capital-intensive industries, rising domestic financial fragilities as well as many social and environmental prob-lems, are some of them.
BBVA economists Alicia Garcia-Herrero and George Xu take a look at the tradeoff between reform and growth that China must make to continue to develop
China’s annual economic growth has remained above 8% entering the 21st century, before moderating to 7.7% in 2012 and 2013 for two consecutive years. Despite having once again averted a hard landing scenario as was feared earlier in the year, economic rebalancing towards domestic consumption has been very slow, with investment continuing to support growth. In fact, in 2013, the Chinese economy was sustained by exports and supportive government policies, including a “mini” stimulus package focused on infrastructure investment. However, high-frequen-cy economic indicators in early 2014 point to a further slowdown, coming on the heels of sluggish exports and soft domestic demand due to the authorities’ tightening measures to curb financial fragilities.
Regarding 2014, the government announced its GDP growth target during the annual National People’s Congress in early March. The tar-get remained the same as in 2013, namely 7.5%. However, in the face of the recent growth headwinds evi-
denced by quite gloomy data out-turns, Premier Li Keqiang recently hinted that the government will fine-tune economic policies to sus-tain the economy within a “reason-able zone”, which is interpreted as a combination of two limits: An upper bound of 3.5% for inflation, and a bottom line of 7.0% GDP growth. Against the background of moder-ating GDP growth and other poor data for the first quarter, maintain-ing growth above 7% actually means more fiscal and/or monetary stimu-lus as Li Keqiang acknowledged.
The need to push demand poli-cies further and underpin the growth above the floor target comes at a time when China really needs to deliver on structural reforms. In fact, China’s long-awaited “blueprint” has been released after the Third Ple-num in November 2013 and aims to enhance the quality of economic growth and facilitate the rebalanc-ing of the economy. The document is ambitious and encouraging for its wide range of scope, reflecting the commitments of China’s new lead-ership after formally taking power in March 2013. The key elements of this blueprint can be classified as follows. The first is financial sector liberalization, which includes greater private entry into the banking sector, further interest rate liberalization and opening of the capital account as well as a more flexible foreign exchange regime.
The second is fiscal reform, including anti-corruption and anti-waste campaign, as well as expan-sion of VAT pilot program. The third key area is urbanization with additional public housing construc-tion and more channels for public housing finance. The fourth one focuses on the always difficult nexus of the private and public sector. One aspect is SOE governance, for
anlhiatco
Alicia
domc2sbogoeml
George Xu
SOMETHING MUST GIVE: BBVA economists argue that China will see long-term benefi ts from reform
but that will come at the cost of slowing economic growth in the short term
China Economic Review | May 2014 15
COLUMN: GROW TH TRADEOFF
which a mixed-ownership structure in SOEs will be explored as well as market pricing for utilities and natu-ral resources. Finally, there is a set of important social measures in the reform package including the relaxa-tion of the one child policy as well as a further streamlining of public administration through reducing the number of administrative tiers and cutting red tape.
The question really is whether China can introduce all of these reforms in a lax environment in terms of liquidity or actually needs to restrain credit to force firms to change. While some of the reforms may not be influenced by the avail-ability of credit, it seems clear that changing the incentive structure in which Chinese corporations and banks operate will not be achieved without financial constraints, not to talk about the reduction of overca-pacity and the improvement of envi-
ronmental concerns. This is where the tradeoff between growth and reform comes from.
In order to meet a bottom line of 7.0% GDP growth this year, the new leaders have already fine-tuned
the policy stance towards a laxer one, at least in terms of fiscal policy. In fact, the government will disburse fiscal funds in a more timely manner, continue social housing construction and accelerate public infrastructure investment (railway, highway and water conservancy). As for monetary policy, interbank rates have been kept at lower levels than those back in last December. Further easing in the coming months cannot be ruled out, including cuts in the reserve requirement ratio (RRR).
We are still optimistic about Chi-na’s medium-term growth outlook as long as China continues with its reform agenda. However, we cannot forget that China’s potential growth rate will inexorably come down given its population trends and its rising income per capita. In any event, potential growth will be higher with reforms than without. That is what matters.
“China’s potential growth rate will inexorably come down given its population trends and its rising income per capita. In any event, potential growth will be higher with reforms than without. That is what matters”
CHINA TAKES A DUBIOUS SHORTCUT ONTO THE GLOBAL FINANCIAL MARKETCHINA TAKES A DUBIOUS SHORTCUT ONTO THE GLOBAL FINANCIAL MARKET
Change of directionChange of direction
HAD ENOUGH: Mainland investors won't miss this opportunity to take their money out of the stuttering Shanghai bourse and plow it into Hong Kong
Investors in Shanghai grumbled loudly in early April 2011 when British bank HSBC Holdings said it would yet again delay a listing in the city.
The state of the market, one of the world’s worst performing major equities exchanges that year, was simply not ready to absorb an international IPO, the bank’s Asia head implied at the time.
After 10 years of mulling over the concept, HSBC’s decision to back out of a mainland listing blackened the prospects for a long-awaited “inter-national board,” on which local officials envisioned major global firms directly accessing China’s capital markets for the first time. Since then, international listings on the mainland have been all but dropped from conversation.
Any international firm still considering a Shang-hai IPO on the international board may have finally abandoned such thoughts earlier this month when the China Securities and Exchange Commission and the Securities and Futures Commission of Hong Kong said in a joint statement that they would open a cross-border investment channel between their exchanges.
The scheme, known as the Shanghai-Hong Kong Stock Connect, will grant qualified inves-tors in the two markets access to some shares on the opposite side of the border. Mainland insti-tutional investors with more than RMB500,000 (US$80,000) in their trading accounts will have an aggregate trading quota of US$40 billion to buy up Hong Kong shares on the Hang Seng large and medium cap indices; investors in Hong Kong will have a trading quota of US$48 billion to buy into firms on two of the Shanghai Stock Exchange’s big-gest indices, the SSE 300 and SSE 180. "Con-
COVER STORY: SHANGHAI-HK CONNECT
China Economic Review | May 2014 17
nect," as it’s come to be called, should launch within six months.
Firms such as European con-sumer goods giant Unilever, which also expressed interest in listing in Shanghai, will find navigating that opaque regulatory environment increasingly unattractive when it can access mainland capital via a list-ing in Hong Kong, one of the big-gest and most efficient IPO mar-kets in the world. The news should also cheer up the red-eyed main-land investors disappointed by the delayed international board. Connect will grant many of them the access to the strong firms with solid over-sight they’ve sought out for years.
Market watchers have lauded the stock connect as a breakthrough
COVER STORY: SHANGHAI-HK CONNECT
in China’s capital markets. Hong Kong, too, can expect its prestige as a hub for fund management to grow with its extended reach northward. Given the increased amount of ren-minbi that will be allowed to move offshore, the scheme is also a sign that Beijing is pushing forward with internationalizing its currency.
But there are worries as well. The dimming prospects for an interna-tional board could set back the repu-tation of the mainland market and its regulator. Some analysts see funds in the two-way investment pilot mainly moving southward into the better-performing and more sophis-ticated Hong Kong market.
The game is Shanghai’s to lose – if mainland regulators cannot update
and reform the local bourse quickly enough to convince domestic inves-tors that it is the best place to gener-ate returns.
“If the Shanghai market cannot catch up, it will inevitably result in a two-tiered market,” Raymond Yeung, a senior economist at ANZ Bank, said from Hong Kong in April. “The Shanghai market will be the second tier.”
This time aroundThis isn’t the first time the mainland has proposed a cross-border invest-ment experiment into the Hong Kong stock exchange. In 2007, the State Administration of For-eign Exchange said on its website that qualified investors could set up accounts at a Bank of China branch in Tianjin’s Binhai special economic zone. The notice said those inves-tors would get limited access to the Hong Kong market, where shares rallied on the expectation of a wave of incoming investment. The plan, though, was never carried out.
“The ‘proposal,’ if it can be called that, was more of a pet scheme from Tianjin mayor Dai Xianglong, an ex-PBOC governor, as a way to enhance the city of Tianjin’s cre-dentials as a financial center,” Fraser Howie, the author of several books on the mainland stock exchange and formerly the manager of a mainland-bound investment fund for invest-ment bank CLSA, said in an email in April. “It never got anywhere near implementation and I think it was only taken seriously by [Hong Kong].”
This month’s announcement is different, Howie said. The joint statement from both the CSRC and the SFC shows that the two sides are serious about the plan. In 2007, details such as quota volume and timeframe were never divulged. Reg-ulators on both sides of the border have included far more information in this statement.
“It could easily have been a much less detailed announcement from the exchanges talking about co-opera-tion,” he said. “But clearly someone, somewhere, has been given approval
Cre
dit
: J
im T
rod
el
BRIGHT BEACON: Hong Kong's solid regulatory environment for securities trading has attracted inter-
national listings for decades
China Economic Review | May 201418
to talk about billions of dollars of quota at this early stage.”
Big quotas to fillConnect will fall into direct compe-tition with China’s original cross-border investment programs. The Qualified Foreign Institutional Investor scheme, or QFII, allowed foreign investors to access China’s capital markets starting in 2003. The Qualified Domestic Institutional Investor program, known as QDII, which lets mainland investors access
COVER STORY: SHANGHAI-HK CONNECT
capital markets abroad, followed in 2006.
The quota for QFII has jumped from just US$30 billion in 2011 to US$150 billion last year. However, the program, known for its burden-some paperwork, has struggled to attract investors, with only US$53 billion, or little more than a third of the quota, allocated for investment in 2013, according to consultancy Z-Ben Advisors.
The poor performance of QFII is directly related to the perform-ance of the Chinese stock market. The Shanghai Stock Exchange has languished during the past five years. Poor corporate governance has led to numerous fraud cases and investors have routinely lost out on hyped-up IPO prices that eventually plummet. Regulators have failed to clean up the mess.
In November 2012, the CSRC stopped approving new IPOs in the hope of cleaning out bad compa-nies from the listing pipeline. Some 900 capital-starved companies were lined up for approval in the sum-mer months of 2013. The implicit ban persisted for more than a year before about 50 firms were allowed to list starting this January. Regula-tors started the year with promises to make it easier for companies to list and boost legal oversight for
“If you open a shop and sell goods, but these goods are of dubious quality, bringing in more customers to your shop may generate more business, but it won’t improve the quality of your goods”- Kevin Lai, Daiwa Capital Markets in Hong Kong
listed firms but investor confi-dence, including that of foreigners with QFII quotas, remains low.
At US$48 billion, the inbound stock connect quota is much smaller than the quota for QFII (however, it is very close to the size of the QFII quotas that are actually allocated). Mainland securities analysts were mixed on the impact the new plan would have on the older system.
“I think the influence on QFII will be limited,” Yan Yijin, an ana-lyst at Chief Securities in Beijing, said last month. Demand for main-land shares could be sluggish given the state of the market, she said. The original program’s international sta-tus should maintain some demand for those quotas. “QFII isn’t just investment from Hong Kong. It’s also used in Europe and the US. Connect will be limited to Hong Kong.”
Cao Yu, an equities analyst at Avic Securities in Beijing, down-
played the initial impact the pro-gram will have on mainland brokers, stressing that more details are need-ed. The model between Shanghai and Hong Kong, if successful, could be replicated between the mainland and other international exchanges in the future, but the government has yet to give any signs that it will do that, he said.
Mainland brokerages that deal in QFII or QDII will need to prepare for a change in the kind of services they offer, said Fu Jing, a Wuhan-based analyst at Changjiang Securi-ties. “The companies should go to expand their scope of operations,” she said. Specifications for the plan, especially those concerning the requirements for taking part, have yet to be issued. Securities com-panies will have to wait for clearer directions before they can respond, Fu said. “We don’t have the details yet. We don’t know what kind of system this is going to be.”
Plug the leakA few details beyond those provid-ed in the early April announcement have emerged. Some media reports say the investment system will be a “closed loop,” meaning that money Hong Kong investors put into main-land firms will not be allowed to flow into the real economy in China, instead remaining locked into the securities market.
Surprisingly, China’s central bank has yet to weigh in on the new plan or demonstrate how its policy will support Connect or prevent capital leakage.
“I haven’t seen any opinions from the PBOC on how this will connect to overall monetary policy,” Yeung at ANZ said. “Is it compatible with monetary policy? This doesn’t seem so apparent yet.”
Making sure Connect doesn’t open another hole through which hot money flows into China will be essential for the central bank. PBOC
30000
25000
20000
15000
10000
0
6000
4000
2000
0
2000
2000
2002
2002
2004
2004
2006
2006
2001
2001
2003
2003
2005
2005
2007
2007
2008
2008
2009
2009
2010
2010
2012
2012
2011
2011
2013
2013
China Economic Review | May 201420
Hong Kong’s Heng Sang Index has performed well for more than a decade, rarely dipping below the 10,000-point mark. Although it is still below its all-time high in 2008, the index has recovered much better than mainland indexes.
At its greatest swell, the Shanghai Composite Index hardly reached above the 6,000-point mark. For half a decade, the mainland’s capital markets have languished due to low investor confi dence
COVER STORY: SHANGHAI-HK CONNECT
and China’s customs officials have been fighting an uphill battle for years against currency speculators who have bet on the slow, one-way appreciation of the renminbi. Trad-ers in China often inflate the value of their exports when shipping to partners in Hong Kong, allowing them to bring extra yuan into China. On top of what was once thought to be guaranteed appreciation against the dollar, the hot money could be invested in high-yielding money market funds or even real estate developments.
Such activity has skewed export data for more than a year. However, since early February, the People’s Bank has fought back by pushing down the value of the renminbi. The currency hit a 16-month low against the dollar in mid-April prompting an abrupt halt to the practice that caused exports in February to plum-met by 18% from a year earlier.
Without close coordination between securities and monetary policymakers, the Shanghai-Hong Kong Stock Connect is another wor-risome channel for currency specula-tion. There’s no definitive answer on how the program could be used for financial arbitrage just yet but Yeung said the use of a company’s shares that are listed in both Shang-hai and Hong Kong as a form of col-lateral could open up a channel for hot inflows.
“I think the real concern from the mainland is hot money going into real estate,” Yeung said, further fueling property speculation and the possible formation of bubbles in one of the country’s most sensitive sec-tors.
Damaged goodsThe CSRC may be concerned with how its experiment could open the country to hot inflows in the short term. Likely greater on the minds of the top decision makers at the regu-latory body are long-term worries over the performance of the main-land exchange, especially after Con-nect opens it to greater competition with the outside world.
The program will, in effect, be
Shanghai’s shortcut onto the global financial scene. Whether that’s good or bad for the long-term develop-ment of the mainland equities mar-ket is up for debate.
It certainly won’t help the devel-opment of an international board in Shanghai. Once mainland inves-tors get access to companies listed in Hong Kong, the listings of glo-bal companies will become the “de facto international board,” accord-ing to ANZ Research. International businesses will have little incentive to wet their feet in the Chinese market before its regulatory and corporate governance problems are cleaned up.
“I think if the Shanghai regulato-ry environment can catch up or meet international standards that will be a plus,” Yeung said. “But if they fail to do this, that might actually be a drag on the development of the market. Companies will prefer to list in Hong Kong … Investors will take advantage of better infrastructure and better corporate governance and the overall high quality of the Hong Kong stock exchange.”
The outbound quota for Connect is lower than the inbound, reveal-ing some fears on the potential for a flight of capital from the mainland.
The Shanghai-Hong Kong Stock Connect isn’t an all-powerful anti-dote set to solve the problems the mainland has faced for a decade. In the end, the onus of bringing a greater level of transparency to the local market and boosting corporate governance at Chinese companies still falls on the regulators, whether it be the CSRC or China’s judicial arm, which has been far too lax on rule-breaking firms.
“If you open a shop and sell goods, but these goods are of dubi-ous quality, bringing in more cus-tomers to your shop may generate more business, but it won’t improve the quality of your goods,” said Kevin Lai, a Hong Kong-based economist at Daiwa Capital Mar-kets. “They need to change the whole investment landscape in China … Then there may be more interest in the mainland market.”
China Economic Review | May 2014 21
ECONOMICS & POLICY: ANALYSIS OF Q1 GDP
GDP pangs
If expectations are low, beating them doesn’t mean much. China’s GDP grew by 7.4% year-on-year
in the first quarter of 2014, a notch above the market consensus of 7.3%.
But after three months of main-ly gloomy economic data, analysts weren’t betting on a powerful punch in overall growth figures. The stats from March alone give reason to believe that China has yet to rebound from a tough start to the year. As for giving the economy a gentle fiscal nudge, Beijing has likely said all it intends to on that matter with some targeted measures in recent weeks. China Economic Review thinks that’s just fine as long as economic reform keeps abreast.
March was a tough month with the important numbers slowing across the board. Fixed-asset invest-ment slowed again to 17.4% from 17.9% in February. Property invest-ment dropped to 14.2% year-on-year growth from 19.3% in the first two
months of the year. Societe Generale noted that new property starts plum-meted to -22% in the first quarter of the year after growing at 33% in the last quarter of 2013. The drop is alarming and bodes poorly for the real estate market in the coming months.
At 8.8%, industrial production in March chinned only slightly above the disappointing figure from the first two months of the year. But the uptick can be misleading. It came off of a sharp decline in March 2013 when factory output, a pulse read-ing on the steel and cement markets, dropped one percentage point. The low base for comparison should have helped the figure look strong but it didn’t.
Many experts are predicting an even worse second quarter of the year. “We maintain our view that GDP growth is on a downward trend and we will continue to expect it to slow to 7.1% in Q2,” Nomura Research said in a report following the release
of the GDP data on April 16.The investment bankers looking
to sell China have extolled the recent “mini-stimulus” or “fine-tuning” package that will boost investment into select areas of the economy such as rail and dilapidated neighborhoods and cut taxes for small and medium enterprises. The government made such pledges in what appeared to be a response to ugly February data. Some analysts cheered.
“ W e b e l i e v e P r e m i e r L i [Keqiang]’s vow to expand tax rebates to small enterprises, accelerate the shanty town renovation and con-struction, and increase railway invest-ment using both public and private funds will also help propel the growth momentum in Q2,” ANZ Bank said in a note, adding that a cyclical upturn was already underway.
The fiscal help might be hyped, though. Many of the measures that the government announced in March were already on the agenda. The pre-
Trying to decipher the meaning and signifi cance of the growth fi gures for China’s economy is no easy task
DON’T BUDGE: Despite decelerating economic growth in the fi rst quarter of 2014, top leaders in Beijing have held back from releasing the fi scal trigger. Staying
the course will be the best thing to do in the long-run
China Economic Review | May 201422
ECONOMICS & POLICY: ANALYSIS OF Q1 GDP
mier simply corralled the efforts into what sounds like a more cohesive plan, perhaps with the intention of lifting confidence in the market. It should also be remembered that, at the Boao financial summit in Hainan province in early April, Li said he would focus on “healthy economic development,” ruling out chances for a more forceful stimulus push in 2014
A lack of support from Li and his entourage at the State Council has led many to look to the People’s Bank of China for relief. In March, total social financing, or TSF, China’s broadest measure of credit growth, expanded more than expected at RMB2.07 trillion. But lending usu-ally rises rapidly in March and the TSF figure for the first quarter of 2014 lagged compared to last year.
The market is now waiting to see if PBOC will use some of the mon-etary tools at its disposal to get money moving through the system. An obvious option is to cut the reserve requirement ratio for big banks, an
explicitly pro-growth move in the face of the country’s many other chal-lenges. Consensus among analysts is mixed, with some saying a slight cut is imminent given the first quarter GDP data and a lowering of the ratio to certain county-level banks. Others say the central bank will wait to see how the light fiscal boost of the mini stimulus will impact the economy.
China Economic Review would like to reflect on some of the maxims that have been thrown around dur-ing the past year to chart out the best course of action in the first half of 2014.
“The core of reform in China today is deleveraging the economy altogether,” an economist from Moody’s said at a conference in Shanghai late last year. That’s a good starting point for policymakers in 2014. Allowing lenders to hold less cash in reserve would be a signal for them to boost lending, something that will work against the goal of deleveraging an economy addicted to
credit. Instead, Beijing should push banks to increase lending to only healthy customers, something they are capable of doing with the current level of liquidity in the market.
While repeated many times, Pre-mier Li continues to point out that “the biggest economic dividend will come from reform.” Those returns will come far slower than those from a powerful stimulus package or loos-ened monetary policy but they won’t come laced with the same kind of financial risk that unbridled credit growth has already wrought on the economy.
GaveKal Dragonomics analysts say the biggest challenge this year is maintaining a public sense that reforms are still moving along even as the country continues to report insip-id economic data. Staying the course with reforms and deleveraging might be the strongest signal that leaders are determined to put the Chinese eco-nomic juggernaut on the right path to development.
China Economic Review | May 2014 23
Export slowdown
At least it wasn’t a double-digit drop like February. That’s what people are saying about
China’s export data for March, which fell 6.6% from a year ago.
After a more than 18% year-on-year drop in exports in the second month of the year, March’s contrac-tion may feel milder than that but there is strong reason to believe that real exporters have taken a harder hit than in the last two months.
The keyword in Chinese trade data for more than a year has been “distortion.” The slowly but steadily appreciating yuan inspired traders to inflate the value of their shipments with the intention of bringing more cash onshore. This was done mainly through partners in yuan trading hubs such as Taiwan and Hong Kong. The proposition has looked less promis-ing since the central bank pushed the value of the yuan downward in recent weeks. Hot money inflows have slowed down considerably.
The depreciating yuan, along with
some seasonal factors such as Chinese New Year, led to the jaw-dropping collapse in February after exports beat analyst expectations just a month ear-lier.
Some of the distortion is start-ing to clear and a distinct difference can be drawn between the numbers for February and March. Some haze still remains, though. For example, exports in the first two months of 2013 surged by 23% when the market expected only 11% growth. Analysts should have seen the drop off from that towering base in February.
March’s data is strikingly different. Government measures had cooled much of the speculative cash inflows by the end of the first quarter last year. Exports grew by 10% in March 2013, spooking the market with the threat of a slowdown. Off the rela-tively low base, economists expected positive growth in exports between 4-5% in March. They didn’t get that; many may prefer the cloak of distor-tion to what is shaping up to be a
clear slowdown.One strong piece of evidence
counters that negative view, however. London-based Capital Economics pointed out in a note that, if Hong Kong and Taiwan are taken out of the export equation, shipments to the rest of the world would have grown by a healthy 7.8%; exports to the two offshore yuan centers sunk by a whopping 42% year-on-year.
“Our field study also shows that the exports are more resilient than what the headline data suggest,” ANZ Research said in a note. HSBC economists say that exports likely grew by more than 5% in March if distortion from speculation a year ago is removed from the picture. Still, “March trade numbers disappoint-ed,” HSBC said, “and the contraction in both exports and imports cannot all be blamed on base effects or sea-sonal distortions. Weak demand is the main culprit, both internally and externally.”
Activity inside of China is in some ways more surprising.
Imports fell 11.3% year-on-year, a further sign of waning domestic demand. The decrease in inbound shipments is also closely linked to exports because large quantities of raw materials are imported, processed and then re-exported. But the slow-down is also connected to products consumed on the mainland. Retail figures have looked bleak this year, falling to a 10-year low in the first two months.
Will the distortion ever end, and can the market adjust to mean-ingless and misleading trade data? That’s hard to say right now. Markets haven’t been hit hard by the news. Perhaps stock traders learned a les-son from February. Coming off of a -18% base, next February’s data will undoubtedly be distorted too. The question is whether or not the market will remember.
Trade data disappointed for a second month in March but the market is coming to accept that the fi gures are going to be muddled for some time still
GOING WHERE?: Shipments may be falling, but not to the extent indicated by government data
ECONOMICS & POLICY: TRADE DATA
China Economic Review | May 201424
China’s crumbling housing
Be careful where you step – even when walking through your own living room. One person
perished and six suffered severe inju-ries early in April when parts of their five-story apartment building in Fen-ghua county, Zhejiang province, col-lapsed into a pile of dust and rubble.
The building was deemed dan-gerous in December after a typhoon damaged it, officials warned at the time. Even so, the incident has reignited discussion on the quality and safety of Chinese buildings and what poor construction practices mean for the future of the country’s development. Building inspectors are reportedly vetting similar structures throughout the region, including some in Shanghai.
Many Chinese buildings aren’t constructed to stand the tests of time, not even for a short period. In 2010, housing officials shocked the country when they revealed that many resi-dential properties had a lifespan of just 20 years.
The average period of time that Chinese housing remains livable in is a meager 35 years compared to a century or more in many developed countries.
Many housing units in China have already hit the lower end of their shelf-life. The apartment block in Fenghua was built just 20 years ago. Large swathes of housing were rolled out across the country in the early 1990s as China transitioned from a government-assigned housing system in urban areas to a form of private ownership.
Housing built during the planned-economy phase of China might be especially shoddy as the highly sub-sidized rents paid by tenants often failed to cover even the cost of con-struction, leading to poorer building quality.
The short lifespan doesn’t mean
that living-room floors across the country will begin crumbling beneath residents’ feet. The term refers to the durability of housing without sub-stantial renovation. Failure of power systems could be some of the early problems with flats. Before too long, many housing blocks across the country will look dilapidated; many already do.
Last year, China Economic Review reported on a controversial study that said poor building qual-ity and China’s short-sighted land-lease system would lead developers in major urban areas to neglect reinvest-ment in city centers.
The study, published by an inter-national team of scholars, said the conditions would push investment to the outskirts of cities, leading to urban sprawl. More alarming, it could also cause city centers to decay into slums.
While the safety of buildings will stay in focus for years to come, some of China’s top development authori-ties have started questioning the phi-losophy behind the faulting construc-tion, as well as some hidden conse-quences of bad practices that could disrupt the country’s growth.
To Qiao Runling, deputy direc-tor at China’s top planning body, the National Development and Reform Commission, the short lifespan doesn’t simply indicate how long the housing is livable in but how long developers wait to tear down one project in order to raise a more expensive one
“Chinese like to demolish build-ings just so they can build new ones,” Qiao said, speaking at a real estate investment forum in Shanghai in mid-April.
The buildings aren’t torn down because they’re dangerous but rather because local officials want to drive the economy with new construction
projects. It’s “political willingness” that often cuts short the life of many otherwise healthy buildings, Qiao said. “The local government wants to stimulate GDP growth and they choose the crudest way to do this: Demolition then rebuilding.”
The practice isn’t just a waste of valuable real estate, it’s a major pol-luter and consumer of energy. The energy needed to fuel China’s con-struction industry accounts for about one-third of the country’s total energy consumption, Qiao said. Where ener-gy consumption is high, so is pollu-tion.
The unceasing cycle of build-ing and demolition adds to China’s already dire environmental con-ditions. On top of that, China has little capacity to reuse construction waste, unlike countries such as Japan. Some reports say that construction refuse has literally encircled cities like Hangzhou.
Political incentives might be wan-ing for some of the wasteful construc-tion, however. As part of the new government’s reform package, Bei-jing will try to reorder the incentives on which local government officials operate.
Spending and building to boost GDP growth has been a key tactic employed by provincial cadres over the past decade. High GDP figures have often earned officials promotion regardless of the efficiency of their work.
Beijing will try to factor in sustain-ability and efficiency when appraising the work of tens of thousands of offi-cials across the country while at the same time reducing the often-high expectations for growth pressed on regional governments.
That could be bad news for those who forged their careers on pulling down buildings just as fast as they could raise them.
The collapse of a barely 20-year-old housing block in Zhejiang province is closely tied to an economic development plan that has come to the end of its shelf life
ECONOMICS & POLICY: HOUSING
China Economic Review | May 2014 25
Confl ict crops
A major shipment of Ukrain-ian corn entered China on December 6 last year, the first
installment of what was supposed to be an annual 3 million tons of the grain from the eastern European country.
Much has changed since 2012 when China and Ukraine signed the loan-for-crops deal that brought the delivery to port. At the time, Export-Import Bank, one of Beijing’s policy lenders that smooth foreign trade, gave Kiev access to US$3 billion in loans in exchange for a steady supply of grain.
Today, a fragile new government clings to power in Kiev, and the
Crimean peninsula, from which 10% of Ukraine’s grains are shipped, has been annexed by Russia, a great con-cern to the international community. In early April violence flared in east-ern parts of the country, major corn-producing areas that border Russia. Beijing’s corn deal with Ukraine’s former government hangs in the bal-ance.
Chinese grain importers dealt mainly with Ukrainian state-owned firms in the past. Now that the gov-ernment has changed, the terms of those agreements may be up for early review.
“If you change the government, there is a very big question mark:
Whether the contract or the agree-ment will still keep on, or if they will break the promise and say they need new investment,” said Jane Peng, a Shanghai-based analyst at the Neth-erlands’ Rabobank. A war in the country has the potential to derail any deals as well, she noted.
The crisis in Ukraine comes as Beijing reorders its priorities for grain imports and domestic food produc-tion.
China has long touted a self-suf-ficiency policy for grain, requiring that domestic farmers produce 95% of the country’s staple crops. On the face of it, the policy remains intact. But a new, more practical generation
Rising tensions in Ukraine fl ag the threats to Beijing’s grain import policy and underscore the risks in relying on state partners for strategic assets
ECONOMICS & POLICY: GEOPOLITICS AND CROPS
SUPPLY RISK: China has an agreement to buy 3 million tons of grain from Ukraine on an annaul basis, as part of its plans to secure its growing import needs, but
that investment is under risk as the government in Kiev loses control of important agriculural regions
Cre
dit
: ti
mq
uij
an
o
China Economic Review | May 201426
ECONOMICS & POLICY: GEOPOLITICS AND CROPS
of policymakers has also recognized the challenges that China will face in the future in feeding its massive population. Earlier this year, the State Council said that domestic produc-ers must maintain 95% self sufficien-cy for edible grains but relaxed the requirements on crops that are used as feed for livestock, with corn the primary target.
Chinese aren’t crazy about corn on the cob, but their pigs are. As the world’s biggest consumer of pork, the grain consumed by the animals is also of strategic importance to the long chain of industries that puts China’s favorite meat on the table.
Over the next few years, China will look to stabilize its total grain production at below the volume culti-vated in 2013, showing that the gov-ernment plans to become increasingly flexible over the amount of grain that it imports.
The new policy stance will like-ly lead to a great increase in corn imports over the next decade and China’s state-owned importers are
gearing up for that change.Late in March, the General
Administration of Quality Supervi-sion, Inspection and Quarantine signed a deal that will allow Brazil to begin exporting corn to China. The deal looked like a bid to move away from reliance on the US, which contributed more than 90% of the corn that China imported last year. Shipments from Ukraine were part of China’s push into new grain mar-kets other than the US. For farmers in Ukraine’s agrarian heartland, the political chaos has come at an incon-venient moment.
During the next 15 years, Chinese feed grain imports could rise by as much as 210%, according to a report by Rabobank’s Peng. Corn makes up the bulk of the feed, with wheat and soybean also filling a substantial role.
Between 2015 and 2020, China’s corn imports are set to jump by about 33% to an annual incoming load of 8 million tons. Ukrainian farmers no doubt hope to fill some of those orders.
Some potential for even greater growth in corn imports exists – if China decides to loosen its policy further. Like many other agricul-tural purchases, corn is part of an import quota regime. For imports within the 7.2 million-ton quota, tariffs stand at 1%, but outside of that quota the tariff can be as high as 180%.
In the past, under pressure to maintain efficiency, keep costs low and feed the population, China has ditched quota regimes. Imports of soybeans soared between 2004 and 2010 after the government scrapped many restrictions.
China’s corn inventory is high this year and demand is low, not the kind of conditions that will push Beijing to remove the quota regime, Peng said. But as demand for pork increases, so will the demand for corn. If China experiences a domes-tic corn shortage, the government may reconsider the quota regime.
In turn, changes to the system could cause “imports to treble over-night,” the Rabobank report says. That’s because the international price of corn is 20% lower than in China due to the higher cost of pro-duction on the mainland.
Ukraine and Brazil have high potential for catering to a hun-gry China. The countries con-tribute 3.3% and 1.4% to China’s corn imports, respectively, but have the greatest prospects for increas-ing shipments as demand grows in China, the Rabobank report says.
China’s state-owned importers have preferred doing business with their peers in government-controlled firms around the world. The rocky political situation in Ukraine might lead them to reconsider signing more deals with state enterprises in the country for fear of losing the con-tracts in a rapid shift in leadership.
Private corn exporters could even become the winners in the political transition.
“[China] would be happy to deal with them,” Peng said. “That will be a totally different story, dealing with the privately owned companies instead of the state-owned ones.” KEEP OUT: The future of Chinese access to farms in east Ukraine is unclear at this point
Cre
dit
: H
an
na
China Economic Review | May 2014 27
BUSINESS: T YCOON TALK
Insights from a property tycoon on how to succeed in a murky market
Ambitious real estate projects in China are not hard to come by. In 2012, an
unknown developer made a splash with plans to build the world’s tall-est building with a prefabricated structure. Cranes are pulling up the last remaining pieces of Shanghai Tower, which aims to be the second-tallest building on Earth.
It is rare, however, for them to be completed on time, on budg-et – or even completed at all. The centerpiece project in the coun-try’s financial capital is unlikely to open as scheduled and its developer, Shanghai Construction, is report-edly struggling to find tenants. The prefab monster in Changsha remains
an unfulfilled vision amid problems with building material quality and ballooning costs.
So a man who can deliver such grand constructions to the market as planned stands out. Wang Jian-glin, chairman and founder of Dal-ian Wanda Group, one of the big-gest and most talked-about prop-erty companies in China right now, is such a figure. His Wanda Plaza shopping malls are ubiquitous in big cities and his firm is taking on Hol-lywood with a US$2.6 billion buyout of US cinema chain AMC and a planned US$8.2 billion investment into a film complex in the northern seaside city of Qingdao.
At a lecture on April 12 at the
China Europe International Busi-ness School’s (CEIBS) Shanghai campus, Wang narrowed down some of the factors that have led the company to take on larger-than-life projects like the one in Qingdao. To Wang, the difference between success and failure has simply meant “walking the walk” with the works he takes on. That is to say, meeting or beating project deadlines.
Wang said meeting the deadline for projects has been one of the most important ingredients for building what is now among China’s most valuable property development com-panies. By completing massive com-mercial and cultural projects on or before the originally set date, Wanda
Walking the walkCONSTRUCTION KING: Wanda Group founder and chairman Wang Jianglin has leapfrogged rivals by completing big projects on time
Cre
dit
: F
ort
un
e L
ive
Me
dia
China Economic Review | May 201428
has elated customers looking to buy space and, perhaps more important-ly, ingratiated itself with local gov-ernments eager to stimulate business and generate tax revenues.
Wanda isn’t a listed company but Wang says it has grown 30% annually for the past eight years. Forbes named Wang the richest man in China last August. With a net worth of US$14.2 billion, he was the world’s 128th richest person in 2013.
Wanda’s track record on some of its latest projects is solid – amaz-ing by the measure of some local off ic ia ls . The government of Guangzhou pressured Wanda to build, market and open the 400,000- square-meter Baiyun Wanda Plaza before the start of the Asian Games in November 2010. That gave the company 11 months to complete the massive project. To the surprise and delight of cadres in the city, the doors of the mall swung open in October, a month before the major sporting event.
“One official [at the project in Guangzhou] thought that Wanda must be operating like an army, where people who don’t meet their targets are whipped,” he said jok-ingly.
Before breaking ground on a new project, the company often holds what Wang called a “town hall” meeting where information, includ-ing the opening date, is distributed to potential customers, mainly the owners of businesses that plan to buy space in Wanda’s malls. If custom-ers know when a project will open, they can organize labor and prod-ucts accordingly. That can make a big difference for a mall that opens at the end of China’s lunar year, when hundreds of millions of people return to their hometowns, draining labor markets for more than a week. “A lot of shop owners have become very loyal to us … On the open-ing day, 100% of shop owners can exhibit their products in our shop-ping malls. In tens of years, we have never seen one delay,” Wang said.
Opening a multibillion-dol-lar project in a country known for bureaucratic obstacles and delays is
no simple task. Wanda keeps tight central authority over its many regional projects. The company does not allow its regional projects to adopt their own financing systems. Managers must adhere to a highly centralized plan. A strong reward and punishment system for the peo-ple responsible for raising these mas-sive developments has been key to making sure the projects finish on time, Wang said.
“It’s easier said than done,” he said. “Everyone wants to set up a reward and punishment system but it takes courage to implement it.” Courage might mean taking down one of your top executives.
Wang has taken a hard line against the kind of malpractice that often slows other Chinese projects, namely self-interest at a managerial level that can lead to inefficiency and poor quality. He spoke of an execu-tive vice president who was tasked to take bids for building materials for a project. Instead of looking to the top industry players, the vice president planned to source cable from a com-pany on the verge of bankruptcy, a transaction rife with corruption. He was fired after an internal investiga-tion.
Wang said he’s tried to eliminate the loyalty-above-all-else mental-ity from his internal business in exchange for a philosophy based on
structure. Many Chinese companies build their business around family and friends with the hope that they won’t be betrayed. At the same time, deadly family feuds still make head-lines in the country. Wang said he’s kept his family and friends out of Wanda, if anything for the percep-tion of transparency. To him, loyalty and trust are fleeting. “When you’re faced by a very beautiful girl, your loyalty might disappear,” he said.
Rewards have also been crucial for motivating employees to meet their target, and competing with clunky state-owned firms where hard work can easily go overlooked. At a project in the city of Wuhan, Wan-da’s sales team was told to achieve US$1.12 billion (RMB7 billion) in sales in a matter of months. The team of 100 people came up with US$1.6 billion (RMB10 billion) in sales by the deadline, Wang claimed. Wanda handed out bonuses to those employees that were several times greater than their peers on other projects.
“In some state owned enterpris-es, people at the same level cannot have this kind of compensation,” he said. State enterprise, which is on the cusp of undergoing its biggest reform in 20 years, should take note. The often inflexible reward system for lowly sales people at state compa-nies could be holding projects back.
The company’s biggest challenge still lies ahead of it in Qingdao.
The ground-breaking ceremony was dazzling. Wanda flew in film stars such as Leonardo DiCaprio and Hong Kong’s Tony Leung for the opening of the multibillion dollar film studio. But Wanda and Wang have a lot riding on the ambitious project, which is slated to open in June 2016. The sheer size of the film metropolis in a region unknown to the film industry and without the lifestyle attractions of Beijing or Shanghai will test the company’s ability to both build and sell its products. As the scale increases and the deadlines tighten, Wang is push-ing his team to the limit of what’s possible while raising the bar for everyone else.
BUSINESS: T YCOON TALK
“One offi cial [at the project in Guangzhou] thought that Wanda must be operating like an army, where people who don’t meet their targets are whipped”- Wang Jianglin, founder and chairman of Wanda Group and one of the richest men in mainland China
China Economic Review | May 2014 29
Aff ordable art
The short queue at the ticket counter for the Claude Monet exhibition is deceptive: Inside,
the rooms are crowded with people studying paintings by the French Impressionist master. Stern-faced guards keep close watch on the pro-ceedings, which are subdued and quiet except for the frequent bleep of an alarm when visitors lean too close to the priceless portraits and landscapes.
“Master of Impression – Claude Monet,” held in a gallery space at the upscale K11 shopping mall in Shang-hai, attracted nearly 7,000 visitors on its opening weekend in March, with some people lining up for over three hours to get inside, according to the show’s organizers.
After hosting only a few block-buster events in recent years, Shang-hai is suddenly awash with major art shows. Japan’s Kusama Yayoi pulled in huge crowds at the MoCA Shang-hai earlier in the year; Pablo Picasso and Victor Hugo will go on display in the coming months. The investors and organizers behind this movement are hoping it is the start of a huge new trend in middle-class art con-sumption.
Previous efforts to bring major art exhibitions to town have had mixed success. The last time Shanghai Tix Media, the organizers of the Monet show, attempted something on this scale, they ran up losses of about US$3.2 million, company director Xie Dingwei told local media pre-
viously. Pablo Picasso wasn’t big enough to pull the masses into the cavernous space of China Art Muse-um in 2011.
This time should be different. “We’ve done some research,” Xie told China Economic Review. “Peo-ple around 18 to 30 usually spend money on leisure rather than buying art books or exhibition tickets. But this is changing now.” The invest-ment in the Monet exhibition has been “huge,” Xie said, without dis-closing exact figures, while noting the company is already working on plans to bring more such shows to China amid growing interest in fine art.
Xie is confident that the large, eager turnout for K11’s Monet exhi-bition represents more than a passing
Is art for the middle classes the next big consumer trend in China?
PAY ATTENTION: Massive queues at big art shows in Shanghai could herald the birth of a new consumer market
BUSINESS: CONSUMER ART
China Economic Review | May 201430
fad. “Recently, going to art exhibi-tions is becoming a fashion among young people, but I believe most of them go to the exhibition out of love and concern for art, or at least out of curiosity.”
His optimism is shared by many who have a stake in the development of the art world. The Shanghai gov-ernment is redeveloping a five-mile area of the Huangpu River into the West Bund Cultural Corridor that will house the Long Museum and Yuz Museum. Both are privately owned by wealthy individuals looking to display their personal collections. More than 10 public and private con-temporary art museums are already open in Shanghai; other big cities like Beijing are home to many more.
On a weekday visit to the Monet exhibition in early April, China Economic Review felt a palpable appreciation of the art among the crowd of mostly young, female, cul-tured Chinese visitors. Two female teachers in their thirties had taken the train into town from Suzhou for the day. Another woman, a paint-ing student who belongs to a large group of art hobbyists and teachers on the mobile social app WeChat, had also come in from Suzhou. There were male admirers too. “I think young men really prefer the Western art,” said a youthful salesman from Guangzhou. “It’s a trend.”
Not everyone is convinced that this upsurge in interest will hold. “Fifteen years ago there were several exhibitions in Taiwan which caused a sensation, but nowadays if they want to hold these exhibitions, frankly, the curators will lose money,” said Hu Yixun, a professor who studies the art market at the Fine Arts College of Shanghai University. “The art exhi-bition market is saturated. If these kinds of exhibitions are continuous-ly held in Shanghai, audiences will eventually feel nothing.”
Art is big business, and not just for museums. China has ranked as the world’s top art buyer for four years straight, accounting for over US$4 billion in sales in 2013, according to France-based research firm Art-price. But most of these purchases
take place at auction houses, where wealthy Chinese collectors snap up high-priced artworks, treating them as investments.
If the current interest in art among the middle class in China becomes a genuine cultural trait, it could spur the emergence of a lucrative afford-able art market.
Affordable art is mostly made up of contemporary artworks that are bought by individuals for their homes and has developed into a huge market in developed countries. Almost one in every four adults in the UK bought affordable art in 2012 worth a com-bined US$8 billion. About 70% of art bought in the West is affordable, according to 2012 data from Surge Art, a Beijing-based art dealer and
consultancy. In China, the figure was 33%; the signs are that this propor-tion is set to grow quickly.
Rising wages are boosting the spending power of middle class art consumers. Around 66% of Chi-nese urban households had an annual earned income in the range of US$9,000 to US$34,000 in 2012, up from just 4% in 2000, according to McKinsey, a consultancy. That is projected to hit 75% by 2020. Increasingly, China’s new bourgeoi-sie craves goods of a more intangible kind.
James Roy, Associate Principal at Shanghai-based research company China Market Research Group, notes a strong shift in middle class spending over the past couple of years away
BUSINESS: CONSUMER ART
SHOWTIME: Modern art is getting more attention from consumers and the media
China Economic Review | May 2014 31
BUSINESS: CONSUMER ART
from “stuff” and towards “expe-riences” – purchases geared to lei-sure and quality of life. Spending on movie tickets, dining and tourism, for example, has been soaring well above overall retail sales growth. Today’s Chinese consumers are also are more willing to invest in decorating their homes for their own comfort and enjoyment, even if they don’t plan on entertaining guests.
Art sellers have stepped in to cater to the growing sophistication and swelling bank accounts of this new consumer class. Leading the way is Surge Art, which sells contemporary Chinese art at prices ranging from around US$80 to US$4,830 (RMB 500 to RMB 30,000). Paintings, sculptures, photographs and other works by emerging artists can be
ordered off SURGE’s website, which allows users to browse products by variables including size, color, and price.
Surge Art, formerly called Afford-
able Art China, launched the online store to complement its annual art fairs, held since 2006 in Beijing, and later expanded to Shanghai and Chengdu. The fairs, which are free for the public to attend, showcase the works of thousands of artists. Accord-ing to Lercier Lei, Surge’s art director and curator, each fair attracts more than 10,000 visitors.
The large turnout at the fairs raises hopes that a new market for afford-able modern art is taking shape. But it may be too early for such optimism. The massive overrepresentation of foreign buyers (half of those at the Surge Art events in Shanghai are foreigners and almost 30% in Bei-jing) implies tepid local demand, at least for now. Surge Art’s less than satisfactory online sales attest to the challenges that remain in convincing those Chinese with a new interest in art to take some home.
Putting a value on the affordable art market in China is hard. Surge Art was not able to provide sales figures from its events and none of the major market research compa-nies contacted by China Econom-ic Review calculate such data. But while the art being sold is affordable, it is not cheap. The average price range of the artworks sold by Surge Art is US$960 to US$1,280 (RMB 6,000 to RMB 8,000).
Nurturing genuine interest in modern art cannot be achieved over-night or even in a single generation. The challenge is harder when the art-works are so different to the native cultural norms in China, which has its own rich art tradition. But there are signs this trend could develop over the long term.
“I think it’s a process of educa-tion and popularization of art appre-ciation. People can learn to appreciate art gradually starting by following the trend,” said Hu, the professor at the Fine Arts College, despite his misgiv-ings about the exhibition craze. “Can we assume that when this young gen-eration reach their forties or fifties and have a middle-class income, they are very likely to become the main buyers in art consumption? Logically and optimistically, this should be the case.”
“I think it’s a process of popularization of art appreciation. People can learn to appreciate art by following the trend,”- Hu Yixun, professor of art at Shanghai University
NOT JUST MEMORIES: Young Chinese like to fl aunt their new-found interest in art
Cre
dit
: D
avi
d G
ran
China Economic Review | May 201432
Surging ahead
It’s a miracle. After a year without an IPO on the mainland, Chi-na’s newest listed firms have per-
formed incredibly well in their first few months on the market.
The 48 companies that listed in January before Chinese New Year were trading at an average of 58% above their listing price as of April 1, according to data compiled by Capi-talVue. None have fallen below the original price and several had experi-enced amazing growth. The price of Geron, a textile carding equipment maker that listed in Shenzhen in Jan-uary, increased 168%.
More likely than not, the rapid gains can be attributed to the rock-bottom prices at which the companies listed. When the China Securities
Regulatory Commission (CSRC) lift-ed its implicit ban on IPOs in Janu-ary, it also ramped up the regulatory hurdles facing companies about to go public. Those with high valuations were asked to tone them down. One IPO was even canceled.
The low offering prices have led to rampant speculation on the new listings. After 14 months without an IPO, in a market that has performed poorly this year, the new shares looked like a steal. “Especially com-pared with current market, those val-uations had a certain advantage,” said Hou Yingmin, an equities analyst at Shanghai-based Aijian Securities. “So the market has led to continuous speculation.”
One mainland equities analyst at
Zhongcheng Securities called this year’s listings a “bubble.”
The reopening of the stock exchange to IPOs wasn’t supposed to happen like this. The problems afflicting the market now are the same ones that have troubled China for years. If this is a bubble, inves-tors will stand to lose as they have in the past. The phenomenon doesn’t bode well for the companies either if they were indeed pushed to list at below what the market thinks they are worth.
Late last year, the Chinese govern-ment pledged to upgrade the listing process to a registration-based system more in line with exchanges in devel-oped markets. The current applica-tion process is arduous and time
China’s fi rst batch of IPO stocks in over a year have skyrocketed
ECSTATIC: The blistering performance of new IPO stocks on mainland markets has no doubt given some investors joy
FINANCE: MAINLAND IPOS
China Economic Review | May 2014 33
FINANCE: MAINLAND IPOS
consuming as firms’ IPO plans are reviewed individually. The CSRC tends to tighten regulatory hurdles when liquidity dries up and goes lax when conditions are better. Many companies wait years to list; some go bankrupt during that time without access to capital.
A registration system, on the other hand, sets standard entry require-ments that don’t change with the weather. This is usually followed up with stringent controls on compa-ny behavior after listing, something China is in desperate need of. Regu-lators have not been tough on fraudu-lent companies that make off with investor funds. Retail investors have ridden speculative waves only to lose it all in Shanghai and Shenzhen when a company is discovered to have filed misleading reports.
Before the market reopened to IPOs in January, experts told China Economic Review that a registra-tion system would likely be adopted in March. In late March, the State Council, China’s cabinet, issued a
document that said it would aim to adopt the registration-based system while also reinforcing the regulation of companies after they go public.
But the market can’t have one without the other. If the CSRC low-ers the regulatory barriers to enter-ing the market but doesn’t throw the book at cheaters, investors will be more exposed to fraud.
“Without the post-listing regulato-ry system, then relaxing the approval system will bring a lot of disasters,” Michael Luk, a Hong Kong-based analyst at investment bank Mizuho, said. At the same time, the new regis-tration system will need to make sure that companies that aren’t fit for list-ing don’t get on the market.
Shanghai Chaori defaulted on a corporate bond. However, the com-pany likely should never have been allowed to issue it. The problem demonstrates how regulators struggle to weed out the duds. "When Chaori got into trouble, we found that it probably should have never been allowed to list anyway,” Luk said. “So this is going to be one of the first kind of problems [CSRC] runs into.
The transition to the registration system is set to be awkward given the heavy regulation this year. Main-land analysts are hopeful for the new system. However, as the researcher at Zhongcheng said: “The change is still a long way off … Regulation will probably remain tight for now.”
“Without the post-listing regulatory system, then relaxing the approval system will bring a lot of disasters” - Michael Luk, a Hong Kong-based analyst at investment bank Mizuho
Cre
dit
: S
ylvi
CHILD'S PLAY: Like a parent reluctant to watch their child grow up, China's securities regulator can often seem indifferent to its obligation to ensure
that Chinese fi rms that go public comply with all the relevant regulations
/Please charge to my credit card Visa Mastercard Mastercard Secure Code: JCB Amex
/Card Number:
/Signature: /Card expiry date: CVV:
BANK TRANSFER (an extra $8 fee is required for services outside of Mainland China and Hong Kong)If paying by bank transfer, please contact our staff for more details.
Please complete this form and fax it back to China Economic Review Publishing Ltd. Or send an email to [email protected]: +86 21 5187 9633 ext. 864, Fax: +86 21 5385 8953