miércoles, enero 30, 2013



China’s Last Soft Landing?

Stephen S. Roach

29 January 2013

NEW HAVENOnce again, China has defied the naysayers. Economic growth picked up in the final quarter of 2012 to 7.9%half a percentage point faster than the 7.4% increase in GDP in the third quarter. This was a meaningful increase after ten consecutive quarters of deceleration, and it marks the Chinese economy’s second soft landing in slightly less than four years.
Despite all the talk about the coming shift to internal demand, China remains heavily dependent on exports and external demand as major drivers of economic growth. It is not a coincidence that its last two slowdowns followed closely on the heels of growth slumps in its two largest foreign markets, Europe and the United States. Just as the soft landing in early 2009 occurred in the aftermath of a horrific American-made crisis, this latest one followed the European sovereign-debt crisis.
China has several sources of strength that have enabled it to withstand the tough external shocks of the last four years. Large buffers of saving (53% of GDP) and foreign-exchange reserves ($3.3 trillion) are at the top of the list. Moreover, unlike the West, which has used up most of its traditional countercyclical policy ammunition, China has maintained ample scope for fiscal and monetary-policy adjustments as circumstances dictate. Likewise, a powerful urbanization dynamic continues to deliver solid support for China’s high-investment economy, while enabling relatively poor rural workers to raise their incomes by finding higher-paying jobs in the cities.
Nonetheless, this may be the last time that China can escape an external shock with its growth intact. Premier Wen Jiabao addressed this possibility nearly six years ago, arguing in March 2007 that the seemingly spectacular Chinese economy had become “unstable, unbalanced, uncoordinated, and ultimately unsustainable.”
Since then, many of China’s inherent strengths have been sapped by all-too-frequent external shocks. The banking sector is still digging out from the bad loans extended in the aftermath of the global meltdown in 2008. Finding affordable housing has become an increasingly serious problem for those relocating to cities for the first time. And corruption scandals and the related risks of political turmoil were unsettling, to say the least, in the months prior to last year’s Communist Party leadership transition.
In other words, the vulnerability implied by Wen’sFour Uns” has increased significantly. China’s economy has certainly become more unstable, with major slowdowns in real GDP growth in 2009 and again in 2012. Its imbalances have gotten worse as well, with the investment share of GDP approaching 50% and private consumption falling below 35% of GDP.
Similarly, China has become more uncoordinated, or fragmented, as its income disparities have continued to widen. And sustainability is being jeopardized by environmental degradation and pollution, which pose a growing threat to the country’s atmosphere and water supply.
In short, China’s growth model has been stretched as never before. And, like a piece of fabric, the longer it remains stretched, the longer it will take to return to its former resilient state – and the greater the possibility that it will not spring back the next time something goes wrong.
The message to China’s new leadership is unmistakable: There has never been a more urgent time to get on with the heavy lifting of rebalancing and reform. Now is the time to implement the measures that will accelerate the transition to a more consumer-led economy.
The agenda is long, but it is hardly a secret. It includes developing the services sector, funding the social safety net, liberalizing an antiquated residential-permit system (hukou), reforming state-owned enterprises, and ending financial repression on households by lifting artificially low interest rates on savings.
Failure to act quickly on this program would leave China far too vulnerable to the inevitable next shock in a crisis-battered world. In the absence of rebalancing, any one of several potential tipping points could seriously compromise the economy’s ability to pull off another soft landing: deteriorating credit quality in the banking system; weakening export competitiveness as wages rise; key environmental, governance, and social problems (namely, pollution, corruption, and inequality); and, of course, foreign-policy missteps, as suggested by escalating problems with Japan.
The Chinese economy has come through two major global crises in the past four years. On the surface, its resilience has been impressive – the first to recover, as Chinese leaders always want to remind the rest of the world. But, beneath the surface, an unbalanced, unstable, uncoordinated, and unsustainable economy risks losing its capacity for resilience. Without rebalancing and reforms, the days of the automatic Chinese soft landing may be over.
I have been an optimist about China for 15 years. I still am. But the clock is ticking. Wen Jiabao’s critique six years ago was a powerful diagnosis of the Old China’s flaws that pointed to the Next China’s hopes and dreams. It remains a blueprint that China’s new leadership cannot ignore. Time is no longer on China’s side. It must act now.
Stephen S. Roach was Chairman of Morgan Stanley Asia and the firm's Chief Economist, and currently is a senior fellow at Yale University’s Jackson Institute of Global Affairs and a senior lecturer at Yale’s School of Management. His most recent book is The Next Asia.

28, 2013 7:02 pm
Markets: Back in the zone
Can flows into the euro last?
ITALIAN Government bonds on trading screen©Chris Batson/FT

Traders on US roadshows trying to sell bank bonds from crisis-hit eurozone countries know about difficult pitches. “A year ago, it was very much aboutwhat is happening to Europe?’ and ‘how likely is the euro to survive?’ ” recalls Paolo Basso, senior banker at Morgan Stanley.

Promoting a $3.5bn bond issue for Italy’s Intesa Sanpaolo bank this month was a different story. “There was not one question on whether the euro was going to survive ... We did not expect such an overwhelming response,” Mr Basso recalls. In the end, Intesa took more than 400 orders from the US, Europe and Asia.

Intesa’s successful bond offer highlighted the wave of money that has returned to the eurozone in the past few months, especially into the economically-stressed countries on its periphery: Italy, Spain, Ireland, Portugal and even Greece.

Since Mario Draghi, president of the European Central Bank, unveiled in September plans for the eurozone’s monetary guardian to backstop government debt markets, the periphery has seen €93bn of net private inflowsequivalent to about 9 per cent of economic output – in the form of loans and investments, according to calculations by ING, the Dutch bank.

As economic stability has returned, the trade-weighted euro has risen to its highest level since late 2011. Its rise reflects an increasing belief that the danger of a eurozone break-up has passed and that assets in the region offer attractive yields when global rates are at historic lows. It is not just eurozone banks that have noted the mood swing: corporate bond issuance has returned to levels last seen before the region’s crisis erupted in late 2009. Policy makers have started to believe that the eurozone is on a self-sustaining recovery path. This month, Mr Draghi talked of “positive contagion, when things go well”.

But a lasting turnround in sentiment will take more than a few successful bond offers. The recent inflow into the eurozone periphery is still dwarfed by earlier, far larger net outflows of private investors’ funds, which exceeded €400bn in the first eight months of 2012 and were €300bn in the previous year.

Still, some money managers see the turnround as tactical and opportunistic rather than a vote of confidence in Europe’s 14-year-old monetary union.

“I’m not jumping up and down saying ‘now is the time to buy Europe’,” says Robert Brown, chairman of the global investment committee at Towers Watson consultancy, which advises sovereign wealth funds and other investors. “The risk of catastrophe has come down and there are potentially some opportunities but I’m saying that in a rather guarded way.”

A first step in defending the euro came just weeks after Mr Draghi took over as its president in November 2011. The ECB flooded the banking system with more than €1tn in cheap three-year loans or “longer term refinancing operations”. With many eurozone banks having been shut out of capital markets and facing soaring refinancing needs, the ECB’s action averted an immediate catastrophe. In the first three months of 2012, eurozone banks secured vital funding by issuing more than €50bn in debt.

But the ECB’s decisive move came in September. With Spanish and Italian borrowing costs having soared to dangerous levels, the ECB announced a scheme by which it could buy the bonds of eurozone governments that signed up to externally-approved reform programmes. Mr Draghi’s proposedoutright monetary transactionsscheme reduced dramatically the risk of countries defaulting and exiting the euro.

Some view the ECB’s actions, while essential, as palliative. “The OMTs are still seen as the blanket that is suffocating the flames of the eurozone crisis. People are happy to buy into eurozone periphery debt modestlynot massively – on the assumption that the ECB is behind the market,” says Andrew Milligan, head of global strategy at Standard Life Investments.

Eurozone politicians have yet to put in place plans for strengthening the region’s bank system and a new crisis in public finances could quickly emerge: heavily indebted Cyprus, one of the eurozone’s smallest economies, is a possible flashpoint.

“It is still an open question whether the politicians will deliver their side of the bargain,” says Mark Cliffe, chief economist at ING. With the ECB’s actions fuelling a rally in eurozone share and bond prices, however, investors had no option but to jump in, Mr Cliffe adds.

People felt obliged to reduce their underweight position in these markets because they had been performing so well. Many were so massively underweight in the periphery even a modest rebalancing had a substantial effect.”

Another tactical factor has been the unwinding of speculative bets on a eurozone catastrophe. A hedge fund strategy at the height of the crisis was to “short” the euro by selling assets borrowed in the expectation of being able to buy them back at a cheaper price. After Mr Draghi acted, some hedge funds took losses.

However, aggressive investors who bet on a eurozone recovery have booked gains. Dromeus Capital, a hedge fund set up to invest in distressed Greek assets, netted gains of more than 40 per cent in the first three months. Third Point, another, doubled its money on a €500m bet on Greek government bonds. Franklin Templeton, the asset manager, last year increased its holdings of Irish bonds to at least €8.4bn, which almost certainly spurred a sharp price rally based on the country’s recovery prospects.

. . .

At the same time, signs have emerged that the turnround in sentiment is solidifying. Data from the US Commodity Futures Trading Commission, used to track hedge funds’ extensive foreign exchange dealings, show a build up in netlongeuro positions to the highest level since mid 2011 – although a large number of “shortpositions remain.

In government bond markets, Spain last week received total orders of almost €23bn for a €7bn 10-year bond. Some 60 per cent of the issue went to non-Spanish buyers.

“I think the ‘easy inflows – the covering of short positions – have happened in Spain. Now there is a little more conviction – and it’s gradually improving,” says Laurent Fransolet, head of fixed-income research at Barclays.

Bond issuance by eurozone banks and companies has risen, taking advantage of investors’ appetites, although, like governments in the periphery, they have paid higher interest rates than in northern Europe. For US investors, who had not followed each twist and turn of the crisis, Mr Draghi’s intervention was the turning point, says Ryan O’Grady, a JPMorgan banker. “They went from a position of being disproportionately detached to disproportionately engaged, which had the effect of reinforcing the rally.” Erik Schotkamp, director of capital and funding management at Spain’s BBVA bank, adds: “American investors were faster [than others] to pick up on the potential of Draghi’s speech and of OMTs.”

With financing conditions recovering, eurozone banks – including in the periphery – will this week repay early €137bn of the three-year funds borrowed from the ECB.

The turnround has become noticeable in flows into eurozone equity and bond markets. Eurozone equities saw outflows in almost every month between mid-2011 and August 2012, according to data compiled for the Financial Times by EPFR, the US-based research company. They were, however, positive in three out of the past four months of the year. “Retail investors have really pulled out of eurozone equities on a big scale since mid-2007, redeeming over $160bn from the European equity funds we track,” says Cameron Brandt, EPFR head of research. “But a lot of the recent flows back in have been from institutional investors, who you’d expect are making that decision with their eyes open.”

The ECB’s actions have led to “a completely different look for the region, which could restore its economic engine”, says Jim Paulsen at Wells Capital Management. “It may be that we are going from 10ft under to 5ft. That doesn’t matter. For investors, it’s momentum that matters.”

Yet recent inflows into eurozone equity funds are still modest even by crisis-standards, and EPFR’s data show inflows into emerging market equity funds have been far stronger lately than flows into European equity funds. Other markets also suggest caution before calling a lasting turnround in investors’ attitudes.

US money market funds, which provide short-term financing, were quick to withdraw from the eurozone when the crisis escalated, dealing a severe blow to banks with project and trading financing operations requiring dollars. Even by the end of November, their allocations to eurozone banks were still 60 per cent below the 2011 peak. “There is a tentative increase,” says Robert Grossman, head of macro credit research at Fitch, the rating agency. “But money market funds are conservative investors and among the first to withdraw and to maintain that caution.”

In foreign exchange markets, an analysis by Deutsche Bank showed a slight bias towards holding euros in January, but Citigroup, another top currency trading bank, reports its clients are neutral. Analysts feel the euro’s appreciation has ended its run and investors are looking for other trades. “Most clients seem to be in a holding pattern, waiting for the next big move,” says Valentin Marinov, a Citi strategist.

Even eurozone bankers who have successfully raised money recently and are keen to talk up deals, know this year’s improved mood could prove fragile. Unexpected political or economic developments could produce fresh tension and, in spite of improvements, stresses remain.

Mr Schotkamp says: “Previously it wasn’t even a question of price. It was justno go. Now we have access to the market but it remains expensive. The question is whether this is the ‘new normal.”

Additional reporting by Alice Ross, Michael Stothard and Robin Wigglesworth

Copyright The Financial Times Limited 2013


The Asian Sleepwalkers

Yoon Young-kwan

29 January 2013

SEOULWhether East Asia’s politicians and pundits like it or not, the region’s current international relations are more akin to nineteenth-century European balance-of-power politics than to the stable Europe of today. Witness East Asia’s rising nationalism, territorial disputes, and lack of effective institutional mechanisms for security cooperation. While economic interdependence among China, Japan, South Korea, and the members of the Association of Southeast Asian Nations continues to deepen, their diplomatic relations are as burdened by rivalry and mistrust as relations among European countries were in the decades prior to World War I.
One common characteristic, then and now, is a power shift. Back then, Great Britain’s relative power was in decline, while Germany’s had been rising since German unification in 1871.
Similarly, at least in terms of economic, if not military, capability, the United States and Japan seem to have begun a process of decline relative to China. Of course, this process is not irreversible: Effective political leadership and successful domestic reforms in the US and Japan, together with China’s failure to manage political pressure from below, could yet halt this seemingly inexorable power shift.
Major power shifts define eras in which key political leaders are likely to make serious foreign-policy mistakes. Indeed, poor management of international relations at such critical junctures has often led to major wars. Rising powers tend to demand a greater role in international politics, declining powers tend to be reluctant to adjust, and key policymakers are likely to misunderstand the intentions of other countries’ leaders and overreact to their actions.
Historically, rising powers tend to become too confident too soon, leading them to behave imprudently, which frightens their neighbors. For example, Kaiser Wilhelm II dismissed Otto von Bismarck as chancellor in 1890, less than 20 years after the formation of the Second Reich, and began to destroy Bismarck’s carefully crafted alliance network. His rough diplomacy frightened France, Britain, and Russia, making it easier for them to unite against Germany.
China’s new diplomatic assertiveness in 2010closely following the eruption of the worst financial crisis since the 1930’srecalled that of Wilhelmine Germany. In both cases, insecurity resulted not from an external threat, but from top policymakers’ own actions.
In late 2010, I was relievedsomewhatwhen a key Chinese leader, State Councilor Dai Bingguo, announced that China would adhere to the path of peaceful development. But the rhetoric of some Chinese, particularly in the military, concerning the South China Sea and other disputed Chinese sovereignty claims suggests that not everyone in the country’s leadership is committed wholeheartedly to such a path. The extent to which policymaking by the country’s new leader, Xi Jinping, takes into account the insecurity felt by China’s neighbors – and abandons a quest for absolute security for China – will be one of the key variables influencing East Asia’s security environment in the years ahead.
America’s foreign policy will be another key factor. If the US pursues a predominantly confrontational approach, East Asian politics will inevitably become polarized, just as multipolar nineteenth-century Europe gave way to an increasingly bipolar order in lockstep with rising tensions between Germany and Britain. America’s so-calledpivot to Asiamight have been necessary from its point of view, given the concerns of its Asian allies about China. But, unless the US wants a Cold War-style confrontation in Asia, it must try harder to engage China in shaping a viable regional security structure.
A confrontational US approach toward China, moreover, would imply an additional destabilizing factor: Japan might become much bolder than necessary in its foreign policy. After Wilhelm II stopped engaging Russia in the 1890’s, bilateral relations worsened, which provided his ally, Austria, diplomatic carte blanche in dealing with Serbia – and, more important, Serbia’s Russian patron. Thus, Wilhelm unintentionally contributed to the outbreak of war in 1914.
There are already some worrying signs of a Japanese miscalculation. Japan’s new prime minister, Shinzo Abe, reportedly said that he is considering renouncing the Kono Statement of 1993, which acknowledged that the Japanese military had raped and enslaved Asian and European women during World War II. If Abe does so, Japan’s relations with South Korea and China will suffer serious damage.
That is in no one’s interest, including Japan’s, given that the Japanese share many security concerns with South Korea. So US diplomacy will need to be dexterous. It must ease Japan’s sense of insecurity in the wake of China’s rise, while persuading Japan’s new leaders to behave prudently and refrain from excessively nationalist behavior. Frankly, with two decades of economic stagnation already behind it, Japan has more important matters to pursue.
In contrast to its multilateral efforts in Europe, the US created a hub-and-spoke security frameworkformed by US-centered bilateral alliances in Asia following WWII. One result is that no direct channel for security cooperation among Asian countries was ever established, which has contributed to the low level of trust in East Asia, even among close US allies like Japan and South Korea. And it is precisely here that South Korea, a medium-sized ally of the US, will be in a better position than Northeast Asia’s bigger powers to act as a facilitator.
There is much to learn from the diplomatic failures that led to WWI. A new history, by Christopher Clark, of the diplomatic prelude to that war is called, fittingly, The Sleepwalkers. The question for the US and East Asia’s leaders today is whether they will wake up and develop effective multilateral mechanisms for security cooperation before doing themselves serious harm.
Yoon Young-kwan, South Korea's foreign minister from 2003 to 2004, is currently Professor of International Relations at Seoul National University and a visiting professor at the Free University of Berlin.
Copyright Project Syndicate - www.project-syndicate.org