Has China Lost Control? UBS Says No.

Wednesday, August 5, 2009 22:20
Posted in category Uncategorized

On Monday night, UBS’s Senior Economists Johnathan Anderson and Tao Wang held a call titled Has China Lost Control?. Personally, I was not able to make it, and fortunately for me they released a detailed transcript of the call.

The call was broken into four parts (broad overview, bank lending, growth, and Q&A), and each part offered some interesting insights not only into what is going on with China’s economies, but how those activities are being seen.

some opening remarks from Tao Wang kicked off the call, where she laid out the UBS position

1. Growth is more broad-based than many investors realize.
2. Current trends are unsustainable if they continue unabated.
3. But we now see the policy mix changing.
4. As a result, look for a more sustainable 8% to 8.5% growth.

This has been the standard steady as she goes position that UBS is know for, and while I would agree that growth has been more broad based than many think, it is also certainly not growing in many areas that many were looking for broad based growth as well (domestic consumption being one of them).  Points 2 and 3 I would agree with wholly, and to point 4.. well, only time will tell, however as the recent FT report shows, sometimes numbers are not all what they seem.

Supporting UBS’s position on the recovery, Tao offered the following three points.:

Over the next year or two, we feel that recovery is sustainable based on three arguments. First, government stimulus still has some distance to run; the authorities are not running out of money or projects. Second, the recovery of property sector investment has already started, and we believe this will hold an important key to Chinese growth sustainability. And third, bank lending does not need to be kept up at the pace of the first half for this scenario to work.

It is only on the second point that I have a bit of concern as I do not see a rebound in the property sector, a sector with huge overcapacity and price fluctuations, as an indicator that should be held up as one of the more important to look at for a sustained recovery.

The time spend on bank lending was quite timely as this is a sector that has received a lot of press lately. PBoC has told banks to increase NPL cash reserves, the leakage of bank funding into speculative areas has been estimated at 20%, and there are a couple other risks.

Risks that Tao Wang addresses:

Now, if bank lending does continue at very fast pace – say, RMB1 trillion a month or even RMB800 billion a month for the next few months – then I would be more worried. I would worry about excess liquidity driving up big asset bubbles, and I would worry about overinvestment and bad investments in the economy.Whichever way you look at it, it could create bigger problems down the road, in the form of substantial nonperforming loans and potentially the need for another big bailout. After that, we would likely end up with a long period of depressed lending and lower economic growth.

Tao Wang also says that Beijing has its finger on the concerns of NPLs and bad investment:

This time around we do believe lending regulations have been relaxed, but we don’t believe banks have “thrown caution to the wind”. We have already seen the bank regulators talking about risks from lending to property developers, about capital adequacy requirements (which they reiterated again recently), about requiring banks to raise NPL provisioning to 150%, about aggressively writing off bad loans last December and again in June this year. So while we do believe NPLs will rise and that this will hurt banks profits, we don’t think we are going back to the kind of scenario we saw in the late 1990s.

Wrapping up the UBS lead discussion, the focus shifted to growth, with particular focus on the consumption economy and its impact on growth.

Some of her points being:
1) Consumption has been resilient (charged by transferring pensioners payments and increasing wages to teachers and civil servants)
2) Unemployment in urban areas did not increase much, and the most affected area was in the export sector.
3) Strong retail sales

Interestingly enough, Tao Wang believes that it is the growth in the property market that will sustain the growth of the recovery.

Since mid-2008 we have been calling for a rebound in property construction this year, and our arguments at that time were that (i) there’s still a lot of demand from the “core” upper and middle-income population, i.e., the market is still an emerging one in terms of housing; (ii) there is no oversupply at the national level, (iii) banking and household sector exposures to property are not that large; and (iv) we expected the government to reverse its policy from tightening to stimulating the property sector.

It is a position that I find downright scary on one level as all I am hearing about, and seeing with my own eyes, and asking my friends to write about is the fact that in some of China’s key markets there are problems. BIG problems. Low occupancies. Rents that are crushing land lords. and more square meters being built than would be needed in 10 years of 2008 take up rates.

Some concluding remarks.

At the end of the transcript there are some questions related to over-capacity and commodity imports that I believe were also quite important as these issues are ones that hold a lot of answers (if not more questions) about the true stability of China’s growth, but the biggest question for me after all this is… what are the real measurements we should be looking at for growth, and over what time frame?

Sure, a booming property market is a driver of investment fueled growth, and employs a lot of people, but if this positive statistic results in dozens of half built buildings scattered across China’s cities, buildings that will never be cash flow positive for the owners, than is that really a good thing?

Secondarily. On the consumption economy, I think that it needs to be said that a large percentage of househols are out buying for reasons unrelated to mass marketing and an urge to buy stuff. In Beijing, one of my friends told me a key driver of the car sales is not that new buyers are entering the market.. but that many are buying second cars so that they can circumvent the license plate restrictions. The government is pushing incentives, and retailers are cutting prices 50%+ to draw people in. Again, it is not that the money isn’t being spent, but is this the growth that we want?

Some interesting insights either way, and ones that I hope to explore further over the next couple of weeks. Until then, take a look at Michael Pettis’s and Victor Shih’s sites. I would recommend Brad Setser’s, but do to the fact that he just got scooped up by the GOV, he has just posted his last post… for now.

If you would like a full copy of notes from the call, send me an email.  UBS forbids I post them, but it is ok for me to forward.

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One Response to “Has China Lost Control? UBS Says No.”

  1. China Growth – Not All What it Appears to Be says:

    August 10th, 2009 at 10:01 am

    […] Richard Brubaker over at All Roads Lead to China recently covered a UBS call on the topic of “whether or not China has lost control. Richard sites four opening remarks made by UBS as […]