Tag Archives: Challenges

Part II: Challenges in China’s Ongoing Financial Reform

In my previous post, I introduced two of the four main challenges facing China as the country is set to optimize its financial system. In this post, I will discuss the rest two—the inflationary pressure and the effective use of private capital.

Apparently, inflation should not be an issue for the country, given the fact that its economy is slowing down, and the Federal Reserve had started to scale back the massive bond purchase program, leading to significant capital outflows from emerging markets. However, there is not a definite link between inflation and money supply. Instead, inflation has a lot more to do with the level of economic activities. In spite of a slowdown in terms of growth rate, China’s economy is still growing rapidly at around 7.5% with increasing number of the middle class, pushing up inflationary pressure naturally. The concern was somewhat eased as China’s Consumer Price Index rose 2.5% in January from a year earlier mainly due to muted food prices. According to estimates by J.P. Morgan, the index might pick up later this year, averaging 3% in 2014. The expected level is still below the government’s stated tolerance of 3.5% but implies another worry for growth, which is weaker domestic consumption. So the government has to face a continuous trade-off between inflation and domestic consumption for sustainable development.

Regarding the incorporation of private capital, it is a welcome trend that would inject vigor to the lumbering, state-dominated banking sector, but a stronger framework of regulations has to be developed to ensure fair play in the capital markets. For instance, Alibaba, China’s Internet giant, recently broke into asset management business by launching a money-market fund called Yu’e Bao. The fund initially offered super appealing returns of around 6.8%, which was much higher than those of traditional bank deposits, but then slid to around 5.5% in anticipation of declining interest rates. In addition, there are concerns that a significant portion of the fund flows into untested and unregulated investments eventually, threatening the stability of the overall financial system. People’s Bank of China Governor Zhou Xiaochuan said recently that while the central bank wouldn’t crack down on the products, it would improve regulations. But how to regulate those private players while offering ordinary Chinese people as many money-making channels as possible remains unclear.

In conclusion, I am bullish about the country’s financial reform as long as the four challenges above could be managed effectively. In particular, the leadership has to deal with existing interest groups wisely to reduce resistance and share growth dividends nationwide.

Part I: Challenges in China’s Ongoing Financial Reform

China, the world’s second largest economy, is undergoing a significant transition from being overly dependent on exports and investments to relying more on domestic consumption for sustainable growth. The leadership pledged to allow the market force to play a fundamental role in the overall economy and open closed fields to the private sector and foreign competition. In order to accomplish the structure upgrade, financial reform is indispensable, including liberalization of the interest rate, internationalization of the Chinese yuan, and incorporation of private capital, etc.

In my observation, the country has to deal with four main challenges to realize its ambitious goals mentioned above.

First, the stability of the Chinese yuan has to be improved. The yuan had been on a steady appreciation path until late February, and then the Chinese central bank started to engineer a decline in the yuan by instructing state-owned banks to buy dollars and allowing the yuan to move as much as 2% on either side of the parity rate on a daily basis, leading to a sharp depreciation of 3% against the U.S. dollar. The reason behind was to drive out international speculators who had been pouring tremendous capital (“hot potatoes”) into China in anticipation of the endless appreciation of the yuan. The influx of speculative capital made the Chinese government harder to manage its economy, triggering potential housing bubble and inflationary pressure. From the long-run perspective, the central bank is trying to introduce greater two-way volatility of the yuan before allowing the market force to play a more critical role so as to ensure its stable movement and promote its international use as an important global currency.

However, this move triggered criticism from Washington as the U.S. Treasury Department said that the yuan’s depreciation would “raise serious concerns” if Beijing is moving away from the plan to make the yuan’s exchange rate market-based, especially if Chinese officials are at the same time citing greater flexibility in the currency’s value.

My prediction is the yuan will resume its appreciation path in the near term because of the Chinese government’s stimulus package. Meanwhile, the People’s Bank of China has to intervene in the yuan in a way both effective and also globally acceptable in the future.

Second, credit quality deterioration is emerging. The non-performing ratio of Chinese banks rose to 1% at the end of the fourth quarter from 0.97% at the end of the third quarter last year, which is the highest since the end of 2011. Many loans were made on the expectation of higher growth rate and the slowdown could lead to serious default issues. To make matter worse, the credit concern spread to Hong Kong since the city posted 30% surge in lending to China on tight credit in the mainland and lower interest rates in Hong Kong.

Weibo’s IPO Debut: Celebration of China’s Most Influential Social Network

Shares of Weibo jumped 19% in its trading debut at Nasdaq this Thursday. The company ended the first day at $20.24, a significant rehearsal of the lackluster initial pricing of $17, which was at the bottom line of the projected range of $17 to $19.

So what exactly is Weibo? It is an affiliate of the Internet giant Sina Corp. and one of the most popular social-media sites in China. People can publish posts, comment on others’, and discuss over hot topics on its platform. Considering the fact that a great many celebrities are active users of Weibo and have thousands of millions followers, it is widely acknowledged as the Chinese version of Twitter.

Some facts

China has the largest number of internet users of around 570 million (42% of the entire population) in the world, and Weibo said that it had grown to 144 million of monthly active user as of March. The company reported a net profit of $3.38 last year with sales of $188 million, against $38 million in losses. In addition, its revenue in the first-quarter this year grew 161% from a year earlier, reaching $67.5 million.

Ongoing challenges

In spite of the brilliant achievement, I think the company still has to face three main challenges for sustainable growth.

First, the model of profitability is yet to stabilize. Like other major social-media sites, Weibo has obtained a broad user base but is still struggling to be profitable. An interesting fact is that many small and medium businesses have been taking advantage of the platform for effective advertising and revenue growth, but the platform itself is cautious when rolling out advertisements on concern that users will be annoyed and abandon its services.

Second, the level of user activity is yet to stimulate. The number of 144 million active users is a little bit inflated because the measure includes everyone who has “logged in and accessed Weibo” during a given month. According to a research at the University of Hong Kong, only 40% of those “active” users actually publish posts and 5% of them—roughly 10 million users—contribute to 95% of the posts on the platform.

Third, it also has to deal with political pressure from government regulation. The censorship somewhat refrains the level of discussions on the platform and even poses potential shutdown risk. So a smart balance between dynamic posts and government commands is certainly a continuous task on the senior management’s top list.

In conclusion, I am bullish about Weibo’s future because of its increasing influence on ordinary Chinese people’s lives, as well as the emerging collaboration with Alibaba, through which Alibaba merchants will be allowed to advertise to Weibo users.

The Challenges of Alibaba’s Yu’e Bao

In my previous post, I discussed the development of Yu’e Bao, a money market fund controlled by Alibaba. With the company’s leading position in e-commerce and the strong client base, the fund tripled in size during the first quarter with a total of 541.28 billion yuan under management in comparison with 185.34 billion yuan at the end of last year, making it the fourth largest in the world in terms of asset value.

Nevertheless, I think there are three main challenges behind the gorgeous achievement.

First, the yield is decreasing. Since the Chinese central bank has been engineering a decline in the Chinese yuan by purchasing the US dollar and increasing the daily trading band of the yuan, interest rates are expected to decrease in the near future. Although Alibaba is able to negotiate higher returns on deposits than what ordinary savors are obliged to accept, the declining interest rates would pose potential risk to the money-market fund. A signal is that the rate fell to around 5.5% now from its peak of 6.8%. Considering the fact that more than 90% of the fund is invested into bank deposits, further slides on return might be inevitable.

Second, traditional banks are fighting back with diversified wealth management products. Those state-owned banks fell behind Yu’e Bao in the competition for liquidity because the rate of a one-year deposit is capped at 3.3%. Nevertheless, they are bypassing the deposit requirement by offering the so-called “wealth management products”, which is just another channel of financing. Basically, they offer higher-than-deposit rates on financial products sold to the general public and then charge even higher rates on lending to government-led investment projects. The return in this scenario tends to be 5%, a level similar to Yu’e Bao’s.

Third, Yu’e Bao will have to face stricter regulation. There have been concerns that a significant portion of the fund flows into untested and unregulated investments eventually, threatening the stability of the overall financial system. People’s Bank of China Governor Zhou Xiaochuan said recently that while the central bank wouldn’t “crack down” on the products, it would improve regulations. Furthermore, since state-owned banks have dominated the nation’s financial sector for years with profoundly political influence, the regulatory authorities might be forced to curb any emerging power just like Yu’e Bao for protection of traditional banks’ profitability.

In terms of Yu’e Bao’s future, I believe there will still be great opportunities down the road because of its private capital nature and the ongoing financial reform in the country. Ordinary Chinese people have limited investment channels, so the promising Yu’e Bao could be a favorable complement to bank deposits and therefore increase their wealth level, an accomplishment in line with the government’s goal of boosting domestic consumption for economic growth.