China’s Mysterious Floating Pigs, as Hard Landing Risks Recede…

On my recent visit to Shanghai, a scandal was breaking involving carcinogenic dyes being used in primary school uniforms; since I left, over 3,000 pigs have been discovered floating downriver toward the city, following a police campaign to curb the illicit trade in pork from diseased animals, which are meant to be buried or incinerated. That backdrop of on-going public health outrages and a blatant disregard for product integrity by domestic suppliers is underlined by HK’s strict new limit on mainland purchases of baby formula, as mainland mothers have been paying a huge premium for reliable HK sourced product rather than the all too often adulterated local version. Coming on the heels of record airborne urban pollution in recent months, the environmental remediation bill for China’s headlong boom is rising fast. All of these disturbing and bizarre stories point to the fundamental lack of trust and strictly objective regulatory oversight within Chinese society as a fundamental issue retarding the next stage of development.

Attempting to establish some semblance of either will be critical to reforming the economy, but implies for the first time imposing formal legal constraints on the party and its wayward officials. Investors are more worried right now about floating shares than pigs, as a record A-share IPO backlog builds, with a surge in issuance threatening to overwhelm equity inflows and net earnings upgrades, as in 2010/11. The Public Offering Review Committee (PORC, how appropriate) at the CSRC determines whether a listing can proceed, and the regulator differs from its global peers in investigating an IPO candidates financial status directly and bearing responsibility for investigating potentially fraudulent activity as part of a 10-step review process. Of over 800 companies applying to the CSRC for a listing, 90 are at the final stage before approval, but more significantly, the new leadership is likely to push further SOE privatisation via secondary and primary A-share listings. Overall, while the IPO pipeline will re-open this year after a long hiatus to restore investor confidence, it is in Beijing’s interest to boost levels of activity and valuations via deregulation of domestic institutional investment rules etc. in order to absorb the much bigger SOE deals likely in 2014 and beyond.

 

As expected, bank lending slowed in February, to 620bn RMB, but February total social financing growth of Rmb1.07trn was 9.7% higher than January 2012, when the last New Year fell and the combined two-month total was a record, despite a still narrowly based FAI led recovery.  Wealth management products (WMPs), the deposit-like instruments that banks offer to customers at higher interest rates than savings accounts, saw issuance fall 24% in February m/m, a decline that was exaggerated by the New Year holiday but it seems likely that regulatory efforts on bank reporting of off balance sheet activities etc. are tempering the growth of shadow banking. The banks allocate the WMP-raised funds to investments in bonds, money markets and trusts to generate higher returns; much seems to have found its way into local government funding vehicles to pay for infrastructure projects and provincial SOE real estate activities.

This is the area of the shadow banking system that has most concerned regulators because it risks default scandals as poorly understood lending risks blow up for naïve retail investors. Regulators in Shanghai have gone so far as to make local banks register all the WMP products they issue, and there also have been discussions about quotas on overall issuance. However, on the demand side, depositors face the reality of negative real rates again; CPI has averaged 2.6% y/y YTD, while the one-year deposit rate at Chinese banks is currently capped by the government at 3.575%.  Overall, hard landing fears are misplaced near-term and China looks set for a 7-7.5% GDP growth year, as last year’s investment project approval surge sees funds disbursed and concrete poured but to sustain investor enthusiasm and inflows, tangible reform news flow will be crucial.