Financial markets: What's next for China?

When Asiamoney was first published in 1989, China was a command economy with a barely functional banking sector, producing goods that few people wanted to buy.

Worse, it was an authoritarian regime that brooked no dissent. On June 3/4 that year, the world watched, horrified, as the communist government crushed demonstrations in Beijing’s Tiananmen Square. Perhaps as many as 10,000 people, who had come out to protest about corruption and the slow pace of reform, were killed.

Yet within a few years China had started to get the attention of international investors as it tinkered with new ideas and piloted schemes to see what would or would not work. Deng Xiaoping, the leader who first set China on the path to reform, inspiring his compatriots with the slogan “to get rich is glorious”, visited Shenzhen in 1992 to unveil the first of its experimental special economic zones. The southern city, bordering Hong Kong, was then little more than a cluster of houses set in rice fields, yet within a few years it was one of China’s most important manufacturing centres.

But plenty more was going on behind the scenes. Kenneth Koo remembers visiting Beijing in September 1992 as part of a delegation from the Hong Kong Stock Exchange, and meeting Zhu Rongji in the Great Hall of the People.

“[He] stunned us by saying he was hopeful of getting the first mainland corporate listed in Hong Kong by the following summer, in a mere nine months,” says Koo.

Koo, who is now deputy general manager of Citi Orient Securities, based in Shanghai, refused to believe the timeline was possible.

“You have to remember that back then, there was no company law in China, no statutory rules for shareholders, no real accounting system, that’s how raw it was.” Zhu, who had attracted attention as a reformer when he was mayor of Shanghai, was the State Council’s rising economic tsar and later became premier; and he proved as good as his word. In July 1993, Tsingtao Brewery sold shares to the public in Hong Kong, marking the first H-share listing.

Sector by sector, China took its big state firms public. First came energy and telecoms, then insurance and airlines, and finally its big commercial banks.

None of them were, in the purest sense of the term, privatizations: Beijing retains control of each corporate body. But, says Koo, the sales, “did a lot of good for China. Most of those companies improved as they were exposed to the glare of public marketing and to annual and semi-annual reporting. It imposed some form of governance.”

Economically and politically, China enmeshed itself in the global community it had once eschewed, joining the World Trade Organization in 2001 and relaxing the renminbi’s strict peg to the dollar four years later. When the global financial crisis hit, it unveiled a huge stimulus package that kept its economy afloat.

The process of engagement has accelerated. In 2013, president Xi Jinping unveiled the Belt and Road Initiative, an ambitious plan to redraw the global trade map in China’s image.

Two years later, he launched the Asian Infrastructure Investment Bank, a new multilateral, with the intention of taking on agencies such as the World Bank, controlled by western powers. A five-year-old ‘stock connect’ programme that links Shanghai and Hong Kong, and allows investors to trade shares on the other market using local brokers, was a hit, persuading Beijing to introduce a similar scheme for bonds in 2017.

China’s currency is now an integral part of the basket of currencies that make up the IMF’s special drawing rights (SDRs), while mainland securities are rapidly becoming mainstays of global indices.

Benjamin Lamberg, global head of medium-term notes and private placements and head of Asia credit at Crédit Agricole, calls the decision to include Chinese bonds in the Bloomberg Barclays Global Aggregate Index, on April 1 2019, the country’s “Big-Bang moment”.

So much for what has been done over the last 30 years. What comes next? Making concrete predictions about any country is problematic. Fortunes wax and wane, demographics shift, and financial crises knock budgets off kilter.

The challenge of forecasting is magnified in a country like China, which has spent three decades defying all the odds. That the People’s Republic has become the workshop of the world without opening its capital account is remarkable, as is the fact that so little is still known about the guts of Asia’s largest economy.

Even the prime minister distrusts GDP figures issued by the national data bureau.

But drawing on our own experience, and after speaking to debt bankers and currency analysts, green finance gurus and investment bankers, all working in the country, Asiamoney feels confident enough to set out 10 bold predictions about where China will change, for better and for worse, in the three decades to come.

China’s bond market is the third largest in the world, with $12.3 trillion outstanding at the end of 2018, according to Swift, behind Japan ($13 trillion) and the US ($40.3 trillion). Despite a byzantine legal framework and a lack of liquidity – matters that regulators must address – foreign investment in onshore bonds has tripled to $300 billion since December 2016.

Inclusion in the Bloomberg Barclays Global Aggregate Index will channel another $150 billion into the asset class by 2021, and Crédit Agricole predicts that the market will quadruple in size by 2025 to between $47 trillion and $55 trillion, putting it on a par with the US. The process will be driven partly by necessity: China is desperate for fresh sources of capital to continue to fuel its economy, and is keen to disintermediate its banks.

“They admire the US economy and financial system and know that it is important to have both a properly functioning bond market and a robust stock market,” says Koo, of Citi Orient Securities.

The process will be expedited by the rise of the renminbi.

Crédit Agricole’s Lamberg expects renminbi-denominated debt to make up between 5% and 7% of the international debt market in five years, against less than 2% at present.

“Renminbi debt is about to make the jump from niche product to mainstream asset class,” he says. “Wherever you are, be it Sydney or Singapore, you will have to buy Chinese bonds.”

China is paying the price for its searing pace of development. Asiamoney asks Ma Jun, the former chief economist at the People’s Bank of China who is now a clarion voice on green finance, if Beijing can take the lead in sustainable investing.

“We already are in many areas,” he replies, pointing to electric car production, renewable energy output and a push to make 50% of all new housing carbon neutral by 2021. “We can force banks not to lend to bad polluters, and do it more effectively than any other country.”

China accounts for 70% of all green bonds sold in the emerging world; mainland issuers, led by financial institutions, printed $31 billion worth of green bonds in 2018, or 18% of the total, according to the Climate Bonds Initiative, ranking behind only the US.

The PBoC is forging global partnerships while innovating furiously at home: take the pilot scheme in Huzhou that matches green projects with green bank loans. Critics might point to the veracity of onshore data and question the inclusion of clean coal in many so-called green projects, but the truth is China has to become the world leader in green finance. The degradation of its air and water, not to mention its soil, which Ma reckons will cost Rmb70 trillion ($7.23 trillion) to clean up, leaves it no other option.

Every agency that sets out to gauge the size of China’s economy by 2050 reaches the same conclusion. All say it will be the world’s largest, way ahead of the US. And all of them are wrong. China’s economic growth has been slowing for years: most global bodies, the IMF included, see growth coming in at between 6% and 6.5% in 2019 and 2020, despite a trade war with the US. But those forecasts are based on fickle state data, and many say the real rate of growth is just half that. Morningstar forecasts GDP to be between 3.25% and 3.5% in 2019, while Mike Pettis, professor of finance at Peking University’s Guanghua School of Management, says it is “not much more than 3%”.

It was China’s great fortune to open up just as globalization kicked in and a surge of young adults entered the workplace. These days, China is an expensive place to operate in, and old: the average mainlander will be 56 years old by the middle of this century, versus 44 in America.

Total debt is nearing three times GDP, while the cost of combating climate change will surge as the country’s north dries out and the south floods.

“People will look back in 30 years and see that today was peak China,” says Fraser Howie, co-author of ‘Privatizing China’. “Indonesia, India and Africa will accelerate, and China won’t be much more of the global economy by mid-century than it is now. A long, Japan-style recession is a very likely and maybe a good scenario for China. If they manage the next transition without massive and violent upheaval, they’ll have done well.”

In conjunction with the central bank, Beijing has managed expectations of its currency well. The renminbi was added to the IMF’s SDR basket in October 2016 and now represents a shade under 11% of the basket, against 41.73% for the dollar and 30.93% for the euro.

Crédit Agricole’s Lamberg predicts the renminbi’s weighting will increase to around 14% or 15% when the IMF next evaluates its basket in 2020. But anyone expecting the renminbi to supplant the dollar as the world’s reserve currency will be disappointed. That Beijing covets a more international renminbi is no secret.

“The US can print as many dollars as it wants,” says Lamberg. “China wants to wield that kind of power: to be able to issue its own currency when and how it wants, and to not be dependent on the greenback.”

But it will not rush the process, opting to “continue moving toward a ‘clean floating’ FX regime”, says Paul Mackel, head of emerging markets currency research at HSBC, as more global capital flows into mainland stocks and bonds.

“The renminbi could be among the top five most liquid and tradable currencies within three to five years,” he adds. (It is currently eighth). Where its impact will be felt is in the belt-and-road countries, notably in Africa and central Asia, where it will, Lamberg says, “within 10 years… overtake the US dollar”, and across Asia, where it is, Mackel believes, already the most influential currency.

Hong Kong’s stock exchange had a banner year in 2018. A record 208 firms listed on the bourse, raising $36.6 billion, according to Deloitte, more than for any other city. Mainland firms still favour a listing in the former British colony: recent additions to the HKSE include phone maker Xiaomi and delivery platform Meituan Dianping. Yet Hong Kong faces an uncertain future. Many of its best traits, like freedom of speech and rule of law, are being eroded. It is also a prohibitively expensive place to live.

The balance of power will slowly shift north to Shanghai, for two reasons.

First, Shanghai is home to the Shanghai Stock Exchange, the world’s fourth-largest bourse by market capitalization (Hong Kong currently lies sixth) and is pushing hard to secure more listings by technology firms.

On June 6, three firms were approved to list on the new Science and Technology Innovation Board, a Nasdaq-style venue that speeds up the IPO process, and waives restrictions on how firms are priced. Citi Orient’s Koo says the new board will be a “game-changer”.

And second, because a confluence of events, from a more global renminbi to the inclusion of Chinese stocks and bonds in global indices, will force financial groups to open offices in Shanghai, following in the footsteps of firms like Aberdeen Standard Investments.

“To get a full picture of the market, you need people onshore: credit analysts, portfolio managers, local experts with the right understanding of context and culture,” says Lamberg of Crédit Agricole.

“Everyone will need to have an onshore China strategy,” says Ning Tang, chairman and chief executive of financial services group CreditEase.

But in terms of global relevance, Shanghai is unlikely to vie with the likes of London or New York: the lack of a free-floating currency will see to that.

Howie says: “You need free flow of people, money and information to be a global centre. I don’t see China having any of them.”

In May 2019, when he became governor of the People’s Bank of China, Yi Gang said capital account convertibility must be achieved “gradually, steadily”, citing the chaos that engulfed Thailand during the 1997/98 Asian financial crisis. Nothing unsettles Beijing more than disorder and mayhem, so the carrot suspended in front of investors for 30 years will continue to dangle.

“I do not expect China to fully open up its capital account in the next 15 years,” says Lamberg of Crédit Agricole.

Jonathan Slone, former chief executive of CLSA, a Hong Kong brokerage owned by Citic Securities, says the country will “continue to liberalize, to move forward in a thoughtful way. But anyone who believes it will open its capital account [fully over the next 30 years] doesn’t understand how the country works.”

The appointment of former China Construction Bank (CCB) chief Guo Shuqing as banking regulator in 2017 was a shock to the system. He clamped down on lending, forced banks to resolve bad loans, and fined those who hid their non-performing loans.

“Guo was giving the banking sector the Heimlich manoeuvre,” says Jason Bedford, a financial analyst at UBS in Hong Kong. A year later, the political heavyweight was promoted to run the newly formed banking and insurance regulator.

For China’s big state lenders, the meaty challenges lie ahead: deciding who they are and what they want to be. At home, they are threatened by the likes of Alibaba and Tencent, tech titans that have expanded rapidly and seamlessly into payments, wealth management products and banking.

These firms pose a “subtle and significant threat” to traditional banks, says Cliff Sheng, a Beijing-based partner at consultancy Oliver Wyman who advises several large fintechs. “Consumers spend no time with lenders, but are on Tencent’s apps seven hours a day. Traditional banks are losing the consumer’s time and attention, but worse, they are losing out on the data they need.”

Stung into action, banks are engaging with fintechs: CCB is cooperating with Alipay and Citic Bank has joined with JD.com to issue over two million co-branded credit cards. Expect more competition and collaboration.

And what of their global ambitions? The likes of ICBC, Bank of China and CCB have expanded selectively, opening branches in big cities and snagging assets here and there, but avoiding buying sprees. Beyond that?

UBS’s Bedford says China will “work assiduously to continue to clean up the banking system, but it will gradually wane in relative importance as the capital markets grow in scale and strength and become much more internationally accessible”.

But will any of the big banks have the guts and gumption to go global?

Howie thinks not: “Wherever Chinese corporates go, China’s banks will be. They’ll do what Japan’s banks have always done with their firms. No more, no less.”

The salad days are over for China’s leading financial technology firms. Yes, they continue to roll out new services at home, while scouring the world for assets to buy and markets to disrupt, but gone is the light-touch regulation that enabled them to grow big, fast. The regulator has cracked down on peer-to-peer lenders: in February 2019, it closed 380 online lenders and froze $1.5 billion in assets. China’s big private firms are savvy survival experts adept at reading the political runes, and fintechs are no exception.

“ They started life in a loosely regulated market, but regulators now want to constrain them,” says Sheng of Oliver Wyman. “Fintechs will have to decide whether to be financial institutions or technology enablers.”

It is worth noting that Ant Financial is repositioning itself as more of a technology firm, while Tencent is keen to specialize in building and marketing technology that supports smaller lenders, particularly in emerging markets, sources say.

As the backlash against big tech ramps up in the west, China’s fintechs, observing events from afar, may withdraw to focus on the one market they know best, one industry analyst predicts.

Along with bonds and the renminbi, this is the big one. There are approximately 1.9 million high net-worth individuals in China, classified by Wealth-X as anyone with a net worth of between $1 million and $30 million.

Many are first-generation tycoons who came of age as China started to open up, says CreditEase chairman Ning, whose firm is a leading provider of wealth management products. He reckons Rmb200 trillion ($29 trillion) will pass into the hands of a second generation of family members in the 2020s, and how the industry handles that challenge will affect China for decades to come.

“It’s a profound moment,” he tells Asiamoney. “It’s the first time so much wealth has changed hands. If it works, there is a strong possibility that in 30 years’ time, China will have the world’s biggest wealth management industry.”

But if the process is botched – if advice is poor or goes unheeded, or if fortunes are frittered away or channelled blindly into speculative and risky investments that “cause the financial markets to become very turbulent, a huge amount of wealth will be destroyed”, he adds.

The challenge is immense. While some super-wealthy Chinese live global lives, their fortunes overseen by bankers in Singapore and Zurich, London and New York, many others “have no idea what portfolio management is”, says Ning, and are often swayed by wild promises of huge returns. “You have to do a lot of basic financial literacy. China’s market is very big, but there isn’t much low-hanging fruit. With a lot of people, you have to start with the basics.”

Expect to see a clutch of world-class Chinese asset and wealth managers emerge over the next 30 years, based in Shanghai and with offices around the world, while an elite group of private banks, among them Credit Suisse and UBS, profit handsomely onshore.

President Xi Jinping’s project of the century, launched in 2013 with the aim of rewriting the global trade map, won’t be a bust. It has led to hundreds of billions of dollars of projects being built in Asia, Africa and Europe, from airports and highways to dams and ports. But too many are frivolous or expensive, mire the host country in debt, and are accused of being poorly built and environmentally damaging boondoggles. Ma, the central bank’s green guru, fears that unless BRI projects are designed more efficiently, “it will lead to the emission of many times the current carbon levels in future decades”.

The latest BRI forum, held in Beijing in April, was poorly attended, and the project is increasingly unpopular both abroad and at home. When Asiamoney met with a group of elite business students in Beijing, mention of the plan was met with derision.

“I foresee rhetoric around the BRI slowly being scaled down,” says Privatizing China author Howie.

“It won’t be a bust, and the infrastructure that is being built will remain, but its global and political ambitions will be wound down, and it will come to be seen as a costly enterprise that generated little in return, and has just annoyed too many people around the world.”