CDT Money: PMI Shows Fall in Manufacturing, Chinese NYSE Firms up Against the Wall

Moderate pessimism continues as the main theme of economic news from China, as it faces turmoil in the EU – if considered a single economy, China’s largest trading partner – and rising concerns about the stability of the Chinese financial system. With confirmation of a $1.7 billion spending plan, the Chinese government is making a major effort to head off a serious recession.

Manufacturers are scaling back in what may be the sharpest cutback since the 2008 financial crisis: HSBC’s preliminary reading on its Purchasing Managers Index is down to 48.0, under the 50.0-mark that separates growth from contraction for the first time since the crisis. The “flash reading” is based on about 90 percent of the sample, so it could still be revised upwards Thursday, when HSBC and the National Bureau of Statistics release their full PMIs. The bank’s version focuses more on smaller, privately-owned firms than the NBS figure, which are generally more export-oriented – so they may be taking a disproportionate share of the hit from Europe, on top of the recent private credit crunch in Wenzhou.
Anecdotal suggests that small factories are feeling the crunch, as China Law Blog reports on a wave of well-established export manufacturers closing up shop and running away with deposits from clients:

In 2009 and 2010 and the first half of 2011, I estimate that I would receive maybe two emails a month from someone who had sent money to a Chinese manufacturer and received no product. And of those emails, I estimate that pretty much all of them involved a relatively unsophisticated buyer who had done none of the three things listed out above.

In the last three months or so, I have received probably 4-5 emails from buyers who have been burned by Chinese manufacturers but have a very different story to tell. These buyers have been burned by Chinese manufacturers with whom they have been dealing successfully for many years.

Investors appear to be moving money out of China, as China’s central bank bought more RMB than dollars for the first time since May last year. China’s Central Bank normally buys an excess of dollars brought into China by the trade surplus. Analysts are citing an outflow of “hot money” by speculators who see growing risks in the Chinese economy.

In the real estate market, the party seems to be over: Caixin has two pieces on Erdos, where the development of Kangbashi has collapsed. Kangbashi, a massive ghost town built to make money off rising real estate prices, became a symbol of speculative excess after Al Jazeera found thousands of empty units of high-priced housing being traded by absentee owners – residents said that many families own at least three houses as investments. Now, Caixin writes, they are finding it hard to sell apartments in a city that has built two-thirds as much housing as Beijing in the last five years for a tenth of the population:

“Erdos has money,” Li said. “It just lacks people.”
For now, though, local investing and private credit operations are in flux as housing sales froze. Individual home buyers, investor-flippers and builders in Erdos who relied on private borrowing against what seemed to be insatiable demands and ever-rising prices have been caught by a capital crunch, and can no longer afford high interest rates.

New housing costs averaged 1,500 yuan per square meter a decade ago and climbed to hit 20,000 yuan in 2011. Since May, however, many new properties have not been sold, bringing construction at unfinished developments to a halt. Small credit companies and underground banks have stopped lending and are making loan recovery a top priority. The pawn business has plummeted, too.

So is China barreling toward a disastrous crash? The IMF says probably not (PDF) in a recent report on the stability of the Chinese banking system. Despite risks from the real estate sector and loans to local governments, stress tests conducted by banks and the IMF found that they are strong enough to weather losses from a downturn in the economy or a decline in the real estate market, although a crisis which spread through other channels could still pose a major challenge to the banking system:

The stress testing results suggest that major banks can absorb moderate potential losses. This reflects improved profitability and balance sheets in recent years, which allowed banks to build up buffers. The single-factor sensitivity calculations indicate that the system would be able to withstand a range of sector-specific shocks occurring in isolation. These specific shocks include asset deterioration in bank credit to the real estate sector, LGFPs, export sector, and other sectors. The macroeconomic scenario analysis suggests, however, that the system could be severely impacted if several major shocks materialized concurrently. (page 31)

Another major round of stimulus could still head off a recession: Chinese officials have talked about plans to invest in “strategic emerging industries” over the next five years, setting a goal of $1.7 trillion combined public and private investment. Unlike the previous stimulus effort, which delivered money indiscriminately through a wave of cheap bank loans to state-owned companies, the SEI program is intended to spur private investment and to aid the development of hi-tech and green industries, putting China on what the government considers a more sustainable development path.


News in Focus: Chinese firms struggle to defend reputations

Muddy Waters Research has launched another high-profile attack on an overseas-listed Chinese company, this time accusing the advertising company Focus Media of lying about the number of public LCD screens in its network and overpaying for corporate acquisitions – with the implication that executives are using purchases to hide embezzlement.

The company’s stock plunged as much as 66 percent following the accusations. They have rebounded partially following a response from the company, but Muddy Waters has most likely made off with a nice profit – the Hong-Kong based stock research firm, which specializes in accusing Chinese companies of fraud, bets against its targets before releasing reports.

As the FT blogs, it is remarkable that investors are so ready to sell on the say-so of a report that supports the company’s own stock positions, but “with so little to go on about these US-listed Chinese stocks you can see why there is such huge interest in anybody who knows what they are talking about.”

The company’s last target, Sino-Forest, which was removed from the Toronto Stock Exchange in June after accusations that it had inflated the size of its timber reserves, is still campaigning to restore its listing, as a $34 million, 111-page independent committee reports that it is very difficult to understand Chinese companies. From the Toronto Globe and Mail:

The obstacles faced by the investigative committee highlight how challenging it is to find definitive answers to the many questions swirling around Sino-Forest’s business practices. The company’s lack of transparency and its reliance on elusive local partners – coupled with the vagaries of the Chinese business environment – tripped up the committee, whose independence has been openly questioned by the Ontario Securities Commission and others. The RCMP and OSC probes now under way are likely to face the same hurdles, and may learn little more than the special committee.

The company is using a lot of informal structures that essentially mean there’s no way to prove the ownership [of forestry assets],” said Paul Gillis, a professor of accounting at Beijing University and a former partner at PricewaterhouseCoopers. “They’re really saying ‘Trust us.’ ”

The barriers have also been a big part of Sino-Forest’s defence since it came under attack from short-seller Muddy Waters LLC in June. Much of management’s response has essentially boiled down to: This is China. Don’t look for the same kind of records and transparency you’d expect in a Western business environment.

Muddy Water’s power to move markets points to a major problem for Chinese companies and their investors – as Paul Gillis explains on his China Accounting Blog, most are listed on foreign markets using complex VIE structures that do not offer stockholders real ownership of the company. With companies formally not existing overseas and not listed in China, their listings fall into a regulatory hole that leaves them with little to no oversight – and investors with little guarantee that they are not being taken advantage of. Without a regulatory solution, or better transparency from Chinese companies, even sound companies have no way of disputing accusations of fraud – and Muddy Waters is probably right to argue that investors should be wary of things they don’t understand.


Other news:

Caixin reports that Chinese telecoms giants China Telecom and China Unicom have reached an agreement with the NDRC over monopolistic practices accusations, ending the first-ever antitrust investigation of Chinese state-owned companies.

From Bloomberg, proposed anti-dumping tariffs in the US have prompted Chinese solar panel firms to move assembly plants to the United States – but this last stage in production is low-value-added menial work.

From the New York Times, the Communist Party has announced a new head for the national television network CCTV. Hu Zhanfan was previously a vice-minister at the State Administration of Radio, Film, and Television, an industry regulator best-known for issuing nonsensical bans such as April’s order to stop producing time-travel dramas. Hu continues a recent trend of shuffling staff between major SOEs and their own regulators

From the Wall Street Journal’s China Real Time blog: China’s smartphone market has passed the US in units shipped, driven by the widespread of availability of cheap phones offering Google’s free Android operating system, becoming the world’s largest. The US smartphone market remains larger by value.

[Editor’s Note: CDT Money is a once-a-week roundup of business and economic news from China. We’ll be giving an overview of business and economic trends from the world’s second-largest economy, as well as collecting the best news and analysis of the week from newspapers and the blogosphere. CDT Money is written by a freelance journalist living in Beijing. He writes regularly about Chinese foreign policy and politics as well as the economy for online media.]


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