Bank of Japan tiptoes toward financial bedlam

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TOKYO — Has Bank of Japan (BOJ) Governor Kazuo Ueda, 103 days into the job, already blown it?

Inquiring minds in trading pits everywhere can’t help but wonder as inflation and gross domestic product (GDP) diverge in dangerous ways. And markets are getting exactly the last thing you’d want from Ueda’s BOJ: crickets.

Data released on Friday (July 21) showed that core inflation, which excludes fresh food, rose 3.3% in June year on year, faster than in the US. Japan’s inflation surge shows how quickly price dynamics can shift — and perhaps get away from a central bank.

This adds an economic exclamation point to next week’s BOJ policy meeting. The two-day event ending July 28 is shaping up to be the BOJ’s last chance to salvage its reputation in world markets.

The odds the BOJ will do just that aren’t great. “Although we don’t rule out some yield-curve-control-related change at the BoJ’s upcoming policy meeting, our base case is for the central bank to stick to its guns,” says Stefan Angrick, senior economist at Moody’s Analytics.

Norman Villamin, group chief strategist at Union Bancaire Privée, adds that “the Bank of Japan may once again be forced to defend the policy via liquidity injections moving through the summer.”

Given Ueda’s recent comments, Mitsuhiro Furusawa, a former vice minister of finance for international affairs, told Bloomberg: “It’s unlikely that the bank will modify the instrument at the upcoming meeting. In the past, I thought July is possible, but the way he’s speaking, if he moves next week, it’ll be a major surprise.”

This crisis of confidence confronting the BOJ has many fathers, of course. Blame must be shared by Prime Minister Fumio Kishida’s ruling Liberal Democratic Party (LDP) for squandering the last decade. The same goes for a succession of BOJ leaders who forget about what William McChesney Martin said about punch bowls 70 years ago.

It was in 1951 when Martin, then chairman of the US Federal Reserve, famously quipped that a central banker’s job is to remove the punchbowl just as the party gets going. Far from internalizing this mindset as, say the Bundesbank of old did, the BOJ has been refilling and refilling the punchbowl for decades.

First, with the quantitative easing that the BOJ pioneered in 2000 and 2001, just after cutting rates to zero in 1999. The unsurprising result is a level of financial intoxication that no Group of Seven (G7) economy had ever known.

Japanese 10,000 yen bank notes spread out at an office of World Currency Shop in Tokyo on August 9, 2010 Reuters/Yuriko Nakao.
Easy money: Japan has a long history of quantitative easing Photo: Agencies

Twenty-plus years ago, when then-BOJ leader Masaru Hayami served up quantitative easing (QE), it was meant to be a special monetary cocktail available for a limited time only. Over time, though, the Tokyo political establishment got hooked on loose monetary policy.

One government after another prodded the BOJ leader at the moment to keep the liquidity flowing — and to up the dosage. This cycle got supersized in 2013, when the LDP hired Ueda’s predecessor, Haruhiko Kuroda.

At the time, then-prime minister Shinzo Abe said he was mixing up his own cocktail of badly needed structural reforms to end deflation. Abe promised a mix of Ronald Reagan and Margaret Thatcher with Japanese characteristics. Mostly, though, Abe just prodded Kuroda to add more punch bowls.

It backfired. As Kuroda fired his monetary “bazooka,” the yen plunged and exports soared. That generated a corporate earnings boom, one that propelled the Nikkei Stock Average up 57% in 2013 alone.

But those gains never made it to the average Japanese as wages flatlined. That’s because Abe’s party failed to implement the supply-side revolution it promised.

Moves fell by the wayside to cut red tape, liberalize labor markets, increase innovation and productivity, empower women and restore Tokyo’s place as Asia’s financial hub. Instead, Abe bet it all on ultraloose central bank policies, the likes of which modern economics had never seen before.

In short order, the Kuroda-led BOJ drove the yen down 30%, hoarded more than half of all outstanding Japanese government bonds and morphed the BOJ into a giant hedge fund by gorging on stocks. By 2018, the BOJ’s balance sheet topped the size of Japan’s US$5 trillion economy, a first for G7 members.

None of it generated real inflation, though. That took Vladimir Putin’s invasion of Ukraine. The massive boost to oil prices had Japan importing too much inflation too fast via an undervalued exchange rate. The Putin factor collided with Covid-19 era supply chain price pressures.

Japan suddenly had the inflation it sought for a decade. It was the “bad” kind, though, generated more by supply shocks than rising consumer demand. It also came too quickly, catching BOJ officials flat-footed.

On Thursday (July 20), Kishida’s government dramatized the problem by projecting that inflation will likely hit 2.6% this fiscal year.

That’s the highest in at least three decades and well above the BOJ’s 2% target. Worse, it’s double the government’s GDP expectations, now projected to expand 1.3% in the current fiscal year ending in March 2024.

In December, with his retirement less than four months away, Kuroda tested out how declaring “last call” might go down. Not well: Kuroda’s December 20 move to let 10-year yields drift as high as 0.5% caused bedlam in markets.

Then-Bank of Japan governor Haruhiko Kuroda has a QE problem. Photo: Asia Times Files / AFP

The yen surged, Japanese stocks cratered and Wall Street panicked. Kuroda’s response was refilling the punchbowl — again — and then passing bartending responsibilities to Ueda.

It now falls to Ueda to devise a 12-step program for Tokyo without crashing global markets. The trouble is, 23 years of open-bar policies made it okay for investors everywhere to drink free on Japan’s dime.

The arrangement gave way to the so-called “yen-carry trade.” Two-plus decades of zero rates made Japan the premier creditor nation. Investors of all stripes got into the habit of borrowing cheaply in yen to fund bets on higher-yielding assets everywhere.

This strategy has kept aloft everything from Argentine debt to South African commodities to Indian real estate to the New Zealand dollar to cryptocurrencies.

This explains why Kuroda’s flash of sobriety in December caused a mini earthquake globally. When the yen or JGB yields surge, the bottom falls out from under markets across the globe. Asian markets in particular don’t tend to fare well amid big yen gyrations.

These pivots back toward “risk off” crouches often blow up a hedge fund or two. And, clearly, the last thing China needs right now as GDP slows, exports stall and questions linger about the depths of its real estate problem is financial turbulence from Japan.

“Given the BOJ’s outlier status among global central banks that have spent the better part of the last two years fighting inflation,” says economist Udith Sikand at Gavekal Research, “even the smallest of changes to its policy stance could create a ripple effect through foreign exchange markets that have gotten used to the yen being a perennially cheap funding source.”

All of which explains why next week’s BOJ meeting is so crucial. It may be Ueda’s last chance to guide yen-denominated assets instead of being overwhelmed by negative market forces, not least the so-called “bond vigilantes.”

The reference here is to activist traders who take matters into their own hands to highlight government, monetary or corporate policies they deem as unwise or dangerous. They make their voices heard by driving up bond yields and boycotting debt auctions, thereby raising government borrowing costs.

If Ueda isn’t careful, the financial forces that the BOJ has long held at bay could strike back. At the very least, his team must emerge from the July 28 meeting with a plan to begin winding down decades of QE.

“We expect the BOJ to widen the fluctuation range for 10-year JGB yields,” says economist Takeshi Yamaguchi at Morgan Stanley MYFG. “That said, we do not see a meaningful rise in yields. We would see a potential knee-jerk negative equity market reaction as a buying opportunity.”

It’s easier said than done, of course. The last thing Ueda’s team wants is to tank the Nikkei — or Japan’s broader economy. Ueda, of course, has the events of December 20 on his mind. But the lessons from the 2006-07 era of BOJ policymaking also loom large.

At the time, then-BOJ governor Toshihiko Fukui tried his hand at weaning Japan Inc off the monetary sauce. QE, after all, was meant to bring the economy back from a kind of near-death experience; it was never meant to be permanent.

Fukui decided it was time to get Japan clean. First, he ended QE. In July 2006, he pulled off an official rate hike and then a second one in early 2007.

Not surprisingly, global markets struck back when investors, banks, companies and politicians howled in protest. Before long, Fukui was on the defensive and the rate hikes stopped.

By 2008, after Masaaki Shirakawa took over as BOJ governor, Tokyo was slashing rates back to zero and restoring QE. Then came Kuroda in 2013 to turbocharge QE.

Kazuo Ueda has a decision to make. Image: Facebook

Ueda also has lessons from Washington on his mind, namely the collapse of Silicon Valley Bank (SVB) amid aggressive US Fed tightening moves. As Ueda’s team understands, some of the conditions imperiling US lenders seem eerily familiar to headwinds facing Japan’s regional banks.

All too many of these 100-plus institutions saw profits squeezed by an aging and shrinking population. The communities they service have been hit by an exodus of companies keen on headquartering in Tokyo rather than the provinces.

The BOJ’s rigid “yield curve control” regime, which makes it hard for banks to borrow at one part of the maturity spectrum and lend at the other, is an added blow. So many regional lenders hoard bonds rather than lending SVB-style. This makes these embattled lenders vulnerable to BOJ tapering or tightening.

On the other side of the risk list is that the BOJ might be letting inflation become ingrained. Earlier this year, Japanese unions scored the biggest wage gains for workers in 31 years. The average 3.91% increase could add fuel to the BOJ’s inflation troubles and exacerbate concerns among traders worried the Ueda-led BOJ is already losing the plot.

“It’s a close call, but we still think yield curve control tweaks are possible, given that recent data support steady inflation growth and a sustained economic recovery,” says economist Min Joo Kang at ING Bank.

The only thing clear about the July 27-28 meeting, however, is that the BOJ will be in the global spotlight as rarely before.

Follow William Pesek on Twitter at @WilliamPesek

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Elon Musk: Tesla may cut prices again in ‘turbulent times’

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Tesla chief executive Elon Musk gets in a Tesla car as he leaves a hotel in Beijing, China.Reuters
By Annabelle Liang
Business reporter

Tesla chief executive Elon Musk has signalled that the electric carmaker will continue to cut prices as the world economy is in “turbulent times”.

The multi-billionaire’s comments came after the company reported that its profit margins had been squeezed as it faced tough competition.

In recent months, Tesla has cut its prices several times in major markets, including the US and China.

The firm’s shares fell by more than 4% in after-hours trade in New York.

Tesla reported that its profit margin had fallen to the lowest level in four years.

The company said its gross profit margin fell to 18.2% for the three months to the end of June, down from 26.2% for the same period last year.

During a call with Wall Street analysts, Mr Musk signalled that he was open to cutting prices further if needed.

“One day it seems like the world economy is falling apart, next day it’s fine. I don’t know what the hell is going on,” he said.

“We’re in, I would call it, turbulent times,” Mr Musk added.

Investors are concerned about the possibility of more price cuts at Tesla, Arun Sundararajan, a Professor at the NYU Stern Business School, told the BBC.

“This feels like a price war with no long term strategy to raise margins if Tesla wins the war,” he added.

Earlier this year, Mr Musk said he believed pursuing higher sales, with lower profits, was the “right choice” for Tesla.

The firm has lowered prices in markets including the US, UK and China to compete with rival manufacturers.

Earlier this month, the company said it delivered a record number of vehicles in the three months to the end of June.

It comes as more carmakers have agreed to adopt Tesla’s electric vehicle (EV) charging technology.

On Wednesday, Japanese motor industry giant Nissan said its EVs in the US and Canada would be equipped with Tesla-developed charging ports from 2025.

Nissan Americas’ chairperson Jérémie Papin said the firm was committed “to making electric mobility even more accessible”.

The announcement follows similar moves by US car manufacturers Ford and General Motors.

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World hunger and the war in Ukraine

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On Monday, June 17, Dmitry Peskov, the spokesman for Russian President Vladimir Putin, announced, “The Black Sea agreements are no longer in effect.” This was a blunt statement to suspend the Black Sea grain initiative that emerged out of intense negotiations in the hours after Russian forces entered Ukraine in February 2022.

The initiative went into effect on July 22, 2022, after Russian and Ukrainian officials signed it in Istanbul in the presence of the United Nations Secretary General António Guterres and Turkish President Recep Tayyip Erdogan.

Guterres called the initiative a “beacon of hope,” for two reasons. First, it is remarkable to have an agreement of this kind between belligerents in an ongoing war. Second, Russia and Ukraine are major producers of wheat, barley, corn (maize), rapeseed and rapeseed oil, sunflower seeds and sunflower oil, as well as nitrogen, potassic, and phosphorus fertilizer, accounting for 12% of calories traded.

Disruption of supply from Russia and Ukraine, it was felt by a range of international organizations, would have a catastrophic impact on world food markets and on hunger. As Western – largely US, UK and European – sanctions increased against Russia, the feasibility of the deal began to diminish.

It was suspended several times during the past year. In March, Russian Foreign Ministry spokeswoman Maria Zakharova, responding to the sanctions against Russian agriculture, said the main parameters provided for in the grain deal “do not work.”

Financialization leads to hunger

US Secretary of State Antony Blinken said his country regrets Russia’s “continued weaponization of food,” since this “harms millions of vulnerable people around the world.” Indeed, the timing of the suspension could not be worse.

A United Nations report, “The State of Food Security and Nutrition in the World 2023” (July 12, 2023), shows that one in 10 people in the world struggles with hunger and that 3.1 billion people cannot afford a healthy diet.

But the report itself makes an interesting point: that the war in Ukraine has driven 23 million people into hunger, a number that pales in comparison to the other drivers of hunger – such as the impact of commercialized food markets and the Covid-19 pandemic.

A 2011 report from World Development Movement called “Broken Markets: How Financial Market Regulation Can Help Prevent Another Global Food Crisis” showed that “financial speculators now dominate the [food] market, holding over 60% of some markets, compared [with] 12% 15 years ago.”

The situation has since worsened. Dr Sophie van Huellen, who studies financial speculation in food markets, pointed out in late 2022 that while there are indeed food shortages, “the current food crisis is a price crisis, rather than a supply crisis.”

The end of the Black Sea grain initiative is indeed regrettable, but it is not the leading cause of hunger in the world. The leading cause – as even the European Economic and Social Committee agrees – is financial speculation in food markets.

Why did Russia suspend the initiative?

To monitor the Black Sea grain initiative, the United Nations set up a Joint Coordination Center (JCC) in Istanbul. It is staffed by representatives of Russia, Turkey, Ukraine and the United Nations.

On several occasions, the JCC had to deal with tensions between Russia and Ukraine over the shipments, such as when Ukraine attacked Russia’s Black Sea Fleet – some of whose vessels carried the grain – in Sevastopol, Crimea, in October 2022.

Tensions remained over the initiative as Western sanctions tightened, making it difficult for Russia to export its own agricultural products into the world market.

Russia put three requirements on the table to the United Nations regarding its own agricultural system.

First, Moscow asked that the Russian Agricultural Bank – the premier credit and trade bank for Russian agriculture – be reconnected to the SWIFT system, from which it had been cut off by the European Union’s sixth package of sanctions in June 2022.

A Turkish banker told TASS that there was the possibility that the EU could “issue a general license to the Russian Agricultural Bank” and that the bank “has the opportunity to use JPMorgan to conduct transactions in US dollars” as long as the exporters being paid for were part of the Black Sea grain initiative.

Second, from the first discussions about the grain initiative, Moscow put on the table its export of ammonia fertilizer from Russia both through the port of Odessa and of supplies held in Latvia and the Netherlands.

A central part of the debate has been the reopening of the Togliatti-Odessa pipeline, the world’s longest ammonia pipeline. In July 2022, the UN and Russia signed an agreement that would facilitate the sale of Russian ammonia on the world market.

Guterres went to the UN Security Council to announce, “We are doing everything possible to … ease the serious fertilizer market crunch that is already affecting farming in West Africa and elsewhere. If the fertilizer market is not stabilized, next year could bring a food supply crisis. Simply put, the world may run out of food.”

On June 8, 2023, Ukrainian forces blew up a section of the Togliatti-Odessa pipeline in Kharkiv, increasing the tension over this dispute. Other than the Black Sea ports, Russia has no other safe way to export its ammonia-based fertilizers.

Third, Russia’s agricultural sector faces challenges from a lack of ability to import machinery and parts, and Russian ships are not able to buy insurance or enter many foreign ports. Despite the “carve-outs” in Western sanctions for agriculture, sanctions on firms and individuals have debilitated Russia’s agricultural sector.

To counter Western sanctions, Russia placed restrictions on the export of fertilizer and agricultural products. These restrictions included the ban on the export of certain goods (such as temporary bans of wheat exports to the Eurasian Economic Union), the increase of licensing requirements (including for compound fertilizers, requirements set in place before the war), and the increase of export taxes.

These Russian moves come alongside strategic direct sales to countries such as India that will re-export to other countries.

In late July, St Petersburg will host the Second Russia-Africa Economic and Humanitarian Forum, where these topics will surely be front and center. Ahead of the summit, President Putin called South Africa’s Cyril Ramaphosa to inform him about the problems faced by Russia in exporting its food and fertilizers to the African continent.

“The deal’s main goal,” he said of the Black Sea grain initiative, was “to supply grain to countries in need, including those on the African continent, has not been implemented.”

It is likely that the Black Sea grain initiative will restart within the month. Earlier suspensions have not lasted longer than a few weeks. But this time, it is not clear if the West will give Russia any relief on its ability to export its own agricultural products.

Certainly, the suspension will impact millions of people around the world who struggle with endemic hunger. Billions of others who are hungry because of financial speculation in food markets are not impacted directly by these developments.

This article was produced by Globetrotter, which provided it to Asia Times.

Vijay Prashad is an Indian historian, editor and journalist. He is a writing fellow and chief correspondent at Globetrotter. He is an editor of LeftWord Books and the director of Tricontinental: Institute for Social Research. He has written more than 20 books, including The Darker Nations and The Poorer Nations. His latest books are Struggle Makes Us Human: Learning from Movements for Socialism and (with Noam Chomsky) The Withdrawal: Iraq, Libya, Afghanistan, and the Fragility of US Power.

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Is the worst over for Sri Lanka’s economic crisis?

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People gather to buy clothes on the busy street market of Maharagama, near Sri Lanka's capital ColomboGetty Images
By Archana Shukla
BBC News, Colombo

At first glance, life in Sri Lanka’s financial capital Colombo looks deceptively normal.

Roads are packed with traffic, public spaces and restaurants are full of both locals and tourists, while shops are bustling.

It is hard to imagine that just a year ago, this was a country struggling with massive shortages after it ran out of foreign currency.

With no money to buy fuel, roads were empty with even public transport at a standstill. Sri Lanka had to go back to pandemic-era measures such as online classes and working from home. But even this was not practical because of power cuts – some of which went on for up to 13 hours a day.

Food, medicine and other essentials were also in short supply, exacerbating the crisis. People had to stand in such long queues in the brutal heat, that at least 16 people – mainly the elderly – died.

But now, just a year later, food, fuel and medicine are available again, offices, schools and factories are all open, and public transport is back up and running.

Restaurants, especially high-end ones, are bustling.

A vendor deals in rupee notes on March 21, 2023, in Colombo, Sri Lanka.

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“Last year this time I was on the verge of selling my restaurant. We had to close for a few days as the shortage of fuel meant no customers were coming. But now footfall has gone up nearly 70%,” said Chathura Ekanayake who runs a fine dining restaurant in Colombo.

The country’s main source of foreign currencies – tourism – is also witnessing a revival. The industry has recorded a 30% jump in revenue from the previous year.

“The recovery has been magical for us. Last year we didn’t even know if the country would survive”, said Hiran Cooray, CEO of Jetwings Symphony, a leading travel and hospitality player in Sri Lanka.

Despite these good news stories, Sri Lanka’s economy is still in a precarious place.

The country still has more than $80bn (£61.1bn) of debt – both foreign and domestic. In the worst of the crisis last year, the country defaulted on its foreign debt for the first time in its history.

Ranil Wickremesinghe who took charge as President after widespread protests saw then-ruler Gotabaya Rajapaksa resign, has managed to secure a lifeline of $2.9bn from the International Monetary Fund (IMF).

This has been crucial to opening other funding channels and easing shortages, but the money came with strict economic and governance policy reforms. The country is now seeking to restructure terms of its debt payments with both foreign and domestic lenders, as mandated by the IMF.

The main focus has been on restructuring its $36bn of foreign debt. This includes more than $7bn of loans from China, Sri Lanka’s largest bilateral creditor.

However, it is the restructuring of domestic debt that is likely to have a much bigger impact on the Sri Lankan people. Domestic borrowing accounts for around 50% of the country’s total debt. Sri Lanka’s cabinet recently approved a domestic debt restructuring proposal, but it has drawn massive criticism as it aims to cut workers’ pensions, while banks will not be affected. There have been protests against the proposals in Colombo.

It highlights that while life may seem to have returned to normal, in reality people are still struggling.

Protesters chant slogans during the protest on July 12, 2023, in Colombo, Sri Lanka. The Inter-company Employee Union held a protest in front of the Labour Department. This protest was held, asking not to touch the Employees' Trust Fund and Employees Provident Fund.

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Essentials are available, but unaffordable for many. Things are more expensive than ever before. Almost half of all Sri Lankan families spend about 70% of their household income on food alone. And prices of food, clothing and housing are continuing to rise.

To add to the burden, income tax has been hiked to as much as 36% and subsidies on everything from food to household bills have been removed.

One area where this has had a huge impact is electricity bills, which have soared by 65% after the subsidy was removed.

“Many families from the middle class have now slipped below the poverty line,” said Malathy Knight, a senior economist with private think tank Verite Research.

And according to the World Bank, this is likely to continue for a while.

“Poverty is projected to remain above 25% in the next few years due to the multiple risks to households’ livelihoods,” it said in a report. The organisation has extended a $700m loan to Sri Lanka for budgetary support, including $200m for the poor and vulnerable.

This is a dramatic fall for a country that was long held up as an economic success story and had one of the highest average incomes in South Asia. The quality of its infrastructure, its free public health and education systems and its high levels of social development have all been held in high regard.

So how did things get so bad?

The government blamed the crisis on the Covid pandemic, which badly affected tourism. However, although the pandemic was a factor, disastrous economic policies were more to blame. Populist moves like big tax cuts in 2019 cost the government $1.4bn in annual revenues. And a move to ban imports of chemical fertilisers in 2021 caused a domestic food shortage.

Police used batton to disperse the university students during an anti-government demonstration by university students in Colombo On June 7, 2023.

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In order to cut expenses further the government has proposed privatising state-owned enterprises like Sri Lankan Airlines, Sri Lankan Insurance Corporation and Sri Lanka Telecom. This has triggered a fresh wave of protests – this time by trade unions.

“The government should not put the burden of the reforms on the salaried class and middle class who are already affected by the economic crisis,” said Anupa Nandula, the Vice President of the Ceylon Bank Employees Union.

Mr Nandula and his union participated in a recent demonstration against the proposal to privatise the Sri Lankan Insurance Corporation. He believes privatisation will lead to massive job losses and further burden the working class.

Ever since last year’s demonstrations were violently broken up, Sri Lankan authorities have been using force – such as tear gas, water cannon and even beating protesters. But experts warn that this is not a tactic that can work.

Rather than using force, the government needs to be transparent and explain that reshaping the economy will be tough, says Bhavani Fonseka, a constitutional lawyer working with Centre for Policy Alternatives.

“I think people since the crisis has happened have gotten used to a harder lifestyle. But in the absence of information coming, in the absence of answers being given, there is growing uncertainty and fear that we will go back to a crisis point.”

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John Kerry in Beijing: Can US and China set aside rivalry for climate action?

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U.S/ Special Presidential Envoy for Climate John Kerry arrives for an official dinner at the Presidential Elysee Palace, on the sidelines of the New Global Financial Pact Summit in Paris, France on June 22, 2023.Getty Images
By Tessa Wong
Asia Digital Reporter, BBC News

As John Kerry touches down in China, the main question will be whether the world’s biggest superpowers – and polluters – can dispel diplomatic tensions to focus on key climate goals.

Mr Kerry, the US special envoy on climate, is the latest top official to be dispatched from Washington following visits by Antony Blinken and Janet Yellen – as the US seeks to restart stalled relations with Beijing.

He will meet his Chinese counterpart Xie Zhenhua and other officials on his four-day trip. Mr Kerry’s office says he wants to engage with China on “increasing implementation and ambition”, and ensuring a successful COP28, the UN climate change conference scheduled for the end of the year.

While their meeting is not widely expected to yield any concrete decisions, it will be seen as a conversation starter. They are likely to discuss their common challenges of accelerating their switch to clean energy and reducing carbon emissions.

The two countries are the biggest investors in renewable energy, with China alone making up more than half of the world’s total renewable energy investment, according to one assessment.

But they are also the world’s two largest carbon emitters, making them the “G2 of energy consumption, energy use and pollution,” noted Dan Kammen, energy professor at the University of California, Berkeley.

“So both are making major steps, but neither are actually seeing emissions fall yet,” he told the BBC Newshour programme.

Contradictory moves

Both governments are evidently still struggling to balance the demands of economic growth and reducing emissions, leading to contradictory moves that have attracted criticism from environmentalists.

It wasn’t so long ago that China appeared keen on reducing its reliance on coal.

In 2020, President Xi Jinping announced key carbon neutrality goals after a steady ramp-up in previous years in clean energy infrastructure. Years of worsening smog in Beijing and other cities had triggered widespread public anxiety, prompting authorities to progressively shut down coal-fired power plants and curtail coal production.

But since then, blackouts have been plaguing the country, mainly attributed to either the coal power slowdown or severe droughts affecting hydropower output. The resurgent post-Covid economy, both domestically and globally, has seen a greater demand for power as China’s factories increase production. Extreme heatwaves – like the one seen this summer – and cold snaps have also led to higher electricity consumption.

China has now shifted to prioritising its energy security. That means moving back to coal power, because this is seen as more reliable when compared with the intermittency of wind and solar energy.

Coal is loaded onto trucks for delivery to power generation plants, after being unloaded from ships at the port in Lianyungang, in China's eastern Jiangsu province on July 12, 2023

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Last year, China approved a dramatic increase in its coal power output, the equivalent of approving two large coal power plants a week, according to one analysis.

Another found that while renewable energy now forms a greater share of China’s power output, coal-fired power was still rising in absolute terms because of the sheer demand.

Activists have criticised the return to coal as a lazy way of solving the problem, arguing that there are market policies and infrastructure solutions that can make clean energy supply more consistent.

As for the US, it has recently passed two pieces of legislation that would put billions of dollars into clean energy. But it has also just approved one of its largest oil and gas drilling projects in recent years in Alaska.

US carbon emissions also grew in 2022 as the country consumed more natural gas during extreme weather that year, according to the International Energy Agency.

“The US is no better… so each one has a long way to go, each one needs to egg the other on, and most importantly all the countries all around are watching to what degree the US and China absolutely are dead serious about the climate goals,” said Prof Kammen.

Laying out their wishlists

Analysts say Mr Kerry may try to persuade China to fully capitalise on its clean energy resources and achieve carbon neutrality more quickly.

China aims to peak its carbon emissions by 2030 and become carbon neutral by 2060 – goals which some say are too far off and give it too much leeway. Others have also taken issue with the fact that China is still considered a “developing country” by the UN, which means it is held to different standards than the US and other major powers.

Earlier this month Ms Yellen urged Beijing to donate to international climate funds set up by richer countries to help poorer economies struggling with climate change. China has rejected such requests in the past, citing its UN status.

China’s own wishlist may include the removal of a recently reinstated US tariff on Chinese-manufactured solar panels. It may also object to proposed US taxes on foreign steel and aluminium based on carbon emissions, which would hit Chinese exports hard.

China's special climate envoy, Xie Zhenhua, speaks during a joint China and US statement on a declaration enhancing climate action in the 2020s on November 10, 2021 in Glasgow, Scotland

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Both sides could also use climate issues as a bargaining chip in their wider trade and political negotiations.

China would be reluctant to be seen as giving in to the US given the current state of their relationship, warned Li Shuo, Greenpeace East Asia’s senior global policy advisor based in Beijing.

But there is an opportunity for Mr Kerry and Mr Xie to “capitalise on this relatively calm period… to separate their bilateral relationship from their climate conversation”, he told the BBC.

In other words, both countries need to urgently put aside their rivalry to address the climate crisis, say experts. There is a hope for a return to the amity seen at the 2021 COP meeting, where they announced a surprise joint agreement to accelerate emissions reductions.

“You could still make an argument to decouple your trade, as long as you are willing to bear the cost. But you can never make an argument to decouple climate engagement because… this issue will never be singlehandedly solved by the US or China. It is truly a global issue that requires all hands on deck,” said Mr Li.

Prof Kammen agreed. “Let’s recognise that if we don’t fix this, all our disputes about human rights and things are important – but they are truly rearranging deckchairs on the Titanic,” he said.

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China needs better and deeper bond markets

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As Chinese tech equities rally, tensions building up in the US$20 trillion bond market risk pulling the rug out from under the sudden rush of bullish stock market sentiment.

China’s Big Tech shares are surging after Premier Li Qiang signaled a sharper pivot away from regulatory crackdowns toward championing the private sector.

Just days after letting Jack Ma’s Ant Group off with a nearly US$1 billion fine, Beijing said it’s increasing support for Tencent and other top tech platforms to raise China’s innovative game.

On July 12, Li said President Xi Jinping’s government is stepping up efforts to normalize China’s regulatory environment. The goal, Li said, is to “reduce the costs of compliance and promote the healthy development of industry.”

Li said that “on the journey of building a modern socialist country, the platform economy has great potential.”

He told tech chieftains in the audience – including officials from Alibaba Group, TikTok owner ByteDance and food delivery group Meituan – to “push to increase their international competitiveness and dare to compete on the global stage.”

To analyst Kelvin Wong at OANDA, “the latest rhetoric from the top man of China’s State Council is likely to boost positive animal spirits, in the short term at least.”

But China faces a longer-term threat to positive sentiment now shining on Asia’s biggest economy: a bond market that’s still not ready for global prime time.

Credit market strains are spreading as two large property builders reneged on a combined US$608 million worth of bond payments. Meanwhile, top mainland banks are avoiding the purchase of local notes, including in the Shanghai free trade zone.

The inclusion of Chinese government bonds in top global bond indexes, including the FTSE Russell benchmark, has pulled giant tidal waves of capital China’s way.

This opening has been a game changer — offering myriad opportunities to build diversified and resilient portfolios via new asset classes to ride the nation’s development.

The trouble is, though, China’s bond market is underpinned by a developing economy with limited liquidity and hedging tools, a giant and opaque state sector, and a rudimentary credit-rating system that often obscures risk and enables the misallocation of capital.

For all of China’s promises, this makes it more of a buyer-beware market in 2023 than many investors expected. It was 10 years ago, after all, that Xi took power pledging to let market forces play the “decisive” role in financial reform decisions.

The split screens of the last two years tell the story. On one screen, China’s inclusion in major benchmarks is luring bond giants like BlackRock Inc.

On screen No 2, the crisis of confidence among creditors of China Evergrande Group offers a stark reminder of the mainland’s opacity and excesses.

The Evergrande Center building in Shanghai. Photo: Asia Times Files / AFP / Hector Retamal

The globe’s most indebted property developer owes them more than $120 billion, potentially posing system risks.

For the rest of 2023, analysts at HSBC Holdings and Goldman Sachs recently raised projections for defaults among junk-rated property bonds to about 30%.

“If property sales remain lackluster with a lack of stimulus from the authorities, we do not rule out the possibility of a further uplift in default rates,” says HSBC analyst Keith Chan.

Chairman Yu Liang at China Vanke Co, the nation’s second-largest developer by sales, says the real estate sector is looking “worse than expected.”

The property industry is “indeed seeing pressure in the short-term,” Yu says. The “real situation,” he concluded, “is a bit worse than what was expected.”

The magnitude of the risks has many economists perplexed about why the People’s Bank of China (PBOC) central bank isn’t acting more forcefully.

Recent “easing, which focused on developer financing, is far from enough to stabilize the sector,” says economist Larry Hu at Macquarie Group. “After all, credit risk for banks would remain elevated if the housing market stays weak.”

One reason: the yuan’s nearly 4% drop this year makes it harder for higher-indebted developers to make payments on US dollar-denominated debt.

The PBOC’s restraint also could mean government steps to stabilize the property sector are soon on the way.

“Looking ahead,” Hu notes, “expect to see more easing on the demand side, such as lowering the down payment ratio and easing purchase restrictions.”

The real challenge, though, is fixing the property sector, which can generate as much as one-third of gross domestic product (GDP) in good times.

Kate Jaquet, a portfolio manager at Seafarer Capital Partners, says that “beyond the importance of this sector to the overall health of the Chinese economy, another motivation for orderly restructurings of the many troubled property developers is the extensive and opaque web of their liabilities.

“Stakeholders in the restructuring process – roughly in order of payment preference – include contractors and suppliers, banks, homebuyers, wealth management product investors and, finally, bondholders.”

Jaquet adds that “there are also off-balance sheet liabilities and other hidden debts to consider. Investors, rightly concerned over the lack of disclosures, struggle to understand some of these off-balance sheet – and largely heretofore hidden – debts. These concerns are further compounded by property developers’ failure to file audited annual results with the relevant authorities.”

The bottom line, Jaquet says, is that “hasty or ham-fisted restructurings might require write-downs by holders of these lesser-understood obligations, which could have unforeseen consequences in other parts of the Chinese economy. It seems that China’s regulators know this and are taking a careful and measured approach to property sector restructurings, particularly the big ones.”

China’s property market is a drag on the economy. Image: Twitter

Considering the large role that property plays in China’s economy, “a great deal hangs in the balance with respect to restructuring in the property sector,” Jaquet says. “The details of how onshore and offshore creditors fare – in absolute terms, and relative to one another – matters a lot for the future health of China’s bond markets”

Jaquet says that “hopefully the restructurings will consider corporate governance and the rights of creditors. Lack of ready access to international capital markets will take a toll on this sector. While it is increasingly clear that the days of housing driving the Chinese economy are likely over, the big question is: where do the funds come from to keep the economy on an even keel?”

One ever-present time bomb: China’s $9 trillion-plus market in local-government financing vehicles (LGFVs) that opaquely finance everything from airports to power grids to roads and rarely raise enough to cover their obligations.

That requires bigger capital injections from municipalities that should be using the funds to build bigger social safety nets and invest in human capital.

China’s ongoing real estate crisis made matters worse. Cash flow pressures weighing on local governments have state-owned banking giants struggling to stave off a credit crunch. If China’s bond markets were more developed and robust, authorities would have more options to defuse blowups in credit markets.

The dearth of alternatives means that when, say, state pension entities sell off weaker bond holdings, it destabilizes the broader market. That, in turn, adds to the headwinds faced by LGFVs and property developers, causing new sentiment-killing feedback effects.

While offloading weaker bonds may help the state pension protect the value of its investments, it risks heightening market concerns about the health of LGFVs and developers at a time when Beijing is trying to restore confidence in the world’s second-largest economy.

Now, both LGFVs and developers are shortening the time intervals for extending credit and demanding higher borrowing costs.

“The most important variables impacting China’s economic growth over the next two years will be the success or failure of local government debt restructuring, and Beijing’s approach to the role of local government investment within China’s economy in the future,” analysts at Rhodium Group write in a new report. “A collapse in local government investment would be comparable to the economic impact of the crisis in the property market.”

All this has Beijing mulling fresh moves to support cash-strapped cities and counties around the nation. According to local press reports, this could entail green-lighting municipalities to boost bond issuance programs to finance the clearing away of hidden debt.

Reducing the prevalence of new LGFVs has never been more important. At the start of 2023, S&P Global Ratings estimated these schemes amounted to 40% of China’s non-financial corporate bond market.

The prevalence of LGFVs can be a major turnoff for foreign bond funds. Not only are they opaque and difficult to analyze, their fingerprints touch the operations of everything from commercial banks’ wealth management units to mutual funds to hedge funds to insurers to the gamut of securities companies.

Hence the urgent need for deeper bond markets. And, of course, for regulators in Beijing to avoid steps that spook global markets anew. Among recent missteps by Xi’s Community Party: this year’s clampdown on foreign consultancy firms on which global investors and multinational firms rely to navigate their way through China’s opaque companies and systems.

The move, supposedly part of a nationwide anti-espionage campaign, reduced the appetite for investment from overseas firms. When US Treasury Secretary Janet Yellen recently visited Beijing, the consultancy policy was among the examples of “non-market” practices and “coercive actions” against American firms her team highlighted.

Deeper debt markets would help sort out the cart-before-the-horse problem that afflicts China’s economy.

During the Xi era and before it, China too often believed that pulling in more foreign capital was a reform all its own. However, it’s been slower to strengthen China’s financial system to efficiently absorb those waves of overseas capital.

For example, China’s inclusion in the World Trade Organization in 2001 did less to recalibrate its growth engines than to remake the global economic system to its advantage.

The 2016 inclusion of the yuan in the International Monetary Fund’s “special drawing rights” didn’t stop Beijing from imposing capital controls or accelerate capital liberalization nearly as much as hoped.

China still applies capital controls. Photo: Asia Times Files / AFP / Nicolas Asfouri

In 2019, A-share stocks’ addition to the MSCI index didn’t suddenly make China’s financial system sounder, the government more transparent, companies more shareholder-friendly or the ginormous shadow-banking world any less of a menace.

Strengthening China Inc. requires significant heavy lifting to curb the dominance of state-owned enterprises, increase economic space for the private sector and eliminate the risk of dueling bubbles in debt, credit and assets.

The key now, says Li Yunze, head of the National Financial Regulatory Administration, is for vibrant debt capital markets to help catalyze growth of all sectors, but particularly those in the high-tech space — the realm Premier Li has been at least rhetorically elevating in recent months.

While it’s important Beijing ends the regulatory volatility of recent years, he adds, more efficient capital markets would accelerate China’s move upmarket.

One priority should be building a big and liquid mortgage-backed securities (MBS) market. The good news is that interest in securitized mortgage loans used to finance residential and commercial buildings is growing, particularly in the green space, says Fitch Ratings analyst Jingwei Jia.

This comes, Jia says, “as the Chinese government prioritizes construction of environmentally friendly buildings to meet its climate targets.”

As Jian Chen, an analyst at MSCI, notes, China’s residential MBS market is growing as global investors eye its relatively high yields and seek diversification options for fixed-income portfolios.

However, he adds, “attracting new foreign investment to Chinese RMBS may depend on improving credit ratings and transparency in data and pricing.”

Another positive sign could be the ways in which LGFVs may be pivoting to issuing more infrastructure real estate investment trusts (REITs). This, says analyst Sherry Zhao, also at Fitch, follows “the authorities’ latest reiteration of the significance of selling infrastructure assets to improve capital efficiency and reduce public-sector leverage.”

Zhao notes that “this is especially for infrastructure assets closely aligned with LGFVs’ public policy roles, such as transportation, public rental housing, urban utilities, and industrial parks, among others.”

When it comes to the direction of reform, the need for a deeper bond market must be goal No 1. The financial opening that Xi and Li claim to be pursuing suggests they are scaling back China’s command economy. This alone should reassure foreign investors.

But the opening China really needs is deeper capital markets, in particular more transparent debt markets. Boosting support for – and loans to – the property sector are fine for today. China coming into its own as a top and productive economy, though, requires a serious bonding experience.

Follow William Pesek on Twitter at @WilliamPesek

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Cross-border data flows improving in ASEAN as countries embrace open data transfer policies: Salesforce

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Indonesia moves up two spots to 13th since 2021
Singapore retains the third spot behind Japan and the UK

Salesforce released Data Beyond Borders 3.0, its third report analysing the state of G20 economies and Singapore’s openness to cross-border data flows. “Cross-border data transfers drive economic success. In ASEAN, economies like Singapore are reaping the…Continue Reading