China Establishes New Railway Corporation

Background

The Chinese government has approved the establishment of China RailwayCorporation to perform the commercial functions of the defunct Ministry of Railways as part of the cabinet restructuring plan.

The company has been set up with registered capital of 1.04 trillion yuan ($165 billion) which was provided by the Ministry of Finance and will be administered by the central government and supervised by the Ministry of Transport (MOT) and the future State Railways Administration (SRA), the other new institution to be formed as a result of the dismantling of the MOR.

The related assets, debts and personnel of the previous MOR will be transferred to thecorporation, while the interests and rights of 18 local railway administrative bureaus, three transport companies and the rest companies will also be added to the corporation.

Debt

There are still many unanswered questions about how the new company will deal with the large amount of liabilities that it is expected to inherit from the MOR.

Data provided by the railway authorities indicates that, by the end of the third quarter last year, the MOR held 4.3 trillion yuan in assets, while debts came to almost 2.7 trillion yuan – a leverage ratio of 62 percent. Sheng Guangzu said in an interview that “We should separate out the railway construction debt into that of a public welfare nature and those related to business operations. The CRC and the state will carefully study this and we ask people to not worry.”

Given the amount of debt that the new company is expected to inherit from the former MOR, the central government has said that they will not require the company to pass on a percentage of its profits to the state for the time being.

Price

As the new “China Railway Corporation” runs commercial operation, the price would be decided by the market demand and supply instead of administrative decision. This marketing reform would tremendously weaken the right of government by reducing the government rent-seeking behavior.

Some have predicted the debts built up by the now-defunct Railways Ministry will lead to a rise in prices. If so, this may increase railway fright cost and even elevate the overall price level. However, some has stated that the pricing scheme should be concerned with both the sector’s normal operation and development, as well as the daily traveling and vital interests of the general public.

 New era

The reform was in response to public criticism over the fact the Railways Ministry was both a policymaker and service provider. The establishment of the China Railway Corporation is a significant act in the deepening of the reform of railway management system, of separating government functions from business and promoting the sustainable development of railway construction and operation. Thus, the new “China Railway Corporation” will face the problem encountered by other state-owned enterprises, such as unclear property rights, unknown responsibilities and rights and invalid incentives. And like other state-owned enterprises, it will figure out how to establish modern corporation system, how to improve efficiency and effectively reduce internal managerial cost.

Stagflation in China?

According to China’s official statistical data, the CPI in February rises by 3.2% on an annual basis while the PPI drops by 1.6%. The former one is higher than the market expectation while the latter is lower. These two figures, together with the sluggish PMI data, raise concerns on the possible “stagflation” in the economy.

Definition of Stagflation

Stagflation is a term used in economics to describe a situation where an inflation rate is high, the economic growth rate slows down, and unemployment remains steadily high. This term was firstly used by British politician Iain Macleod in 1965. When the situation of stagflation occurs, economic policy comes to a dilemma: If the government chooses to tackle inflation, the economic recession will go worse, pushing unemployment rate higher. Correspondingly, if the government simulates the economy, people will have to tolerate higher inflation rate, leading to possible social instability and even unrest.

Figure 1

 

Causes of Stagflation

 In economics field, there are two principal explanations for stagflation. First, stagflation is resulted from some kind of negative supply shock. Such shock pushes the price up while slows down the economic growth by making the producing process more costly and less profitable. Second, inappropriate macroeconomic policy can also cause stagflation and deteriorate the situation. When economic downturn occurs, the policy makers will simulate the economy with expansionary fiscal and monetary measures, which raising the expectation on inflation. After such expectation turn into effect, the market worries that the government will change the policy direction to draw down inflation, discouraging investment and then driving away economic recovery. The global economic recession in 1970s is a typical case of stagflation. The sharp rise of oil price dried up manufacturers’ profit and lead to inflation. At the same time, the stimulus macroeconomic policy pushed the inflation higher without significant improvement on GDP growth and unemployment rate.

Case in China

Strictly speaking, the case in China is not a typical stagflation. Even though the economic growth rate in China experienced a significant slowdown in 2012, it still remains relatively high, at least above the government’s expected target. During the same period, the unemployment rate of China did not rise significantly. In addition, from the fourth quarter of 2012, the downward trend has reversed, supported by a series of indices like GDP growth rate, PMI, industrial added-value growth rate, etc. All things mentioned above suggest that China is not in economic recession. Hence, it is not reliable to conclude that China is facing stagflation, at least not a typical stagflation similar with the global case in 1970s.

However, the situation is still worth concerning. The latest leading economic indicators in February (Table 1), along with the negative PPI, imply that the economic recovery is not as strong as expected. Meanwhile, as shown at the very beginning of this passage, the CPI growth rate rises sharply from previous 2% to 3.5%. Even taking the effect of Chinese Lunar New Year into consideration, the figure is still relatively high. In addition, statistical figure shows that the housing prices in large and median cities grow up again compared to the stagnation of past few months. Even though the inflation rate is still “moderate” and the economic slowdown does not necessarily lead to recession, the trend is worrying. If such scenario continues, it will be probable for the whole economy to fall into the trap of stagflation. Once stagflation really happens, it will bring severe threat to the social stability because of the immature economic system and sharp social conflicts in China. What’s worse, the characteristics of stagflation leave limited room for macroeconomic policy, making the problem difficult to be resolved.

Figure 2

Table 1

	2013	2012
PMI (Feb)	50.4	51
Social Electricity Consumption (Jan-Feb)	5.5%	6.7%
Industrial Added Value Growth (Jan-Feb)	9.9%	11.4%

Hence, the government should take decisive action before the coming of stagflation. Policies to reverse inflation expectation, moderate economic stimulus measures (eg. tax reduction) and accelerating industrial upgrade are expected.

Reference

Xinhua 08, China Macroeconomic Data (Feb. 2013) (In Chinese): http://news.xinhua08.com/zt/jjsj/201303/

British House of Commons‘ Official Report (also known as Hansard), 17 November 1965, page 1,165.

N. Gregory Mankiw (2008). Principles of Macroeconomics, page 464

J. Bradford DeLong (3 October 1998). “Supply Shocks: The Dilemma of Stagflation”. University of California at Berkeley. Retrieved 2008-01-24.

A Share prediction in 2nd half of 2013

The blog is about making money!

If you invest in stocks in China, be cautious!!

If you haven’t invested in A share, the market will be ready for you soon!!!

From market capitalization point of view, let’s have an overview of Shanghai composite,

There are about 1000 firms listed in Shanghai stock exchange market, from Figure 1 we can see that few giant firms almost dominate the whole markets. The top 25 firms account for half of total market capitalization and all of these firms are SOEs. Among the 25 firms, banking and financial firms account for more than 60% (4796 billion).

The simple information that the market delivers to us:

•   SOEs are definite majority of A share,
•   Banking and financial firms paly important role in A share

Our prediction of A share in 2nd half of 2013 is that the market will slowly go down. (Talking about 2013 whole year trend, as I predicted last Nov. the market will first go up in first half year especially Q1 then steadily goes down in 2nd half year.) The prediction bases on below analysis:

•   GDP growth slowing down and how money outflows: The figure 3 shows the GDP growth trend in last 10 years. Starting from 2007, the growth rate decreases and even the target central government set for 2013 is in historical low at 7.5%. Although the government announced a series of policies including expanding consumption, urbanization and unti-corruption, the result of all these policies can’t be shown in short term and depends on execution. With the low net exports growth (rmb appreciation, trade barrier etc) and relatively tightening monetary policy (target for 2013 is 13% growth, lowest since 2005), the GDP growth for 2013 could be historically low.

•   Global economy unsettledness:

a)  Major economies like U.S. and Japan applied quantitative easing policy which will lowering their own currency, expanding their net exports and flooding other country with inflation.

b)  EMU debt crisis: the fundamental problem of EMU are different productivity and unit labor cost, the bailout could help in temporary but not long; austerity program and expending cut will further hit the GDP. The EMU debt crisis will drag on.

•   As we know for SOEs, the managers there are responsible to government rather than shareholders and most of their business are domestic business, and they are more affected by fiscal and monetary policy, urbanization policy, housing tax policy and other policies rather than the trade or exchange rate. The profits of SOEs will be hit by the smooth monetary policy and lowering investment rate policy.

•  For banking industry, they enjoyed too much from the expansionary monetary policy and the net interest income between compulsory lending rate and deposit rate. And below Figure 4 list the profits from net interest income of some large banks:

The trend cannot continue as banks try to get more deposits by offering implicit higher interests (financial products) and some banks even directly raise the deposit rate recently. Compare with international bank like HSBC (net interest income accounts about 50% of revenue), the business of most of domestic banks are not diversified and rely too much on interest income. With the slowing economy growth and strict controlling in property market, the margins of banks are squeezed and risk will be enlarged.

Refinanced Securities Pilot Program（转融券）

1. Introduction

1.1 Brief History

The margin trading and short selling businesses were introduced by the China Securities Regulatory Commission three years ago. On 27^th Aug 2012, China Securities Finance Corporation Limited (CSFC) issued the “Interim Rules on Refinancing Business” and “Interim Rules on Accounting and Supervising Margin Trading and Short Selling Business”, indicating the official launch of the refinancing pilot program. However, CSFC only kicked off the refinanced funding business at first, and put off the refinanced securities business. Finally on 28^th Feb 2013, the refinanced securities business was officially launched for a trial run.

1.2 Rules of Refinanced Securities

Eleven domestic leading Securities companies become the first ones to join the program. The refinanced securities business can currently be conducted against 90 stocks with a total market cap of 9.3 trillion yuan, accounting for almost half of the A-share market, which include 50 ones from the Shanghai market and 40 ones from the Shenzhen market. Refinanced securities will take the form of 3-day, 7-day, 14-day, 28-day and 182-day securities loans, and different terms are subject to differentiated interest rates.

2. Impacts on China A-share Market

2.1 Positive Effects

After heated discussion, our group thinks that the Refinanced Securities Pilot Program is a big step in promoting a sound capital trading mechanism. Firstly, refinanced securities can help drag the stock price of targeted securities back to its inner value. This is because the price bubble can hardly be eliminated without short selling; now thanks to refinanced securities, we don’t need to worry about the chips at hand so that the long-short power would balance out eventually. Secondly, it will boost the change of investment value. As we all know, the China A-share market is highly speculative, which is regarded as “Casino”. Certain companies’ stock price enjoyed wealth effects through unethical or illegal approaches such as performance control; however, overvalued stocks will be found by short sellers in the end. Thus shorting strategy will eventually influence “long forever” strategy, and promote the market to a more mature level. Thirdly, the program can facilitate securities companies to be more objective. As the sell side, securities companies have the incentive to sell all securities to get more commission fees, resulting in ignoring individuals’ risks sometimes. After the refinanced securities, those securities companies would be more prudent to and more responsible for their clients. So a major market player in the China A-share market will be more professional in certain degree.

2.2 Negative Effects

However, we can never ignore the other side of the refinanced securities. First of all, this may trigger off “black swan events” in the stock market. Since some securities, especially those in the same industry, are highly correlated, if certain event happens to a company, other related companies may also suffer heavily in their stock prices. Such events are not rare in China, say the plasticizer event of Jiugui Liquor (000799), the tripolycyanamide event of Yili Milk (600887), etc. With refinanced securities, “black swan events” may go even worse. Moreover, this program can also divide institutional investors and individual investors even further. As one of the rules of refinanced securities business, only institutional investors have the change to short sell. Then individuals may get marginalized in the future. Such separation is no good to a diversified market.

3. Conclusion

We think that the launch of refinanced securities is an indispensable part of Refinanced Securities Pilot Program as well as a supporting mechanism of the China A-share market, although it may have potential impacts on the market volatility. So far, the refinanced securities business has run safely and smoothly through the whole process, and we highly look forward to its role in promoting more financial creativity in the future.

Group Members

Hi, everyone!

Welcome to China Apex’s World!

There are six talented & diligent members in our group:

Lanjie WU, 20073273;
Xin SU, 20075348;
Woolio WU, 20023668;
Wenyue QIN, 20074588;
Jianming ZHU, 20072970;
Dan XU, 20079760.

Thank you!