The Next Chinese Boom
Russian President Vladimir Putin cut a 30-year deal with China last week to deliver 38 billion cubic metres of natural gas a year.
The estimated value of the contract is US$400 billion. Since gas is a buyer’s market these days and Russia is struggling on the economic front, it can safely be assumed that the Chinese who have been haggling over the price for nearly a decade have achieved a significant discount on the current price level.
The deal has prompted speculation that Putin has outflanked the US attempt to isolate Russia because of its annexation of Crimea and subsequent undermining of the Ukrainian political system with armed militia.
In fact, a case can be made that sanctions imposed by the west and led by the United States have exposed the economic fragility and political vulnerability of Putin’s Russia.
Putin’s Russia is in a state of decline, while China has chalked up three decades of strong growth.
Russia’s status as a superpower has been long gone. In economic terms, it is around the same size as France. On the other hand, it is only 20 per cent of the size of China.
Last Friday, that’s after the gas deal was announced, Putin delivered the key note speech at an economic forum in St Petersburg where he said Russia had to “drastically change” the structure of its economy to reduce its over-dependency on resources exports.
He then outlined a program “to give the market back to the Russian producers”. He proposes an import substitution plan that sounds like something dreamed up in Argentina.
In that same speech, Mr Putin acknowledged that western sanctions were having some impact on the economy. He said: “The overall economy feels the impact as access to resources for our companies has been restricted, but there is no systemic impact on the economy.”
Internationalisation of RMB
Rather surprisingly in view of China’s determination to internationalise the renminbi (RMB), the gas deal currency is denominated in US dollars.
Australia has been quite supportive of this RMB internationalisation policy.
Last week, our Treasury secretary Martin Parkinson told a Hong King conference: “Growing trade and investment ties between Australia and China make Sydney a natural destination for the next RMB offshore hub.”
Last month, Rio Tinto and Baosteel settled a sale of over 170,000 tonnes of iron ore in RMB, valued at over RMB144 million.
In early April, Bank of China’s Sydney branch issued CNH 2 billion worth of two-year bonds, the largest RMB bond issue in Australia to date. (CNH stands for offshore yuan and usually trades at a slight premium to the yuan traded in mainland China).
Internationalising the RNB is a significant development in itself. But there are a number of ultimate goals that are far more important.
For example, the Chinese authorities have announced that they expect to liberalise interest rates within two years.
But the most important is the removal of capital controls, the liberalisation of the capital account.
Impact of China’s liberalisation
As an article in the Bank of England’s Quarterly Bulletin by John Hooley of the bank’s International Finance division put it: “If China does liberalise, few other events over the next decade are likely to have more impact on the shape of the global financial system.”
The Chinese banking system is the largest in the world in terms of total assets. Its system is subject to more controls than any other country with the exception of India.
The advanced economies are several times more open than China. This suggests that full liberalisation of capital controls in China could potentially lead to very large changes in flows.
John Hooley offers what he calls an “illustrative thought experiment” which suggests that capital account liberalisation in China and internationalisation of the renminbi would have a large impact on the global financial system.
China’s gross international investment position could increase from around 5% to 30% of world GDP by 2025.
Asia revolves around the China axis.
Warren Hogan, chief economist at the ANZ Bank, which has a strategy of expanding into Asia, cites rebalancing the global economy, avoiding the middle income trap in Asian economies and Asia’s financial transformation will be among the most powerful forces in the global economy over the decades ahead.
He argues: “This will mean an explosion of Asian private portfolio capital flows (both into bonds and equities) and a much greater role for Asian direct investment in other countries.”
He points out that the outstanding stock of Chinese Foreign Direct Investment (FDI) into other countries was around US$500 billion in 2012.
“This,” he says, “could rise towards US$10 trillion in 2030.
“Chinese private portfolio flows into global bond and equity markets could increase by US$1.3 trillion a year for the five years following the opening up of the Chinese financial system.
“But just as significantly, these flows will not go into existing asset classes such as US Treasuries to the same degree, with important implications for Europe and the US.”
Chines boom not guaranteed
If Hogan and Hooley are correct, financial liberalisation will underwrite the next Chinese boom.
Such an outcome is far from guaranteed.
As of today China is flirting with a financial crisis due to the explosive growth of its shadow banking system alongside a robustly regulated banking system.
Both lent aggressively to the residential construction sector.
In addition, the local government sector has borrowed heavily for infrastructure expansion, which appears to have run well ahead of demand.
As we saw with the global financial crisis, these situations can take some time to unwind.
Much as the Chinese authorities would like to fast track the liberalisation process, they are aware that prudence must take priority when attempting structural change on institutions which are built on public confidence.
For these reasons the next Chinese boom can not be said to be imminent.
But the pre-conditions are reassuring.
Patient positioning is called for.