Caixin Insight: ‘Dual Circulation’ Under the Spotlight Ahead of 14th Five-Year Plan

Top banking regulator warns of surge in bad loans

Guo Shuqing, chairman of the China Banking and Insurance Regulatory Commission (CBIRC), published a colorful article in party journal Qiushi on Sunday, reiterating the importance of disposing of non-performing loans. Guo warned that “after the Black Swan of the pandemic, the banking industry’s asset quality will inevitably deteriorate” and that current loan classifications haven’t reflected the true quality of assets, meaning banks’ on-paper profits have been inflated.

Nonperforming loans (NPLs) held by China’s commercial banks recently hit their highest point in over a decade, reaching 2.7 trillion yuan ($389 billion) at end of June. The NPL ratio also jumped to 1.94%, up from 1.81% the previous year. Considering that banks often avoid revealing the scale of their bad debts, the real picture may be even worse.

The banking watchdog has responded by proposing new regulations for how commercial banks classify their nonperforming assets, hoping that having a more accurate sense of banks’ NPLs will help regulators grasp the reality of the financial landscape and roll out targeted measures to deal with them, CBIRC Chief Risk Officer Xiao Yuanqi said at a meeting last month.

Supreme court weighs in on securities fraud

China’s highest court issued guidance on Tuesday discussing how courts should handle criminal activity related to the new registration-based IPO regime, less than a week before the first batch of companies list under the system.

Aiming to ensure consistent rulings across the judiciary, the SPC said it was committed to fully implementing the government’s “zero tolerance” for criminal conduct in the country’s capital markets and that courts had been instructed to ensure severe punishment for securities-related crimes.

The new registration system, which is similar to the procedure used in developed economies, gives markets a far greater role in deciding the pricing and timing of IPOs but also puts greater responsibility on companies and their advisers to ensure accurate and compliant information disclosure.

The SPC is eager to make sure the benefits of the new registration system don’t open the door to securities fraud, particularly amid the rash of high-profile scandals in recent months –– Nasdaq-listed Starbucks wannabe Luckin Coffee Inc., Kangmei Pharmaceutical Co. Ltd. and Kangde Xin Composite Material Group to name but three.

Financing new infrastructure

The National Development and Reform Commission announced on Tuesday that six state banks would provide credit for urbanization projects at the county level, in keeping with the top-level focus on ensuring financial support makes it to those who actually need it most, rather than being held up along the way by other levels of government.

The “notice on credit support for county urbanization to strengthen weak areas” specifically highlights new infrastructure (e.g. 5G, internet of things projects, smart manufacturing facilities, data centers, smart logistics, etc.) in addition to more standard shanty town redevelopment, sanitation, public transit and the like.

The same variety of projects were also highlighted in an NDRC document published Monday, elaborating on the REIT pilot we wrote about last week (...once again proving that we were right about REITs’ intended application.) That policy interpretation also heavily emphasized REITs’ role in contributing to “dual circulation” (see below) for their ability to put existing assets to good use and shore up weak areas.

The two NDRC notices are each interesting enough in their own right, but also for their relationship to each other and to the broader “dual circulation” concept — expect to see more discussion of all these initiatives moving forward.

Weathervane

“Dual circulation” (as we’ve discussed before) has become increasingly prominent in recent weeks as the top focus of macroeconomic policy. Prominent economist Yu Yongding spoke at a Sunday event on the topic organized by the China Wealth Management 50 Forum, and the state-run Economic Daily newspaper on Wednesday published a front-page article (link in Chinese) on it under the Zhong Jingwen 钟经文 pseudonym, indicating an authoritative interpretation of the theory. That article concluded with a specific reference to its importance as the 14th 5-year plan approaches.

Both Yu’s talk and the Economic Daily article are fairly long and heavy on jargon, so we don’t have room to fully unpack them here, but the buzz is a clear signal of the concept’s importance, which ICBC International economists Wang Yuzhe and Cheng Shi recently explained (link in Chinese) somewhat more clearly.

They argue it’s based on three key trends:

- relying on the scale of China’s domestic economy and available policy space and putting existing economic resources to better use

- domestic consumption and industrial upgrading forming a more closed loop, helping create a new growth engine against the background of shifting global trade patterns and value chains

- reform and opening up, particularly in terms of factor markets enhancing resource allocation efficiency and financial sector opening helping actively link internal and external “cycles”

They provide a handful of examples to illustrate those points:

- “consumption backflow” supported by strong domestic demand amid contraction of service trade

- China is the world’s largest tourism exporter — if the tourism service deficit can be converted into domestic demand, they estimate it could contribute some 1.15 trillion yuan to GDP and create 4.9 million jobs

- new duty-free policies and strong online services improving supply-demand discovery and matching domestically; they highlight Hainan’s duty-free boom

- policy focus on industrial upgrading, as discussed by Xi Jinping at last week’s meeting with entrepreneurs and highlighted at the two sessions

- specifically, the new infrastructure initiative, the April guiding opinions (link in Chinese) on “setting up a better market-oriented production factor allocation mechanism” and the May guiding opinions (link in Chinese) on “accelerating the improvement of the socialist market economy system in the new era”

- Cheng and Wang consider the two guiding opinions “programmatic documents” that lay an institutional foundation for supply-side reform, minimizing government intervention in markets and breaking through bottlenecks to domestic “circulation”

- financial opening and reform enhancing links between the sector and real economy, as well as between China and the global economy

- loan prime rate helping marketize interest rates

- increasing lending to SMEs

- opening the sector to foreign institutions producing a ‘catfish effect’ and improving competition

- loosening capital allocation restraints helping direct more resources to high efficiency sectors

- unification of the bond market helping to improve monetary policy transmission and attract more investors [u1]

Economic recovery slowing down

July economic data released on Friday showed the economy continuing to recover, but key indicators also pointed towards weakening momentum, particularly on the demand side.

On the supply side, value-added industrial output grew 4.89% y-o-y, the same as in June, slightly lower than the median forecast of 5.1% growth in a Caixin survey (link in Chinese) of economists.

Demand side performance was more mixed. Fixed asset investment fell 1.6% in the first seven months, an improvement from the 3.1% drop over the first six months, driven primarily by real estate investment, which has grown for the past two months and rose 3.4% y-o-y in the first seven months. Infrastructure investment also performed slightly better than overall investment, falling 1% y-o-y, due largely to accelerated issuance of special-purpose local government bonds and special treasury bond money flowing into infrastructure.

Private investment, however, fell 5.7% y-o-y from January to July, suggesting endogenous momentum remains limited.

Consumption also continued to fall behind, with retail sales dropping 1.1% y-o-y in July, improving somewhat from June’s 1.8% decline but still worse than the median forecast of 0.5% growth.

Employment likewise remained weak, with the surveyed urban unemployment rate remaining unchanged at 5.7%. In the first seven months, the country only added 6.71 million urban jobs, down 1.96 million, or 22.6%, year-on-year.