China Research

A discussion forum on emerging markets, mainly China – from a macro, micro, institutional and corporate angle.

Global Financial Reform and Cross-Border Integration: Is Asian Leadership Needed?

November 7, 2012

Before 2007–08, most global financial reform initiatives were based on a near-consensus about the benefits from the free circulation of capital across jurisdictions and from free cross-border competition among financial services firms. As a consequence of the financial crisis in the United States and Europe, however, this near-consensus can no longer be taken for granted. One implication is the increasing possibility of a fragmentation of the global financial system.

Such a trend could take many forms. Rating agencies were unregulated in most of the world outside the US before the crisis (South Korea being one exception). But the G-20 recommended that they be regulated and supervised by all major jurisdictions. Implementing that recommendation raises the risk of incompatible or inconsistent regulatory frameworks and supervisory practices among different countries. Rating methodologies could vary even within the same rating agency. Another example of fragmentation could arise for over-the-counter (OTC) derivatives. Trading has until now been cleared bilaterally among market participants. The G-20 has mandated central clearing in regulated clearing houses starting in 2013, however. Many investors fear a division of corresponding markets along the borders of country or currency areas. A third new development would flow from the new standards at international financial institutions, particularly the International Monetary Fund (IMF), governing the adequacy of capital control measures under certain conditions. But these new standards could potentially run counter to the previously received wisdom of the so-called Washington consensus.

Across the globe, supervisors have nudged banks to separate and protect assets and maximize lending in their respective jurisdictions, in some cases pushing for subsidiarization of activities previously conducted through branches. In countries that have run into fiscal difficulties, domestically headquartered banks have been pressed to increase their purchases of national sovereign debt. “Financial repression,” an expression long reserved to economic historians, has reentered the mainstream financial vocabulary to describe the possibility of such pressure. These developments have been striking in the euro area, where countries are in principle committed to total openness to capital flows but where an abrupt U-turn from financial integration to financial fragmentation has been identified by policy authorities, including the European Central Bank (ECB). They are by no means unique to Europe, though, and variations of the same themes have been observed in most if not all main economic regions.

Simultaneously, the pre-crisis momentum for harmonization of global financial standards has run into setbacks in crisis-affected countries. The United States has delayed any decision about the adoption of International Financial Reporting Standards (IFRS), which it had endorsed for US-listed foreign firms in 2007 and had seemed on the verge of extending to US-listed issuers in 2008. In another example, the European Union, after championing the global use of the Basel II Accord on capital standards during the 2000s, now seems set to adopt legislation that the Basel Committee has deemed materially non-compliant with the new Basel III Accord adopted in 2010. For all the G-20 talk about global solutions to global problems, financial reform often seems more driven by politics in the post-crisis context than in the previous period. And as the saying goes, all politics are local.

This new reality poses an unprecedented challenge for Asian policymakers. Asia has gained from dynamic financial development in the past two decades, and is entering a new phase in which cross-border financial openness could improve the allocation of capital and make financing mechanisms more efficient. Asians generally are likely to benefit from the continuation or even the acceleration of global financial integration. Until recently, Asians could take such integration for granted, counting on the commitments to financial openness of both the United States and Europe, which dominate the global financial order as embodied by such institutions as the IMF, the International Accounting Standards Board, or the Basel cluster around the Bank for International Settlements.

But the assumption that the West will continue to champion further cross-border openness of the global financial system can no longer be taken for granted. As a consequence, Asians may have to take more leadership in global financial reform discussions to make sure that global financial integration is not reversed. This would be a new situation. Some Asian policymakers may feel ill-prepared for such a trend, but they could find its implications difficult to escape.

Nicolas Véron
Senior fellow at Bruegel, Visiting fellow at the Peterson Institute for International Economics, Washington DC


Nicolas Veron gave us his kind permission to include this contribution in our blog chinaresearch.se  The article was initially published last week by Bruegel and Peterson Institute for International Economics.
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China’s Impact on the Global Commodity Markets

Today, China dominates the global commodity markets by its strong demand for oil, metals and agricultural commodities. China is not only consuming an increasing portion of ores, fuels and food, but is also an important supplier of a lot of commodities, e.g. rare metals, coal and some special metals.

We can illustrate China’s role by a closer look at the world steel market. The worldwide steel production has recovered more rapidly than initially expected. In 2011, production amounted to about 1.53 billion tons of crude steel worldwide. For 2012, we forecast a crude steel production of around 1.55 billion tons. We expect a further increase of up to 1.75 billion tons for 2015. This development enhances the demand for iron ore, blast furnace, coke and steel scrap. Important impetus continues to come from China and other Asian regions. China’s output will be up to 720 million tons in the current year and close to 800 million tons in 2015. This equals the global production level of the mid nineties!  In addition, we see rising production volumes in India, Vietnam and Indonesia.

On the other hand Western European steel production is still below pre-crisis level and will only stagnate in 2013  while some Eastern European countries will show a stronger growth during the next years. Within Europe Turkey could reach a new all-time high with a production volume of up to 38 million tons in the current year. For 2015, we expect a volume of more than 40 million tons.

To fulfill the needs of the output highs of the global steel industry new capacities for iron ore are necessary. About 70 per cent of the worldwide iron ore reserves are hold by three companies (Vale, BHP and Rio Tinto). Together with capacities of Anglo-American and the captive capacities of ArcelorMittal they control the worldwide supply of iron ore. Compared to our steel production forecast another 450 million tons of iron ore per year will be needed in 2015.

Today China influences the spot market price for iron via its tremendous demand. The leading iron ore producers invest mainly to fulfill Chinas needs, e.g. Vale ordered new vessels with higher capacities ever seen primarily for the transport of iron from Brazil to China. Beside steel China holds a nearly similar position  in the markets for aluminum, copper, nickel and zinc as well as the casting of these metals. In the long-run China will become the main consumer of oil instead of the United States.

The country is the leading producer of rare metals with a production share of 97 % in 2010, needed in high-tech applications worldwide. Restrictions for exports of these rare metals via tariffs or volume constraints are not unusual in China. And even in the medium-term countries outside of China are unable to substitute these raw materials or find other suppliers. This will result in a rising production of high-tech application within China. Therefore, Western companies discuss more and more joint ventures in China to secure their raw material supply.

During October 2012  China announced a further restriction for the export of copper scrap. Holding the scrap in the country improves Chinas resource base, because it is the leading copper user worldwide.  Outside of China the reduced scrap supply  induces higher prices for scrap and via higher input costs in a second step  higher prices for secondary and primary copper. In addition, there are high inventories of copper in the Chinese  warehouse of the SHFE and higher strategic reserves of copper.

These are only a few examples for the rising importance of China in the commodity markets. But does this behavior result in an optimal allocation of resources? In our opinion it does not. With a completely free trade of commodities the market would chose the best location for the production of goods via the price mechanism. Restrictions for free trade induce higher prices than necessary.

 

 

 

 

 

 

 

Heinz-Jürgen Büchner
Vice President Economics and Research, IKB Deutsche Industriebank

 

 

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Winds of Change in China?

On November 8, the National Congress of the Communist Party with more than 2000 delegates will start its convention in Beijing and some days later select its next political leadership for – probably – the next decade – a decade that will be much more difficult to surmount than the previous one.

The powerful politburo will almost completely be replaced by new faces, and probably seven/five out of nine/seven individuals of the even much more powerful inner circle Politburo Standing Committee will have the same change, i.e. that only the – most probably – forthcoming Party  Leader  Xi Jinping and future Prime Minister Li Keqiang will keep their seats in this forum of all important decisions (currently considered as number six and seven).

A lot is currently discussed about the future political, social and economic course of Xi Jinping. But this discussion is too simple-minded since the Party Leader is not making decisions on his own. He has to find consensus himself within the Standing Committee which mostly urges for a “middle-of- the-road position”. This line can only be left in extraordinary cases,  like the opening-up policy by Deng Xiaoping almost 35 years ago. Currently, such moves cannot be seen. I still cannot see Xi as a major reformer, neither in political nor in economic terms. But nobody knows what will happen in the next, very challenging 10 years. Not many scenarios can be ruled out completely.

Political challenges

Discussions about future policy and strategic issues were not taken up in the past months  by  the leading candidates for China’s new leadership. However, it seems to be completely clear that domestic issues will have to /should dominate politics in the future. This may concern amoung other areas

–  institutions  (including the fight against corruption and more application of the rule of law)

–  transparency (also an institutional factor)

–  better environment in all respects (quality of food and water included)

–  acceptable minimum social security standards for the whole nation

–  acceptable health care for the whole nation

–  better income distribution.

All post-war leaders had so far their political legitimacy, lately particularly high economic growth and internationalization. In my feeling, the new Chinese leaders will have to look mainly for acceptable growth – which may be closer to 8-9 percent than maximum growth around 10 percent as seen in the past two decades. But such a development will assume that the above-mentioned political challenges will be taken seriously by the new leaders.

Economic challenges

Many of the future economic challenges have a nexus with politics or globalization. Some of them are mentioned below (but have been described more thoroughly by me in earlier pieces).

They are, for example (without ranking):

–  generally: more marketization and transparency (vs political control)

–  modernization of financial markets (institutions such as the stock exchanges and bond markets, instruments, products for savers, supervision, etc)

–  cleaning up the state-owned banks (and make them more transparent)

–  financial deregulation (domestically, cross-border, sequencing)

–  transparency and the creation of sustainable real total government debt (central and local)

–  modernization of monetary policy

–  modernization of exchange rate policy

–  new growth model (higher share of private consumption in relation to GDP)

–  creation of conditions for improvements of corporate productivity and industrial value chain

–  creation of improved conditions for product quality and services

–  decrease of the state-owned corporate sector

–  decline of regional disparities

–  creation of strategies for gradually worsening demographic conditions.

 

This leads us finally to three crucial questions (which cannot be elaborated in this little blog contribution):

–  Can the new Chinese leaders achieve an appropriate way of combining state intervention and marketization?

–  How sustainable are Chinese current account surpluses in the long run?

–  What happens the day when China’s yuan finally achieves the status of a convertible currency (probably not within the next decade – but serious preparations may start during Xi’s leadership)? How will the U.S. and the U.S.dollar react on such a change?

We stay here for today – predicting no  major changes of wind in the foreseeable future. Gradual and smaller steps forward, however, should continue in the next years. Political, social and institutional strategy considerations should gain political momentum in the next decade – maybe somewhat at the expense of economic growth.

 

Hubert Fromlet
Professor of International Economics
Editorial board

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