ICTF 20180424 FINAL...State-Owned Enterprises Bigger, stronger, redder More big SOE mergers...

Ken DewoskinDeloitte Chinese Services GroupICTF's Global Credit Professionals SymposiumApril 24, 2018

China:Credit where credit is due . . .

Copyright © 2018 Deloitte Development LLC. All rights reserved. 2

2018, a year in which . . .

Chinese leaders have committed to driving ahead with the Belt and Road investments

Chinese leaders have committed to significantly deleveraging the domestic economy

Chinese leaders have committed to opening up markets, especially financial services to foreign investment

Chinese leaders have chartered a course toward more centralized control and more Party involvement in State-owned, domestic private, and foreign invested enterprises

There are signs the economy may be at a turning point

Globally winds of change are impacting attitudes toward trade and investment


Major themes

MainlandMarket Regions

MainlandAs a Whole

NeighborhoodSphere of Influence

Global Economy, ODI, MNCs,

1 The Party, the Plans, and the Prospects

2 As the World Turns: External Environment

3 2018 Q1 Trends: A turning point?

4 Credit and Credit Scoring, with Chinese Characteristics

5 Looking ahead


October Outcomes: The New Standing Committee of the CPC Politburo

The CPC’s seven most powerful leaders, typically including the successor to the current leader . . . .

But recent constitutional change eliminating term limits changes the succession prospects


Xi declared a “New Era”– what does it mean?

“Xi Jinping Thought” written into Party Constitution. 3.5 hour Work Report outlines “new era” in all areas of political, economic, and global policy

China is now so successful and wealthy, the Deng doctrine of “bide and hide” is unnecessary

Xi reiterates that Party will now pursue growth quality, not quantity

Party leadership hints that growth target might be amended after 2021

No apparent factional balance in newly-elected Politburo and Standing Committee. Members recognizable as Xi allies and advisors, some with strong growth track records

No apparent successor has been identified, which in the past has been typical of second term NPCs


Party Congress Work Report – Party Building

OVERSIGHT“We will intensify political inspection to identify problems and ensure that deterrence works”

Stepped up political inspections and oversight

PENETRATION“Strengthen grass-roots level Party organizations”

Party cells to become more alert and proactive

OBEDIENCE“The primary task of Party building is to ensure the whole Party obeys the Central Committee”

Increased Party meetings, ideological oversight, and influence over public discourse

The party leads everything, everywhere – Xi Jinping, Oct 18The party leads everything, everywhere – Xi Jinping, Oct 18

Source: People.cn


The Work Report Outline: . . . planning advances, markets retreat

State-Owned Enterprises

Bigger, stronger, redder More big SOE mergers Stepped-up efforts to

boost profitability Re-draw the boundaries

of the “commanding heights” to incorporate new industries

State-Owned Enterprises

Bigger, stronger, redder More big SOE mergers Stepped-up efforts to

boost profitability Re-draw the boundaries

of the “commanding heights” to incorporate new industries

Innovation

Huge state-led investments into quantum computing, AI, semiconductors, robotics, green

Planned innovation via pilot programs, demonstrations projects and innovation clusters.

Innovation

Huge state-led investments into quantum computing, AI, semiconductors, robotics, green

Planned innovation via pilot programs, demonstrations projects and innovation clusters.

Supply-Side Structural Reform

Written into CCP Charter Dominant future

economic “re-form” framework

“Attack” on industrial overcapacity

Upstream M&A: fix price volatility in commodities

Supply-Side Structural Reform

Written into CCP Charter Dominant future

economic “re-form” framework

“Attack” on industrial overcapacity

Upstream M&A: fix price volatility in commodities

Macro-Economic Policy

Across the board risk containment (i.e. monetary policy, housing, etc.)

Carefully guarded capital account

Tighter local gov’t fiscal constraints

Macro-Economic Policy

Across the board risk containment (i.e. monetary policy, housing, etc.)

Carefully guarded capital account

Tighter local gov’t fiscal constraints

13-5SSSRBRI

MIC2025Socialist Core ValuesTwo Studies, One BecomeThree Necessaries Four ComprehensivesFour Confidences Four Consciousnesses Four Greats Five-in-One Constructions

Plans&

CampaignsSource: Economist, MOFCOM, Xinhua Net


The China Dream Achieving Rejuvenation Is the Dream of the

Chinese People – November 29, 2012 Hard Work Makes Dreams Come True – April

28, 2013 Realize Youthful Dreams – May 4, 2013 The Chinese Dream Will Benefit Not Only the

People of China, But Also of Other Countries –May 2013

Right Time to Innovate and Make Dreams Come True – October 21, 2013

The Rejuvenation of the Chinese Nation Is a Dream Shared by All Chinese – June 6, 2014

The Dream: major theme continues . . .

“The Party exercises overall leadership over all areas of endeavor in every part of the country.”

– Xi Jinping, Oct 18, 2017

Source: China Daily, Xinhua Net, Xi Jinping: The Governance of China


Two hats for Xi Jinping– one voice?

President Xi’s VisionOpen borders, open markets Environmental leadership Win-Win global agreements Peaceful and constructive rise Opening themes reiterated at the 2018 Boao conference by Xi

General Secretary Xi’s Vision Never forget national humiliation Politics in command Top-Level industrial planning Caged markets Digital walled garden Secure borders via “loyal” military

Xi has given several major speeches, his 3 hour, 30,000 word work report at 19th NPC, a much briefer, more global viewpoint at APEC meetings in Hanoi, and most recently a keynote at China’s Boao Forum.


Major themes


MainlandAs a Whole







5 Looking ahead


The US-China Relationship and beyond

Tariff Tweets

IP issues and 301

China ODI down trends

Clipping the wings of the biggest outbound investors

CFIUS and FIRMMA


Probing the meaning of the Tariff confrontation

China’s imports of US fruit (US$ M and %)

Source: China customs, J Capital

Escalating tariff threats interspersed with responsive and sometime conciliatory rhetoric appear to be impacting investor sentiment and moving markets but so far not being implemented at scale or even laid out in useful detail

5 Key Questions

1.What is the probability of broad implementation?

2.What is the probability of escalation?

3.Who has the greatest leverage?

4.Where are the pain points?5.How does this relate to

broad trade and investment challenges?


The IP frictions and regulatory evolution

China’s Tech imperatives

CFIUS– recent decisions

FIRMMA– extending the reach

National regulators go global

Other channels

Perhaps more complex and critical than trade imbalances, issues of innovation, IP transfer, and IP theft are helping fuel a sharpening of regulator activity and reach

U.S. hits ZTE with ‘denial of export privileges’ for violating sanctions settlement 4/16/2018The U.S. Department of Commerce Monday imposed a denial of export privileges against ZTE and a related company for seven years for failing to comply with settlement terms in an earlier sanctions case. Source: www.fcpablog.com

China delays Qualcomm, Toshiba deal reviewsApr. 15, 2018 7:50 AM ET|By: Yoel Minkoff, SA News Editor

China is slowing reviews of multibillion-dollar takeover deals as U.S.-China trade tensions escalate, WSJ reports

Source: https://seekingalpha.com/news/3345669-china-delays-qualcomm-toshiba-deal-reviews


China’s outbound investment: Plays and Players

Chinese Commerce Minister Zhong Shan said on Sunday that China will continue to restrict irrational outbound investmentReuters, 3/1//2018

• Several of the largest Chinese outbound investors--real estate companies, insurance companies, and conglomerates-- have had their wings clipped, chairman changed, and assets sold off or transferred

• Focus is on critical investments, aligned with MIC2025, BRI, and China’s technology and resource acquisition priorities

• Steady growth in Chinese company presence in global financial markets, with equity listings and bond sales

Source: Ministry of Commerce, Bloomberg, Deloitte analysis

2018 new deals in the making down 90% yoy

Source: MOFCOM, China Daily


China’s broader geo-eco-political outbound thrust

• Bilateral trade agreements in the wake of WTO accession

• Alternate regional trade pacts: RCEP

• Bilateral investment deals• Alternate institutions:

AIIB, CIP, CNY/CNH, Commodity trading boards, Equity markets

• Belt and Road Initiative (BRI)

Domestic Market Access

Production Base

Financial Resources

China’s Geo-Economic Levers

Largest goods producer Largest infrastructure builder Largest commodity consumer Largest financier Largest FOREX holdings

Source: The Conference Board China Center for Economics and Business, Deloitte analysis

China’s Geo-Economic Projects


What is the Belt and Road Initiative?

Map source: Grisons Peak

A platform for China to try to soak up acute overcapacity and support growth for distressed State industry

Encompasses increased connectivity via rail, road, and energy infrastructure as well as increased seaborne engagement via new ports in the South China Sea and Indian Ocean

The publicly proclaimed notion is that OBOR is about driving newfound China-ASEAN-Central Asia-Middle East (and beyond) trade connectivity, cooperation, and integration –and associated growthSource: The Conference Board China Center for Economics and Business


Major themes


MainlandAs a Whole







5 Looking ahead


Rate of leverage growth decreasing but debt growth continues

Growth in 2016 and 2017 remained largely debt fueled.

In 2017 Q1-Q3, it took 0.3 units of credit to create one unit of GDP. In comparison, the average credit/growth ratio during 2011-15 was 0.28.

At the current status quo, credit intensity, the total debt-to-GDP ratio, will increase from 259% in 2016 to 317% in 2022.*

*Assumptions for calculation: (1) the credit intensity ratio in the coning 5 years remains unchanged from the 2016-17 period; and (2) the government debt-to-GDP and foreign-debt-to-GDP ratios remain unchanged

0.22

0.40

0.34

0.260.29 0.29

0.260.28

0.310.30

0.0

5.0

10.0

15.0

20.0

25.0

30.0

0.0

0.1

0.2

0.3

0.4

0.5 Local government debt replacement (LHS)TSF increase (LHS)Nominal GDP growth,ytd (RHS)M2 growth, ytd (RHS)

Source: NBS, PBoC CEIC, The Conference BoardNotes: local government debt when replaced by bonds is not included in TSF, so the replacement amount is added back to TSF for 2015, 2016 and 2017 Q3.

Credit Intensity Ratio Growth, percent


Originally primarily driven by mortgage borrowing, now durable goods buying, consumption credit, and unspecified investment credit

0

1000

2000

3000

4000

5000

6000

7000

0%

5%

10%

15%

20%

25%

12/20

08

12/20

09

12/20

10

12/20

11

12/20

12

12/20

13

12/20

14

12/20

15

12/20

16

9/20

17

New bank loan to households: short-term (RHS)

New bank loan to households: long-term (RHS)

New bank loan to housholds over householddisposable income ratio (LHS)

Sources: NBS, CEIC, The Conference Board

Loan to Income Ratio, % RMB, billion Lending to households increased

RMB 6.3 trillion in 2016, a 64% YOY increase. The newly-added loans were equivalent to 19% of household disposable income in the year (blue line) From 2017 Q1-Q3, the ratio of new

bank lending to households over disposable income increased to 21% The outstanding household debt

over annual household disposable income ratio reached 88% in 2016, up from 74% in 2015. If this ratio continues to rise at the same rate as in 2017 Q1-Q3, by the end of 2019, it will be higher than the pre-crisis peak in the US in 2007 at 130%.

Now many Chinese households are leveraging-up . . .


Little progress toward deleveraging, and rating downgrades

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

2016

U.S. Japan

China

China bank assets as a percent of world GDP

Source: IMF, FDIC, BOJ, Bloomberg, The Conference Board, Deloitte analysis

The PBoC’s Financial Stability Report 2017 noted that “the outstanding balance of off-balance sheet assets of banking institutions was an additional RMB 253.52 trillion” at the end of 2016, although asset types are unclear During and around the 19th

Party Congress, regulators have promised tough action on gray financial markets Downgrades from Moody’s

and S&P; China argued back

Less and less a closed system, we believe China had three external vulnerabilities: 1) cost of borrowing abroad; 2) support of Chinese listings in foreign markets; 3) exchange value of the RMB


As 2018Q1 reports in . . .

After a buoyant 2017 and good start to 2018, PPI, CPI, commodity prices, construction activity are all in retreat. That is unusual for this time of year.

• Steel demand down 2% through March and production up 2%, leading to accumulating inventories and declining prices

• Retail sales increasing, but at the slowest rate since 2004

• Consumer debt increasing 23% yoy

3 Snapshots

Capital Flight

Shanghai Composite Index

Controls on capital outflows have strengthened greatly over the last three years, but high net worth families and enterprises of all size continue to show interest in diversifying assets and currency holdings

Sources: China customs, MoC, PBoC, SAFE, Wind, J Capital, Deloitte analysis


Financialization of the Chinese economy

Heavy Process Manufacturing

Basic Goods Manufacturing

Export Sector Development

Financial and New Economy

1980 NowTech Transfer - JVs

Import Substitution –Locality Development

Export Capacity –Locality Development

Zone Value Chain Development

Asset based wealth creation

Capital Gains-based Wealth Creation

Value Added Manufacturing

Urbanization and Real Estate

1979-84 Modern Agricultural Bank and ICBC founded; BOC begins overseas expansion; PBOC becomes “new-era” central bank

1994 China Development Bank founded1999 Big Four bailout with new AMCs2009 Explosive growth of Total Social

Financing, Trusts, WMPs, Derivatives, Interbank market, Commodity markets

2016 China’s Other Financial Institutions (OFI) value reaches US$10T, +27% yoy

Sources: The Conference Board, Wittbrot “New Phonebook,” Deloitte analysis


China’s paired currency– a unique monetary tool

China's M3 in circulation has nearly doubled in the last five (5) years to US$25 Trillion, nearly tripling in the last eight (8) years

China M3 in circulation

• Under depreciation pressure, MoF shrinks accessible CNH supply

• Demand for CNH remains & even increases• Accessible CNH increases in exchange value

to US$ because of supply-demand imbalance

Only SDR currency that is non convertibleOnly major economy with two forms of the same currencyVery limited use in international settlementLimited number of exchange centers abroad, operating with State-owned banks

China is the only major economy with a non convertible currency

Sources: Federal Reserve of St. Louis, Bloomberg, GlobalRMB estimates, Deloitte analysis


Major themes


MainlandAs a Whole







5 Looking ahead


A generation of change

During less than 40 years of reform, China has evolved from a total cash society with a single state bank to arguably the world’s most digitalized and diverse system of financial services, channels, and exchange assets

“Masses” become “consumers”

Urban pops nearing 60%

Largest CNY bill remains 100元

Currency alternatives/financialization proliferate

Consumer debt expands rapidly


China continues to lead the way in highly integrated eco-systems built around payments

The BATs, several second tier Internet companies, property developers, logistics companies, and several other business classes are aggressively building highly networked business modelsThe intense market interest is already pointing to fragmentation, oversupply, and standard conflicts, but consolidation is underway

Maintenance/Repair

Finance

InsuranceSharing

Intermodal Integration

Operating Systems Mapping and navigation

Payments

Lifestyle

e-commerce/sales

Marketing

BAT LAND

The Future of MobilitySource: Deloitte Studies, China Daily, Xinhua Net


Eco-system enabled FICO +++

公民得分 Social Credit Scoring System

1. “You must receive packages at the same address where you pay utilities!”

2. “Your investments should be proportionate to your online spending.”3. “In the last half year, you should donate at least 1 RMB each month.”4. “The top 20 people you contact most by phone are the most

important for Alipay. Everyone please treasure this!”5. “It’s ideal to have 3-5 credit cards.”

Sesame Credit: Path to an ideal credit scoreEC

ON

OM

ICS

ECO

NO

MIC

S +

BEH

AV

IOR

• A more comprehensive scoring system planned for every citizen, linked to national ID card, mobile phone number, and facial recognition record

• Inputs include such things as buying behavior, economic patriotism, Party agenda alignment, school achievement, on-line game time, garbage sorting, illegal activities, jay walking, etc.

• Impacts include such things as school admission, access to high speed rail, air travel and good hotels, mortgage availability, access to passports and foreign travel, access to purchase luxury goods, etc.

Source: Deloitte Studies, The Conference Board Studies


Major themes


MainlandAs a Whole







5 Looking ahead


Big Data Instead of Market Forces“Big Data will make the market smarter and make it possible to plan and predict market forces so as to allow us to finally achieve a planned economy.” – Jack Ma, statement at an economic conference, reported by the Financial Times, Sept 4, 2017

Why central planning should work in the 21st Century

Socialism with Chinese CharacteristicsDeng argued that the transition to a perfected form of socialism would require the use of capitalist activities as an interim step – market forces, controlled competition, labor market flexibility, etc. – until such time that the socialist economic model was ready to be perfected…

Guiyang International Big Data Expo 2016 is held in Guiyang International Conference and Exhibition Center in Guiyang, capital of southwest China's Guizhou Province, May 25, 2016Investors in Guiyang include Apple and Qualcomm

. . . When it failed in the 20th!


Becoming a dominant global player in Industry 4.0

Technology guidance, subsidies, public and private R&D investment, and other resources are pouring into the basic building blocks

RoboticsDigital<> Hardware

interfaces

Big Data and Analytics

Artificial Intelligence

Industry-Internet Integration

2013 2015

23%11% VS.

R&D Production

Promotion and application

Comprehensive application

China smart manufacturing equipment market has entered a rapid growth era. Around 23 percent of surveyed companies apply automation extensively in 2015, versus 11 percent in 2013IT, IOT

connectivity

Sources: Deloitte survey and analysis


Campaigns suggest continuation of investment-fueled super-scaling

From 0 to 800+ robotics companies in several years87,000 robots installed in China in 2016

As always, construction leads the way . . .— Over 600 high-tech incubators started since 2014— 12 or more “Big Data zones”— Dozens of eco-city new zones in the works

http://www.reuters.com/video/2011/10/23/chinese-robots-display-ping-pong-prowess?videoId=223838974

Ping pong playing robots…

http://www.telegraph.co.uk/news/2017/08/04/legal-robots-deployed-china-help-decide-thousands-cases/

‘Legal robots' have been deployed on thousands of cases in China to help decide sentencing http://www.scmp.com/news/china/article/2112197/c

hinese-robot-dentist-first-fit-implants-patients-mouth-without-any-human

Dental robot performs procedures without human intervention

Source: Reuters, China Daily, South China Morning Post


The FIE environment, market access, and investment

We will expand foreign trade, develop new models and new forms of trade, and tum China into a trader of quality

We will adopt policies to promote high-standard liberalization and facilitation of trade and investment

We will implement the system of pre-establishment national treatment plus a negative list across the board

Significantly ease market access

Further open the services sector

Protect the legitimate rights and interests of foreign investors

All businesses registered in China will be treated equally

Prospects?

Debated and TBD

Source: Deloitte Studies, China Daily, Xinhua Net


This presentation contains general information only and Deloitte is not, by means of this presentation, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor.

Deloitte shall not be responsible for any loss sustained by any person who relies on this presentation.

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ICTF 20180424 FINAL...State-Owned Enterprises Bigger, stronger, redder More big SOE mergers...

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