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A Political Year in China

Dr. Hans Belcsák

Some straws in the wind indicate that the relatively strong economic growth shown in official figures for China in the first two months of this year may not be quite what it is made out to be, but politics will prevent the authorities from allowing any real weaknesses to show up in what will be reported in the coming months.

Chinese statistics often make one scratch one’s head even when all is going well and there is no obvious incentive to cook the books. This year is a politically critical one—leading up to a Communist Party congress in the fall that will name the country’s leaders for the next five years—and President Xi Jinping will undoubtedly want to make sure that there is nothing overshadowing the record of his stewardship.

He faces no real challenger because he has used anti-graft and other disciplinary campaigns to eliminate rivals and promote loyalists. Just last month, he shook up his economic team, replacing the retiring top banking regulator, the commerce minister and the highest-raking economic planning official with close associates. Even the country’s No. 2 leader, Premier Li Keqiang, concluded a press conference this month with the words “See you again, if there’s a chance,” suggesting that a second five-year term for him is not a sure thing. Still, Pres. Xi will want to make certain that any unwelcome developments are avoided in the economic as well as political arena, and that those that do occur are not widely reported.

Efforts to keep the yuan’s exchange rate on a reasonably steady course are important in this context, also to dissuade Washington from taking disagreeable steps, but they are not being made any easier by the U.S. Federal Reserve’s plans to continue ratcheting up interest rates. There are some signs that capital controls clamped on by the authorities—to wit, curbs on Chinese companies seeking to invest overseas, restrictions on converting yuan into other currencies and a crackdown on underground banks often used to evade controls to move money offshore—are having some effect. Also, the People’s Bank of China (PBOC) has begun to use forward contracts and futures to influence the exchange rate without having to shell out money from the official hard-currency reserves.

In addition, the renminbi, while showing more volatility than in the past, is not likely to stay on the persistent downtrend that has taken it 4.7% lower against the dollar in 2015 and another 6.9% in 2016. But Beijing’s dream of turning the yuan into a global currency rivaling the dollar has been set back a great deal. Last year, the value of international payments in renminbi plunged by 29.5% compared to 2015. In the near term, this trend will not be turned around, even though the PBOC has succeeded in keeping official FX reserves above USD 3 trillion (the largest in the world).

The economy is said to have grown by a real 6.7% in 2016, as planned, and at a yearly clip of 6.8% in the final quarter. It purportedly made a solid start to 2017 in January and February, which statistically are usually taken together to iron out distortions caused by the Lunar New Year holiday. But Premier Li, in setting out the target for the current year, allowed a note of caution to slip in when he talked of “about 6.5%” rather than the firm 5.5%-7.0% range that had been predicted for 2017. And there are, indeed, signs that this caution is not unjustified. The Northeastern industrial province of Liaoning, for instance, reported a 23% drop in nominal economic output for 2016, which hints at the extent to which activity in the Chinese rustbelt had previously been exaggerated. The much-trumpeted progress the country has made in paring back the bloated steel industry looks grossly overstated. In fact, excess capacity continues to weigh on much of the industrial complex, from mining and metals to glass and cement.

Wages in manufacturing have been pushing upwards and have, on average, already jumped above those in countries such as Brazil and Mexico. They are, in fact, higher than in every Latin American nation save for Chile and are within shouting distance of those in weaker European countries such as Greece and Portugal. Even so, retail sales are not doing nearly as well as the authorities had hoped and the momentum the economy has been gaining from massive infrastructure spending and a super-easy monetary policy will fade as the year progresses. While a flood of credit and fiscal stimulus helped in 2016 to keep factories humming and construction sites crowded, there is now growing concern in official circles about asset bubbles and rising debt. Whereas rising prices have been bolstering corporate profits and have eased debt burdens, annual consumer price inflation in February was measured at a mere 0.8%. Infrastructure spending is delivering progressively less growth, given inefficiencies in government and a much-shrunken pool of good projects.

With the approach of the Party congress later this year, there will be a premium on avoiding risk in official circles and the government will continue to be very cautious as it seeks to trim the ballooned industrial sector to mop up red ink. I would be very surprised if it did not continue to bail out large state firms in trouble, since Beijing does not want to provoke a crisis. But it will keep up efforts to weed out a limited number of smaller, heavily indebted “zombie” companies. Last year, Chinese courts accepted 5,665 bankruptcy cases. Reports have it that 3,600 of these have been resolved and that 85% of the resolved ones resulted in liquidation. Between 2008 and 2015, not quite 20,000 cases were accepted by the courts and it is a fair assumption that for every one of them another couple of hundred enterprises went out of business (according to the IMF [International Monetary Fund] mostly via deregistration and the cancellation of business licenses). The time frame under review is significant because it was in 2007 that the legislature in Beijing approved a modern bankruptcy law. But even today, debt disputes are still often handled through backroom negotiations because local officials tend to be much more worried about the prospect of creating unemployment than about attracting the wrath of creditors.


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Record-Setting Penalties for Sanction Violations

The U.S. has announced record-setting penalties for violations of export controls and economic sanctions after China-based Zhongxing Telecommunications Equipment Corporation and ZTE Kangxun Telecommunications Ltd. and their respective affiliates (collectively, ZTE) pled guilty and agreed to a combined civil and criminal penalty of $1.9 billion for violating U.S. sanctions by sending U.S.-origin items to Iran.

ZTE simultaneously reached settlement agreements with the U.S. Department of Commerce’s Bureau of Industry and Security (BIS) and the U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC), according to a U.S. Department of Justice news release. The BIS, however, has suspended $300 million, which ZTE will pay if it violates its settlement agreement with the BIS.

“The settlement marked the largest penalty ever imposed by BIS ($661 million) and OFAC's largest settlement to date with a nonfinancial institution (almost $101 million),” according to a Skadden, Arps, Slate, Meagher & Flom LLP and Affiliates blog. “If the criminal plea agreement with DOJ is approved by a federal judge, the combined $1.19 billion in penalties would be the largest fine and forfeiture ever levied by the U.S. government in an export control case.”

According to a Reuters article, “ZTE conspired to evade U.S. embargoes by buying U.S. components, incorporating them into ZTE equipment and illegally shipping them to Iran.” It was also “charged in connection with 283 shipments of telecommunications equipment to North Korea,” the article states.

The plea agreement, which is contingent on the court’s approval, also requires ZTE to submit to a three-year period of corporate probation, during which time an independent corporate compliance monitor will review and report on ZTE’s export compliance program.

According to court documents, between January 2010 and January 2016, ZTE, either directly or indirectly through a third company, shipped approximately $32 million of U.S.-origin items to Iran without obtaining the proper export licenses from the U.S. government. In early 2010, ZTE began bidding on two different Iranian projects. The projects involved installing cellular and landline network infrastructure. Each contract was worth hundreds of millions of U.S. dollars and required U.S. components for the final products.

“The ZTE guilty plea and resulting criminal and civil penalties of USD 1.9 billion for violations of U.S. sanctions laws and regulations are no doubt record-breaking,” said Jon P. Yormick, special counsel for Phillips Lytle LLP in Buffalo, NY. “However, U.S. and foreign companies, of all sizes, need to understand that much less egregious conduct and even unintended sanctions violations can lead to costly civil penalties and reputational damage.” Yormick will present a free FCIB members-only webinar, Navigating Economic Sanctions: The First 60 Days of the Trump Administration, at 11am ET, Tuesday. It will help provide insight about new challenges in a host of areas.


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Strategic Global Intelligence Briefs

December 11-December 15

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EU Expansion Reconsidered

Chris Kuehl, Ph.D.

When the Iron Curtain fell, the worldwide response was nearly ecstatic. The division of Europe into East and West was going to come to an end.

In 2004, the EU expanded dramatically by adding eight countries from the former Warsaw Pact or from the USSR itself—Poland, Hungary, Czech Republic, Slovakia, Slovenia, Latvia, Lithuania and Estonia. Two island states that had not been part of that bloc were also added—Cypress and Malta. In 2007, Bulgaria and Romania joined, and Croatia in 2013. This massive expansion has been very hard to absorb. In many ways, it has led to the British desire to pull out. The migration of people from these former eastern states triggered the anti-immigrant attitudes in the U.K.

The further growth of the EU is very much in doubt now. There is a general sense that immigration worries will stall expansion. There are financial concerns as well given the fact the new applicants will be taking far more aid and assistance than they will be providing.

Turkey is the largest applicant and by far the most controversial. It is not even clear that President Recep Tayyip Erdoğan really wants to join at all. The other states that came out of Yugoslavia are applicants as well—Montenegro, Serbia, Macedonia and Bosnia. There has even been talk of Ukraine trying to join, but that would be something that Europe would be very reluctant to take on as long as the Russians occupy half the country.

The EU experiment has never been in greater jeopardy with at least six states discussing withdrawal. It is unlikely that France, the Netherlands, Greece, Italy, Spain and Portugal would make that choice, but the fact that some in these states want to should be taken seriously. The EU has had trouble assimilating the states that joined in the last decade and all efforts have been directed toward getting the mission reestablished.

Election Calendar

April 2 – Armenia, Armenian National Assembly

April 6 – The Gambia, Gambian National Assembly

April 9 – Serbia, President

April 16 – Turkey, Referendum to dramatically increase power of president

April 20 – Timor-Leste, President

April 23 – France, President

May 4 – Algeria, Algerian National People’s Assembly

May 6 – Niue, Niuean Assembly

May 7 – France, President (second round, if needed)

May 9 – South Korea, President

May 19 – Iran, President

May 24 – Cayman Islands, Cayman Legislative Assembly

June 11 – France, National Assembly of France

June 18 – France, National Assembly of France (second round, if needed)

June 24 – Papua New Guinea, National Parliament of Papua New Guinea

June 26 – Mongolia, President

July 2 – Senegal, Senegalese National Assembly

Aug. 4 – Rwanda, President

Sep. 11 – Norway, Norwegian Parliament

Sep. 23 – New Zealand, New Zealand House of Representatives

Sep. 24 – Germany, German Federal Diet

Oct. 10 – Liberia, President

Oct. 10 – Liberia, Liberian House of Representatives

Nov. 19 – Chile, Chilean Chamber of Deputies

Nov. 19 – Kyrgyzstan, President

Nov. 19 – Chile, Chilean Senate

Nov. 19 – Chile, President

Nov. 26 – Honduras, Honduran National Congress

Nov. 26 – Honduras, President

Global Roundup

U.S. sanctions 30 firms, individuals for aiding Iran, North Korea arms programs. The United States has imposed sanctions on 30 foreign companies or individuals for transferring sensitive technology to Iran for its missile program or for violating export controls on Iran, North Korea and Syria, the State Department said on Friday. Eleven companies or individuals from China, North Korea and the United Arab Emirates were sanctioned for technology transfers that could boost Tehran's ballistic missile program. (Reuters)

Back home after icy Trump meeting, Merkel calls for open markets. German Chancellor Angela Merkel and Japanese Prime Minister Shinzo Abe issued a staunch joint defense of free trade last Sunday, as the United States pushes toward greater protectionism. (EurActiv)

Brazil hit by meat import bans. China, the EU, Japan, Chile, Mexico and Hong Kong have imposed various degrees of import bans on Brazilian meat after a corruption scheme allowing the sale of products past their due date was uncovered late last week. Meat is Brazil’s fourth-largest export by value (at almost US$14bn), and the bans could hurt the country’s slow economic recovery. (Global Trade Review)

Venezuela in dire straits as oil production falls further. Venezuela’s economic crisis continues to deepen. The South American OPEC member is thought to be sitting on nearly 300 billion barrels of oil, far more than any other country in the world, including Saudi Arabia (estimated at 268 billion barrels). But the economy has been in freefall for several years, with conditions continuing to deteriorate. The economic crisis has morphed into a full-blown humanitarian disaster. (Yahoo Finance)

Default fears resurface over Singapore's looming debt wall. Default fears are resurfacing in Singapore ahead of a wall of maturing corporate debt, as a U.S. bankruptcy filing by a firm from the city flags lingering pain despite economic recovery. Pressure to pay down obligations has been unrelenting. Companies excluding banks must repay $27 billion of local bonds over the next four years. The maturities peak in 2020, when S$11.2 billion comes due, the most since 2012. (Bloomberg)

India’s demonetization policy: Have the risks been averted? India’s demonetization policy has caused disruption and reawakened concerns for the country’s growth prospects. Despite a resilient economy and the recent electoral victories of the ruling BJP party, financial and political risks remain. (Global Risk Insights)

Trump, China, and Section 301. With the advent of the Trump administration, the long standing rhetoric surrounding U.S.-China trade disputes has not only become more ominous but also, threateningly, real. One of the available legal instruments in Trump’s tool kit that is being frequently discussed in this discourse is the dreaded Section 301 action. This article explains the investigation and enforcement mechanism contained in Sections 301-310 of the U.S. Trade Act of 1974, which should, to a large extent, help allay the fears of Chinese exporters. (Global Trade Magazine)

Greece won’t last in eurozone in long-run. Greece will not last in the eurozone in the long run. Officials working on a review of its bailout package should prepare for such a possibility, a senior member of the Bavarian sister party of Chancellor Angela Merkel’s conservatives said. Greece has lost a quarter of its national output since it first sought financial aid in 2010. Its current bailout package is the third in seven years. (Hellenic Shipping News)

The Odebrecht scandal reveals Latin America’s changing attitudes on corruption. That high-level corruption is a serious problem in much of the world is no surprise. But when the Odebrecht case—a massive corruption scandal, possibly even the largest ever uncovered anywhere—burst onto the front pages of newspapers in nearly a dozen Latin American countries, it raised an important question: Is the uncovering and prosecution of major cases of graft a good sign or a bad one? (World Politics Review)


Week in Review Editorial Team:
Diana Mota, Associate Editor and David Anderson, Member Relations