1 Politburo meeting on financial accountability hints at worsening of risks
Politburo reviews new rules for financial accountability
May 27
The CCP Politburo held a meeting and reviewed new rules for financial accountability (“Regulations on Accountability for Preventing and Resolving Risks [Trial],” 防範化解金融風險問責規定 [試行]) and the promotion of China’s central region (“Several Policies and Measures to Promote the Accelerated Rise of the Central Region in the New Era,” 新時代推動中部地區加速崛起的若干政策措施).
The meeting stressed that China’s central region is an “important grain production base, energy and raw material base, modern equipment manufacturing and high-tech industrial base, and a comprehensive transportation hub for China.” Officials must “deeply understand” the strategic intentions of Party Central and promote the rise of the central region to achieve “new major breakthroughs.” The Regional Coordinated Development Leading Group should “strengthen overall coordination, refine and implement various tasks, and promote implementation [of policies] through a checklist approach.” Also, the relevant departments should increase their support and the six central provinces of Shanxi, Anhui, Jiangxi, Henan, Hubei, and Hunan must “effectively shoulder the main responsibilities.”
The meeting said that the formulation and introduction of regulations on accountability for preventing and resolving financial risks are aimed at “further promoting the comprehensive and strict governance of the Party in the financial sector,” “effectively strengthening Party Central’s centralized and unified leadership over financial work,” and “further consolidating the responsibilities of relevant management departments, financial institutions, industry regulatory departments, and local Party Committees and governments in the financial sector.”
Major Chinese state banks plan to issue ‘risk-resistant’ bonds
May 22
Mainland media reported that the Industrial and Commercial Bank of China, China Construction Bank, Agricultural Bank of China, Bank of China, and Bank of Communications will issue no more than 440 billion yuan in total loss-absorbing capacity (TLAC) non-capital bonds, citing information discussed at the beginning of 2023 by the five banks. The ICBC and Bank of China each issued 40 billion yuan of first phase TLAC bonds this year from May 15 to May 21.
TLAC bonds were introduced after the 2008 financial crisis as a tool designed to prevent large banks from triggering systemic risks and to enhance their self-rescue capabilities. When a bank faces systemic financial risks, TLAC bonds can be written down or converted to equity without prior notice or consent, thereby allowing a bank to avoid bankruptcy and liquidation. The yields on TLAC bonds are generally higher than those of ordinary bonds under normal circumstances.
New property policies show limited effect
May 26
Mainland media reported that 200 out of 343 prefecture-level and above cities implemented a 15 percent down payment ratio for first-time home buyers after the People’s Bank of China introduced new policies to that regard on May 17. Additionally, more than 250 cities removed the lower limit on mortgage interest rates, which indicated that over 80 percent of Chinese cities have begun implementing the central bank’s policies.
May 27
1. Mainland media reported that the transaction volume of new homes in 15 key cities (including Beijing, Shenzhen, Shanghai, Chengdu, Suzhou, and Nanjing) increased by 0.85 percent week-on-week and the transaction volume of second-hand homes increased by 10.98 percent week-on-week in the first week (May 20 to May 26) after Beijing introduced new property policies, citing data from Zhuge Data Research Center.
As of May 26, the cumulative transaction volume of new homes in the 15 key cities in May had decreased by 38.63 percent compared to the same period in 2023, while the transaction volume of second-hand homes decreased by 13.81 percent from a year ago.
2. S&P Global said in a report that the PRC’s latest property stimulus measures could temporarily increase property demand, but the increased leverage could also result in more mortgage defaults.
S&P Global expects property prices in third-tier cities to decline about 14 percent during the 2024 to 2025 period. This could force some homebuyers into negative equity situations where their outstanding mortgage balances exceed the value of their properties, and lead to some homebuyers giving up their properties and defaulting on the mortgages.
Our take
1. The introduction of new rules for financial accountability at the May 27 Politburo meeting appears to be Beijing’s attempt at using administrative means to compel financial system officials to focus on mitigating financial risks, especially those that would result from credit contraction as the property sector crisis rapidly worsens. The Xi leadership’s call for financial officials to take greater responsibility for defusing risks is itself a sign that China faces significant levels of financial risks and that such risks are expected to expand further.
Financial risks and contagion are set to spread as the Xi leadership’s latest property stimulus measures fail to take off. The real estate data reported by mainland media shows that the property policies had minimal effect in stimulating sales, with the week-on-week growth in new home transactions at less than 1 percent and no significant rise in second-hand home prices despite the nearly 11 percent increase in transactions. In contrast, the transaction volume of new homes and second-hand homes fell by nearly 40 percent and 14 percent respectively from a year ago. Even if sales pick up somewhat, falling home prices raises the prospect of property becoming negative equity for homebuyers and lead to an uptick in mortgage defaults.
We believe that Beijing’s latest policy policies are not enough to stimulate home sales because they do not address the Chinese people’s concerns about the economy, future income reductions, further declines in home prices, and the deterioration of the real estate crisis. This is reflected in an online survey by mainland media China Real Estate News that was published on May 27:
- 75.01 percent of those surveyed said the new property policies would not lead them to buy a house.
- 78.05 percent believe that current housing prices are high or very high.
- 1.38 percent and 3.88 percent believe that high down payment ratios and property purchase restrictions are the biggest obstacles to home buying.
- 49.42 percent believe that housing prices will fall in the future.
The five major state banks issuing 440 billion yuan worth of TLAC bonds is the latest sign that there is a significant build up of financial risks in China and the CCP authorities are striving to find ways to prevent an outbreak of risks. Another recent sign is the National Financial Regulatory Administration allowing national asset management companies (AMCs) to acquire assets from large and joint-stock banks. We analyzed that AMCs being allowed to expand their acquisition of assets suggests that the “scale of non-performing assets in those banks may have reached a point where it has become difficult to conceal and the PRC authorities have no option but to allow AMCs to acquire those assets to provide liquidity to the banks.” As financial risks expand and threaten to break out, the Xi leadership would naturally want officials in the financial system to assume more responsibility to resolve those risks.
Banks and other financial institutions aside, another area where significant financial risks could be triggered is local government debt and local government financing vehicle debt. The current cumulative local government debt is in excess of 100 trillion yuan, and a good portion of that figure is likely non-performing. Wen Tiejun, a prominent Chinese scholar and agricultural expert, noted in a speech in November 2015 that county-level and town-level local governments hold debts in the range of billions of yuan to over 10 billion yuan because successive local leading cadres pursued fiscally reckless policies in the pursuit of high growth. However, the issue of non-performing assets, overdue loans, and local debt issues were never exposed because successive local leading cadres repaid the interest on debts accrued by their predecessors by expropriating land and mortgaging it to the banks and converted old debts into new loans.
Local governments, however, appear to be increasingly unable to hide their debt problems and the central government has been scrambling to keep them afloat. Many local governments began to openly acknowledge their problems with local and LGFV debt in the first half of 2023 and sought assistance from the central government. The CCP authorities then required large state-owned banks to provide liquidity to local governments facing debt crises in the second half of the year. This year, the authorities commenced the sale of 1 trillion yuan in ultra-long-term special sovereign bonds, a move that appears to be aimed at providing liquidity to local governments in need. A triggering of local government and LGFV debt problems will bring very serious consequences to the CCP regime.
2. Beijing’s call for financial officials to take greater accountability is partly a way for the Xi leadership to shirk some of the responsibility of a financial crisis and is unlikely to effectively mitigate financial risks. In response, financial officials are likely to become more motivated to conceal financial risks or transfer them to other departments or the central government in self-preservation as they seek to avoid being held accountable should crises break out. As a result, the CCP authorities will likely struggle to salvage risks that are triggered and exposed, and the Xi leadership and the CCP will find economic risks transforming into social and political risks for the regime.
2 Beijing pours more money into chips amid Sino-US ‘tech war’
PRC rolls out 344 billion yuan chip fund
The PRC had established its third planned state-backed investment fund for its semiconductor industry, according to a filing with the National Enterprise Credit Information Publicity System dated May 24.
The third phase of the National Integrated Circuit Industry Investment Fund, known as the “Big Fund,” is the largest to date with a registered capital of 344 billion yuan. The first phase of the fund was set up in 2014 with registered capital of 138.7 billion yuan and the second phase was established in 2019 with 204 billion yuan.
Tianyancha, a Chinese companies information database company, listed the PRC finance ministry as the biggest shareholder of the fund with a 17 percent stake and paid-in capital of 60 billion yuan. The second-largest shareholder is China Development Bank Capital with a 10.5 percent stake. Seventeen other entities are listed as investors, including the five major Chinese banks (Industrial and Commercial Bank of China, China Construction Bank, Agricultural Bank of China, Bank of China, and Bank of Communications) with each contributing around 6 percent of the total capital.
The Chinese language edition of Voice of America cited analysts as saying that the third phase of the “Big Fund” is likely to focus on artificial intelligence chips, lithography machines, and photoresists.
CCP seeking advantage in legacy chips?
May 24
DigiTimes Asia reported that Ye Tianchun, the President of the Integrated Circuit Branch of the China Semiconductor Industry Association and Secretary-General of the China Integrated Circuit Innovation Alliance, is encouraging Chinese companies to focus on building innovations in mature nodes and back-end technologies, and that this should take precedence over trying to catch up to Western and Western-aligned semiconductor companies like TSMC, Intel, and Nvidia in the nanometer race.
The focus on mature nodes, or legacy chips, allows China to tap its core strengths and become a leader in that area. For one, almost 80 percent of the 12 million 12-inch wafers that TSMC makes annually uses older nodes rather than the latest designs on the newest system on a chip (SoCs).
Ye also recommends focusing on architectural innovations and back-end processes because Chinese semiconductor firms are still some years away from developing 2nm and 3nm chips and Moore’s Law suggests that companies are reaching current architectural limitations. Therefore, Chinese chip companies should consider working on architecture innovations as early as 7nm and work with system packaging firms to deliver these innovations to gain a comparative advantage in this area.
External pressures on PRC tech
May 8
Reuters reported that the U.S. revoked licenses that allowed companies like Intel and Qualcomm to sell chips used for laptops and handsets to Huawei, citing three people familiar with the matter. A fourth person said that some of the companies were notified on May 7 that their licenses were revoked effective immediately.
The move follows Huawei’s release of its first AI-enabled laptop (MateBook X Pro) in April.
May 14
Politico’s “China Watcher” newsletter wrote that the European Union is following the U.S.’s lead in shifting its attention to legacy chips and whether there is a dependency on China supplies in that area.
In April, U.S. Commerce Secretary Gina Raimondo told reporters during a huddle between EU and U.S. officials in Belgium that China is estimated to produce around 60 percent of the legacy chips coming to the market in the “next handful of years,” and “we know there’s a massive subsidization of that industry on behalf of the Chinese government, which could lead to huge market distortion.”
May 21
Bloomberg News reported that ASML and TSMC have methods to remotely disable their sophisticated chipmaking machines in China in the event of a PRC invasion of Taiwan, citing people familiar with the matter.
The people said that the remote shut-off applies to ASML’s line of extreme ultraviolet machines (EUVs), for which TSMC is its single biggest client. As part of an EUV’s regular servicing and updates, ASML can remotely force a shut-off, said the people, which would act as a kill switch.
Bloomberg also quoted TSMC chairman Mark Liu in a September 2023 interview with CNN where he said, “Nobody can control TSMC by force. If there is a military invasion you will render TSMC factory non-operable.”
May 24
The U.S. Department of Commerce continued an investigation into Applied Materials Inc.’s shipments to Chinese clients.
Our take
1. The roll out of the third phase of the semiconductor “Big Fund” and apparent focus on legacy chips are Beijing’s latest moves to cope with the Sino-U.S. “tech war” and secure advantages to further its domination agenda.
The CCP is pouring huge sums to fund China’s domestic chip production capabilities as it increasingly loses access to advanced semiconductors produced by Western and Western-aligned semiconductor companies. Beijing would be hoping that the latest round of investments eventually pay off and allow the regime to innovate its way around Western restrictions in the long run. While Beijing’s chip funding initiative could produce some breakthroughs, we are not optimistic that the CCP can simply spend its way out of trouble given the failure of the chip “great leap forward” launched in Xi Jinping’s first term and China’s growing economic troubles.
Meanwhile, the CCP regime is certainly playing to its strengths by focusing on legacy chips in the interim while it gradually grows its advanced chip capacity. China’s global share of mature-process capacity was 31 percent in 2023 and is expected to reach 39 percent in 2027. A March 2024 report by the Centre for Strategic and International Studies noted that “an unintended consequence of U.S. export controls on advanced chip technology to China may be a wave of state-backed investment leading to overproduction and, potentially, Chinese dominance of global legacy chip production.”
Legacy chips look increasingly like the next front in the “tech war” between the PRC and the West. Such chips hold strategic value because they are used in everything from modern household appliances to broadband, electric vehicles, medical devices, and military systems. However, the U.S. and its allies are likely to be limited in what they can currently do to curb China’s exports for legacy chips given the present lack of domestic production capacity in the U.S. and elsewhere. The CCP is likely to seize upon the weakness in American chip production to build a monopoly in the PRC’s legacy chip production, increase global dependency on Chinese semiconductors, and grow the regime’s strategic advantage.
2. Beijing’s funding of chips also ties in with the Xi leadership’s broader move to grow the real economy and shift the regime away from the Chinese economy’s “financialization” under Jiang Zemin and Hu Jintao.
Xi Jinping’s prioritization of the real economy started as early as 2015 with the “Made in China 2025” program. In Xi’s second term, his leadership targeted tech giants and other problematic industries, as well as started to rectify the financial sector, in a bid to de-financialize the economy and ensure that politics firmly controls capital in the regime instead of the other way around.
Xi’s emphasis that finance should serve “socialist construction” was made explicit at the 2023 Central Financial Work Conference. Notably, Xi called for financing major strategies, key areas, and weak links like technological innovation and advanced manufacturing, and stressed the need for finance to serve the real economy and maintain financial stability.
In the first half of 2024, Xi promoted manufacturing, advanced manufacturing, and technological innovation during inspection trips to central, western, and eastern parts of China like Hunan, Chongqing, and Shandong. Xi visiting the aforementioned areas and focusing on growing the real economy instead of traveling to the southeastern regions, which are characterized by Western-style “financialized” economies and service industries, suggest that Beijing believes the latter regions will not be able to provide substantial support as the regime’s internal and external crises worsen. Beijing could also believe that the overly “financialized” southeastern regions are a potential source of instability under the current climate.
The Xi leadership’s stance on the proper role of capital can too be glimpsed from the views of Chinese academics. Prominent Chinese scholar and agricultural expert Wen Tiejun noted in a speech in May that China’s capital market serves the PRC’s national strategy, and industrial capital is the mainstay of the economy. Wen added that the Chinese stock market exists solely to provide direct financing for industrial capital, and therefore the shift from industrial capital to financial capital after the former reaches a “certain level of maturity and profitability” does not occur in China.
Businesses, investors, and governments must be aware that the Xi leadership’s promotion of the real economy over the “financialized” one is not temporary or transitional, but the “new normal” of China’s financial sector. They should also expect the CCP authorities to more strictly regulate the financial sector as it strives to have finance and capital serve the needs of the Communist Party.
