SinoInsight 1
1. On April 13, the PRC State Council issued a guideline on deepening budget-management system reform (國務院關於進一步深化預算管理制度改革的意見). The guideline instructed local governments to “strengthen budget management coordination, standardize budget expenditure, and enhance budget management and performance management” to “pass tight times” (過緊日子). The guideline also called on local governments to “step up risk prevention and control” while ensuring “fiscal sustainability.”
Highlights of the guideline include:
- Local governments are strictly forbidden from including scale and increase of fiscal revenue data during assessment and evaluation. Moreover, local governments are strictly forbidden from collecting “excessive taxes” (including collecting future and potential taxes) and arbitrary fines.
- Local governments are required to include government administrative monopoly revenue into their budget figures, and strengthen the management of department and work unit revenue.
- Local governments are required to “live within their means” (量入為出), and budgeting will not longer be coupled to fiscal revenue growth and expenditure, or GDP growth. Also, government borrowing leverage ratio must be controlled, and local government policies must make contingencies for “deteriorations in the economic cycle.”
- Budgeting at all levels of local government must ensure the “three guarantees” (guarantee the people’s basic livelihood, wages, and operations). Local governments must also strictly control financial investment in competitive fields, as well as strengthen support for innovation development and economic layout of the state-owned economy.
- Local governments must improve fiscal fund issuance to ensure that funds reach work units directly.
- Local governments must strengthen constraints on mid-term fiscal planning in annual budgeting. Also, local governments should strictly determine their sources of debt repayment and formulate debt servicing plans.
- Local governments must “resolutely curb” the increase of implicit debt, and properly handle and resolve existing debt piles. Local governments are also “not allowed to take on new projects that could incur new implicit debt.” Further, local governments are strictly prohibited from increasing implicit liabilities through borrowing from corporations and financial institutions, as well as other forms of disguised borrowing. Meanwhile, financial institutions are strictly prohibited from requesting or accepting local government loan guarantees. Insolvent local financing vehicles could be restructured or liquidated. The guideline warns local governments against “malicious evasion of debt” to guard against the accumulation of risks and systemic risks, as well as requires the implementation of a lifetime government borrowing accountability system and a mechanism of retroactive debt investigation.
- Central and local government financial information systems will be fully connected by the end of 2022 to allow the central government to monitor the flow of funds in real-time.
2. In recent weeks, the state-owned financial company China Huarong Asset Management Co. postponed the release of its 2020 annual report and suspended trading of its shares. Subsequently, there was panic selling of Huarong bonds after financial markets started suspecting that Huarong was possibly on the cusp of bankruptcy.
On April 13, Huarong’s bonds fell to a record low; one $1.5 billion value, 4.5 percent coupon rate perpetual bond dropped to 61.2 cents on the dollar, the lowest price since its listing. Another investment grade, 3 billion yuan scale domestic corporate bond (“20 Huarong G1”) fell to 86.48 yuan and saw its yield rise to 11.1624 percent, or the average high bond yield level of mainland real estate companies.
Huarong is one of the PRC’s four largest state-owned asset management companies specializing in the disposing of non-performing assets. The company has total liabilities exceeding 1.5 trillion yuan. According to a China International Capital Corporation report, the total value of outstanding domestic and foreign perpetual bonds held by Huarong and its subsidiaries exceeds 350 billion yuan, of which approximately 152.5 billion yuan ($23.3 billion) are U.S. dollar bonds.
Huarong is currently on the negative watch list of major international rating agencies like Moody’s, Fitch, and Standard & Poor’s, as well as domestic rating company China Chengxin International.
OUR TAKE
1. Huarong’s debt debacle and the State Council’s guideline on deepening budget-management system reform reveals that the CCP is facing serious financial difficulties and is pessimistic about China’s economic outlook. The guideline aims to address the PRC government’s issues with fiscal deficit, which has sharply increased since the start of the Sino-U.S. trade war. The pandemic likely worsened the deficit. In 2020, China’s fiscal deficit totaled 6.3 trillion yuan, or more than double the 3.1 trillion yuan in 2017.
2. When read from the perspective of CCP logic, the guideline also uncovers official malpractices that are contributing to regime crisis.
The CCP has been prioritizing GDP growth and economic performance since the Deng era. Overtime, the focus on GDP has become a political orthodoxy unto itself. Officials have a tendency to put self-interest before regime interest and “prefer left rather than right” (寧左勿右) to preserve career safety. When it comes to economic performance, officials will use all means, fair and foul, to hit or exceed GDP targets. This means manipulating data, imposing arbitrary fees on the people, collecting “excessive taxes,” and messing around with the budget, which is closely tied with GDP growth.
Beijing is well aware of what is going on in local governments, but has largely turned a blind eye in years past when the regime’s financial health was excellent. But when times are tough and penny-pinching is a must, the central government cannot allow past practices to continue. And in true CCP face-saving and positive propaganda fashion, Beijing is now attempting to change ingrained official habits through new prohibitions and oversight mechanisms.
To stop CCP officials from causing more economic harm in the blind pursuit of GDP growth, the recent State Council guideline “strictly forbids” local governments from using crucial fiscal revenue data in assessment and evaluation. When the data is no longer “counted,” local governments at all levels will be disincentivized from competing with each other and demanding that certain growth targets are met. With less political pressure on local governments, they will be less inclined to impose arbitrary fees and collect “excessive taxes” from the people and private enterprises. This gives breathing space to private enterprises and the people to make a living, and allows the central government’s recent fee and tax cuts to take effect. Without imposing checks on local officials, they will likely overburden their constituencies in their quest for higher GDP growth numbers in the accumulation of political capital.
Beijing has also strengthened its financial oversight regime to ensure that higher level local governments are not skiving off central government subsidies meant for lower level local governments, particularly those at the basic level. For instance, the linking of central and local government financial information systems is aimed at preventing higher level local governments from withholding or embezzling central funds, and so is the direct fund issuance requirement. Beijing is trying to avoid situations where lack of funding in grassroots government sparks social problems that ultimately rises up to haunt the central government.
The fact that Beijing needs to use prohibitions and direct oversight mechanisms to regulate budgeting measures and force officials to change their behavior reveals both a glaring weakness in the CCP’s authoritarian model and hints at the severity of the regime’s fiscal problems.
3. Beijing’s dilemma with local government finances is perhaps best seen through guideline’s items on implicit debt and local financing vehicles. On the one hand, the CCP wants local governments to be self-sufficient in maintaining their operations. On the other hand, they want local governments to “live within their means” in “tight times.” If this means that underperforming local financing vehicles collapse, then so be it. However, the central government may face difficulties in regulating this, and Beijing may yet again find that its orders never went beyond the gates of Zhongnanhai (政令不出中南海).
4. The large-scale issuance of debt by local governments will affect enterprise financing costs and increase the risk of debt defaults.
Net financing of government bonds in 2021 is expected to be around 7.23 trillion yuan. This is a decrease of 1.28 trillion yuan from the 8.51 trillion yuan planned for 2020, but an increase of 2.32 trillion yuan from 2019.
Meanwhile, the scale of local bond issuance in March 2021 exceeded 470 billion yuan, an increase of more than seven times as compared to the previous month, and a new high since September 2020. Local government bond issuance is expected to peak in the second quarter, and the first peak could come this month. Concurrently, more than 2.2 trillion yuan worth of bonds will mature in Q2 2021, with companies expected to borrow new debt to pay off the old. This means rising financing costs and greater incidence of debt defaults. In 2020, the scale of debt defaults exceeded 150 billion yuan; Q1 2021 defaults exceed 60 billion yuan.
According to data from Zhongtai Securities, more than 1,100 bonds have seen their coupon rates increase since March, exceeding the number of bonds whose coupon rates were adjusted downwards. Meanwhile, there were 1,286 rate increases in the 50-200 basis point range, with three bonds seeing their coupon rates go up by more than 400 basis points—a situation that last occurred in 2019. Further, the ratio of outstanding explicit debt to fiscal revenue could break through the warning line of 100 percent in 2021.
SinoInsight 2
On April 12, four masked men forced their way into the printing press of the Hong Kong edition of The Epoch Times (Dajiyuan) and smashed up equipment with sledgehammers. Later, it was discovered that some computer equipment, including a CUP, was stolen. Damage to computers and printing equipment meant that the Hong Kong edition of The Epoch Times had to suspend printing for several days, or just before prominent pro-democracy activists were scheduled to appear in court.
The attack of the Hong Kong Epoch Times’s printing press drew widespread international condemnation. Lawmakers and human rights organizations slammed the CCP and denounced the erosion of press freedoms in Hong Kong. A U.S. State Department spokesperson said, “We condemn the attack on the Epoch Times’s printing plant and urge the Hong Kong authorities to thoroughly investigate and bring the perpetrators to justice.” Former Secretary of State Mike Pompeo said, “The attack on The Epoch Times and on the free press in Hong Kong is appalling, but not unexpected. The Chinese Communist Party continues to demonstrate they will not honor their agreement on the freedom of the people of Hong Kong.”
The Hong Kong Epoch Times also reported that local thugs had vandalized or attacked at least six Falun Gong information street booths in Hong Kong on more than a dozen occasions between April 2 to April 9. The thugs destroyed exhibition boards exposing the CCP, stole banners, and intimidated or attacked Falun Gong practitioners manning the booths.
The Hong Kong Epoch Times reported that while the anti-Falun Gong Hong Kong Youth Care Association was officially disbanded on Dec. 31, 2020, propaganda attacks against Falun Gong resumed in March. Individuals were spotted putting up anti-Falun Gong displays throughout the city. An elderly woman who was responsible for setting up displays told reporters that she was instigated to do so by the Shenzhen Communist Party branch. Meanwhile, some residents in Hong Kong’s Sham Shui Po district told The Epoch Times that they had received propaganda material attacking Falun Gong in their mailbox.
OUR TAKE
1. It is unclear who ordered the four masked men to attack the printing press of the Hong Kong Epoch Times. However, it is reasonable to infer from recent attacks against Falun Gong in Hong Kong that the CCP elements responsible for those incidents are also the ones behind the printing press attack.
2. Observers who have closely followed Beijing’s evisceration of Hong Kong’s autonomy via the 2020 National Security Law and are familiar with what Falun Gong practitioners in Hong Kong have done in the past two decades to expose and condemn the CCP may find the Party’s treatment of Falun Gong in Hong Kong to be baffling. On the one hand, pro-democracy activists and journalists are being rounded up one after the other on national security charges. On the other hand, Falun Gong practitioners, who display banners with the words “Heaven will destroy the CCP” and partake in other behavior that Beijing would consider to be clearly “anti-CCP” have not been arrested on national security grounds. One would expect “national security” raids of the Hong Kong Epoch Times for breaking news of the CCP’s forced organ harvesting of prisoners of conscience, and other “counter-revolutionary” reporting. Instead, elements of the CCP, such as the Shenzhen Communist Party branch, continue to resort to the use of local thugs and gangster-style intimidation instead of more overt methods.
One possible explanation for the CCP’s baffling behavior is that it is merely working its way up the food chain. When a good number of pro-democracy activists and newspapers have been sidelined, there will be fewer voices left in Hong Kong to defend Falun Gong when a crackdown occurs. However, this explanation cannot properly account for why the Hong Kong Youth Care Association officially disbanded itself at the end of 2020.
Further, it is curious that the CCP feels a need to take thuggish extralegal actions against Falun Gong when the Hong Kong National Security Law is already in place. Those familiar with the CCP’s long-time effort to pass national security legislation in Hong Kong (Article 23) know that a primary reason for the Party’s effort is its desire to expand the persecution of Falun Gong in the city (see here and here). Surely, it would be more “elegant” for the CCP to push for the arrest of leading Hong Kong Epoch Times executives and impound the printing press on national security grounds, rather than order masked men to bash up printing equipment. After all, Beijing is already willing to risk international condemnation by arresting famous pro-democracy figures and raiding the headquarters of Apple Daily; in comparison, Falun Gong and the Hong Kong Epoch Times are much less prominent.
3. A plausible explanation for the CCP’s curious behavior towards Falun Gong in Hong Kong lies in the clash of factional interests between Xi Jinping camp and the Jiang Zemin faction.
Jiang Zemin ordered the persecution against Falun Gong in 1999, and the anti-Falun Gong campaign has become a major negative political legacy for the Jiang faction. The initial push to enact Article 23 in 2003 by pro-Beijing politicians happened at a time when the persecution of Falun Gong on the mainland reached a peak and Jiang faction number two Zeng Qinghong was the Politburo Standing Committee member overseeing Hong Kong and Macau affairs. The establishment of the Hong Kong Youth Care Association in 2012 also coincided with the election of Jiang faction associate Leung Chun-ying as Hong Kong Chief Executive, and the Hong Kong Youth Care Association was spawned from the Shenzhen Communist Party branch.
For the Jiang faction, sustaining the anti-Falun Gong campaign in Hong Kong is an important component of safeguarding Jiang’s political legacy. Getting thugs to attack the Hong Kong Epoch Times and setting up anti-Falun Gong displays in the city serves to perpetuate the Jiang faction’s legacy and undermines Xi Jinping by reinforcing negative views of Xi in the international community. However, with Xi tightening control over Hong Kong through mass personnel reshuffles in the Hong Kong and Macau apparatus, and holding ultimate sway over the “supra-authority” national security organization that has been set up in Hong Kong, the Jiang faction can only tap into its extralegal underworld assets to go after Falun Gong.
Meanwhile, Xi Jinping has been slowly chipping away at Jiang’s political legacy as he looks to gain an edge in the “you die, I live” factional struggle. Since Xi took office in 2012, the 610 Office has seen multiple leadership reshuffles, and was formally dissolved altogether in March 2018 as part of state and Party institutional reforms. Several top 610 Office officials have also been arrested on corruption charges, most recently this March with the anti-corruption authorities announcing an investigation into former 610 Office deputy director Peng Bo. Recent weeks have also seen the fall of political and legal affairs officials who actively participated or are likely to have participated in the persecution of Falun Gong practitioners on the mainland. It is very possible that the disbanding of the Hong Kong Youth Care Association is part of a broader effort by Xi to oust the Jiang faction from Hong Kong and stop the city from turning into an “anti-Xi” base.
Escalating Xi-Jiang factional struggle and the emergence of an “anti-Xi, not anti-CCP” strategy in the West may better explain why Beijing is hesitating on using national security legislation to clamp down on Falun Gong in Hong Kong. Should global and domestic pressure on Xi Jinping over his negative political legacies like Hong Kong and Xinjiang threaten his political and personal security, Xi could seek to turn the tables on the Jiang faction and their supporters by targeting their negative political legacy (Falun Gong).
SinoInsight 3
April 12
Ant Group announced that it would implement a “rectification plan” under the guidance of Chinese regulators. Under the “rectification plan,” Ant would separate its financial holding business from its payment business, as well as comply with personal credit business laws and regulations.
April 13
The State Administration for Market Regulation, Cyberspace Administration of China, State Taxation Administration summoned 34 Chinese internet companies for a meeting. The companies, including Tencent, Baidu, ByteDance, JD.com, and Meituan, were warned against monopolistic practices like “er xuan yi” (二選一, or forcing customers to forgo the use of other platforms) and ordered to carry out a month of self-inspections. The regulators added that those found guilty of monopolistic practices after the “rectification” period will be severely punished.
April 14
In a video conference meeting on payments and settlements in 2021, the People’s Bank of China announced that priority tasks for the year include strengthening anti-monopoly regulation in the payments sector, preventing disorderly expansion of capital, and accelerating the introduction of “regulation on non-bank payment institutions” (非银行支付机构条例).
April 15
1. The Standing Committee of the Zhejiang Party Committee pledged in a special meeting to “supervise and guide” the “rectification” of Ant Group, as well as implement Beijing’s orders to rein in the platform economy.
2. During a regular State Council policy briefing, Liu Weijun, director of the State Administration for Market Supervision’s Certification Supervision Department, announced Party Central’s decision to intensify investigation into major cases in accordance with the provisions of the PRC Anti-Monopoly Law.
OUR TAKE
1. Recent CCP actions against Ant Group and other Chinese internet companies affirm the analysis in our April 12 newsletter. The CCP’s “rectification” of internet companies, including anti-monopoly and payment industry regulations, are designed to rein in private capital. Rapid and massive expansion of Chinese internet companies through monopolistic practices saddle the regime with financial risks while allowing private capital to vie with the CCP for control over data and society.
2. The fact that the 34 Chinese internet companies were allowed one month to “rectify” their operations and not fined out right is further evidence that factional struggle played a greater role than political and financial risks in influencing Beijing’s decision to punish Jack Ma and his companies.
