As one walks through sleek Asian airports, discordant signs can sometimes be spotted; particularly in Hong Kong, with its declaration of a ban on the carrying of “excessive” milk powder tins into mainland China. This curious advertisement is the result of the 2008 melamine milk powder scandal in the mainland, following which relatives of newborn children there started carrying dozens of tins of powder back home. Seeing a populist challenge to the carefully calibrated image of domestic quality, the authorities are rumored to have leant heavily on Hong Kong to ban such exports.
This is a useful lesson though, for other reasons: confidence, once lost, is never regained quickly or even fully.
A curious thing happened on the way to the markets for the last two months, namely the comprehensive bout of skepticism that greeted China’s trade figures for both March and April (released respectively in April and May). Wall Street analysts, a breed all too renowned at the game of converting giant fibs into giant investment theories (such as “triple-A-rated CDOs”; remember those?) somehow choked on these releases and simply refused to pass on the baton.
Instead, you had the curious situation of everyone, ranging from small to larger investment banks, publishing their own estimates for what the actual Chinese trade figures were for the two months. A sample of two observations from news reports highlights the gap:
Firstly from Bloomberg dated May 8, 2013:
The report deepens skepticism on the reliability of trade data from the world’s largest exporting nation, with Royal Bank of Scotland Group Plc saying export gains may be overstated by 9 percentage points. Regulators announced a crackdown this week on companies using trade reports to disguise speculative money inflows chasing a yuan that’s already exceeded last year’s gains against the dollar.
Previously in sister publication Businessweek dated April 09, 2013:
So if the figures are fudged, how is it happening? One popular theory is that inflated export numbers are being used to siphon capital covertly into China, perhaps to invest in the hot property market or to take advantage of a rising yuan. The way it would work: a Chinese exporter inflates the value of the goods it sells abroad. This inflated amount is entered on the invoice that records the transaction. The other party – the one receiving the goods – then pays the amount falsely added to the invoice into the exporter’s overseas account. The amount paid into the exporter’s overseas account may actually be the exporter’s own money or the money of an associate of the company.
Whatever the case, the exporter then submits the invoice to Chinese government officials, who permit him to change the money earned abroad (usually dollars) into yuan – including a sum above the amount he may have legitimately earned from selling goods.
“It is possible that some of the trade flow disguised capital inflows – such that trading companies may overstate their exports and understate their imports in a bid to circumvent capital controls and bring capital into China,” wrote Nomura economists Zhang and Wendy Chen in a March 8 note. “Indeed, net capital inflows appear to have been very strong in January as foreign exchange purchases hit an historical high at RMB26.5 trn [US$4.272 trillion].”
The effects of such distrust are manifold:
i. Declining commodity prices as the notion of robust global growth supposedly signaled by rising Chinese trade figures are doubted. This has caused softness in the prices of coal, oil and other commodities;
ii. Currencies of key exporting countries, such as the Australian dollar, went for a toss in the few short weeks since this data was questioned;
iii. Given the apparent focus of the incoming government of China led by President Xi Jinping on controlling asset bubbles, data that shows surging capital inflows must be deeply concerning to policymakers and suggest a crackdown over the near-medium term;
iv. Questions have been raised about the efficacy of quantitative easing as data on the ground remains sparse in terms of supporting actual economic growth; this has caused renewed doubts on policies such as QE in the US, Japan and elsewhere.
It can thus be said that doubts about Chinese data lie at the very heart of the malaise that has seized global markets and business confidence in the past few weeks.
You can run …
Walking away from the markets, we are greeted with a barrage of news articles that allege Chinese cyber-criminality is at the heart of a global hacking network stealing secrets from companies, governments and educational institutions globally.
To be sure, the allegations are poorly cast given that the United States and various European countries, including the United Kingdom, have been recently implicated in vast invasions of people’s privacy and illegally accessing data from individuals. Nevertheless, accusations about the Chinese cyber-snoops tend to catch greater attention, especially as economic data remains indifferent globally and fears of joblessness and loss of manufacturing technology remain persistent worries in both the US and the European Union.
A practical example is useful here: both the EU and the US have moved relatively quickly to impose sanctions on solar panels made in China on anti-dumping grounds. Whilst the concept of China dominating the solar panel industry is cited as the primary factor, a more important issue is probably the technology that was allegedly pilfered by Chinese manufacturers in the renewable energy space to build their current dominance in the sector.
China is hardly unique in these governance issues – recent reports from India have been equally damning, if involving entirely different sectors such as pharmaceuticals. In what has become yet another large-scale scandal in a country that has had no shortage of such stories of late, one of its leading pharmaceutical firms, Ranbaxy, now stands accused of passing along adulterated drugs into the US market between 2005 and 2008 which necessitated a $500 million settlement with the US Food and Drugs Administration. The Wall Street Journal reported on May 13, 2013:
Indian generic pharmaceutical maker Ranbaxy Laboratories Ltd.’s US subsidiary pleaded guilty to felony charges Monday relating to adulterated drugs made at two of Ranbaxy’s manufacturing facilities in India, according to the Justice Department. Ranbaxy agreed to pay a criminal fine and forfeiture totaling $150 million and to settle civil claims for $350 million in what the US government called the largest drug-safety settlement to date with a generic drug manufacturer.
Ranbaxy USA pleaded guilty to three felony counts under the Food, Drug and Cosmetic Act – which prohibits adulterated drugs – and four felony counts of knowingly making material false statements to the US Food and Drug Administration.
Worse perhaps for business reputation, the company had itself been sold in the interim to Japanese major Daiichi, which now cried foul about the hiding of information by shareholders who negotiated the sale for over $1 billion. The scandal affecting one of the top generic drugmakers comes at a time when major pharmaceutical firms are up in arms globally about the current patents regime, which allows such generics to take up their inventions and undercut them severely in the market place.
In effect, India’s own goal is on the same lines as the Chinese firms that are accused of stealing technology secrets that in turn diminish the brand value and acceptability of their products going forward in the US and EU.
Conclusion
The current bout of declining confidence in markets has a strong flavor of poor data; however it carries with it the added stigma of “nowhere to turn”, as anyone fleeing poor performance in the US or EU can hardly now turn to Asia for higher growth expectations.
Scandals and questions on data reliability, while hardly new for the region, have assumed greater urgency in the wake of the current malaise gripping markets. It may well be a tragedy for the 2.5 billion people living in the world’s two biggest countries that their governments are not doing more to enhance the importance of “soft” issues such as governance and transparency at this time.