Foreign institutions eye nation's financial liberalization

While talk of economic decoupling from Beijing has been floated in Washington, the notion has not resonated on Wall Street or with investors, who have been spurred by lucrative opportunities in the opening-up of China's financial markets.

Politics will likely continue to play a role in economic exchanges between the United States and China in the nascent administration of President Joe Biden, but Wall Street will be inclined to do what it does best－pursue profits.

As part of trade talks under the previous U.S. administration, officials in Washington requested that China open up its markets, which would suggest that decoupling would not apply to Wall Street banks.

Beijing offered to remove restrictions on foreign capital in the phase one trade deal signed with the U.S. in January last year.

Some of Wall Street's biggest banks have been preparing for greater access to China's financial sector. Goldman Sachs will raise the number of its staff members on the Chinese mainland this year, where by 2024, it expects to have a workforce of 600, up from the current 400, Nikkei Asia reported on Feb 27.

In December, the company applied to take full ownership of a Chinese securities joint venture, which would be the first by a foreign multinational bank.

JPMorgan Chase will expand its asset and wealth management business as well as investment banking operations in China.

"Asia will be one of the fastest-growing markets in the world," JP Morgan CEO Jamie Dimon said in an earnings call last month.

Morgan Stanley's joint venture partner, China Fortune Securities, announced that it would auction off stakes, leaving an opening for the New York bank to take full ownership. In 2019, Morgan Stanley bought a 2 percent stake from China Fortune Securities, also through an auction.

Majority or full ownership could make it easier for foreign banks to expand their operations in the multitrillion-dollar Chinese financial sector.

Zhang Monan, senior fellow at the China Center for International Economic Exchanges, wrote in a Feb 23 article on chinausfocus.com, "China's financial liberalization will create huge value-added and profit margins for foreign financial institutions."

She noted that in 2019, PayPal became the first foreign company to provide online payment services in China after acquiring a 70 percent stake in Chinese company GoPay.

In June, American Express became the first foreign credit card company to conduct domestic operations in China through a joint venture with a Chinese financial technology company, and it also was allowed to carry out network clearing operations. Visa and Mastercard applied to form a network clearing license.

S&P Global established a wholly foreign-owned company in 2019, the first foreign company licensed to run credit rating services in China's domestic bond market, Zhang wrote.

China will target GDP growth of at least 6 percent this year as it looks to shore up its economic fundamentals from the pandemic fallout.

Premier Li Keqiang made the growth announcement in the Government Work Report delivered at the opening of the fourth session of the 13th National People's Congress on March 5.

"In setting this target, we have taken into account the recovery of economic activity. A target of over 6 percent will be well aligned with the annual goals of subsequent years in the 14th Five-Year Plan (2021-25) period, and they will help sustain healthy economic growth," Li said.

The value of China's financial market is estimated at $47 trillion. Foreign financial institutions account for less than 2 percent of banking assets and less than 6 percent of the insurance market in China, Zhang wrote.

Strong rebound

On Feb 6, the South China Morning Post reported, "Encouraged by signs of the world's second-largest economy mostly back to pre-pandemic levels of production, they (foreign financial institutions) have snapped up Chinese stocks, bonds, exchange-traded funds and other financial assets available to them under the country's tightly controlled capital account."

UBS Global Wealth Management, which invests $3 trillion for wealthy individuals, expects "China equities, fixed income and currency to shine" amid a strong economic rebound.

According to analysis of Treasury data by Seafarer Capital Partners, at the end of 2019, U.S. investors owned $813 billion worth of stocks and bonds issued by Chinese mainland companies, compared with $368 billion in holdings three years earlier.

Eswar Prasad, an expert at Cornell University on China's financial system, told the Financial Times in October: "Economic imperatives are certainly overriding political concerns. Ultimately, private capital and private financial institutions are going to respond more to economic incentives, irrespective of what political masters say."

Hayden Briscoe, head of fixed income for Asia Pacific at UBS Asset Management, told the newspaper: "Money is starting to pour into China because they're looking for that income. It's a really interesting point in history－the Chinese have opened up and you've got the rest of the world in dire straits."

One wealth manager told Bloomberg in an article on Wednesday, "The rivalry between the U.S. and China means that investors can no longer afford to leave Chinese assets out of their portfolios."

Another investor said, "As both countries test their power and influence in the coming years, investors should build portfolios resilient enough to withstand all possible outcomes."

Billionaire hedge fund manager Ray Dalio sees China's economy outperforming the world, regardless of other nations' attempts to contain it.

"For as long as I can remember, people have said that China cannot succeed. Yet every day we see China succeeding in exceptional ways," he wrote in a post on his LinkedIn page in October.

"Over the past year (2020), its economy grew at almost 5 percent, without monetizing debt (such as the U.S. Federal Reserve does when it buys U.S. Treasuries for its own account), while all major economies contracted.

"China produces more than it consumes and runs a balance of payments surplus, unlike the U.S. and many Western nations."

Dalio said nearly half the world's initial public offerings this year would be in China.

"The world order is changing, yet many are missing this because of a persistent anti-China bias. Whatever criticisms you may have about Chinese 'state capitalism', you cannot say it hasn't worked, even if you strongly disagree with how Beijing has done it," he wrote.

"When I first visited China 36 years ago, I would give $10 pocket calculators to high-ranking officials. They thought they were miracle devices.

"Now, China rivals the U.S. in advanced technologies and will probably take the lead in five years. Since 1984, per capita incomes have risen more than 30 times, life expectancy has increased by a decade and poverty rates have fallen nearly to zero. In 1990, China's first stock market was launched, designed by seven young patriots who I knew. Since then, it has become the second-largest in the world."

Dalio, who manages the $148 billion Bridgewater Associates, the world's largest hedge fund, wrote: "China's fundamentals are strong, its assets relatively attractively priced, and the world is underweight Chinese stocks and bonds. These currently account for 3 percent or less of foreign portfolio holdings; a neutral weighting would be closer to 15 percent.

"This discrepancy is at least in part due to anti-Chinese bias. I think it is about to change. Chinese markets are opening up to foreigners, who can now access at least 60 percent of them, compared with 1 percent in 2015."

Dalio's All Weather China strategy fund has earned a 22 percent return over the past two years.

"In brief, empires rise when they are productive, financially sound, earn more than they spend, and increase assets faster than their liabilities. This tends to happen when their people are well educated, work hard and behave civilly," he wrote.

"The fundamentals clearly favor China," Dalio added.

If the U.S. were to take the road to decoupling, it may not be easy to bring its allies along for the ride.

On Jan 29, an article on the investment website Seeking Alpha said: "Despite U.S. opposition, allies are choosing to do business with China because it is in their best interest to do so. You have to understand that Europe has suffered a decade of economic stagnation and will face another one if they don't get heavily involved with the fastest-growing market in the world.

"On the other hand, Asian nations have no interest in joining the West in confronting China, the growth engine in their own backyard."

The article added: "Even if the elites in the U.S., Europe or Asia want to contain China, they will find it extremely difficult to rally their people, who will ultimately bear the cost of a confrontation. For Asian nations, it is simple: the population will certainly not support a clash of civilizations against China."

Looking east

Meanwhile, the European Union may have more reasons to look east.

"The eurozone will be the last major economy to return to pre-pandemic levels and will suffer continued substantial output gaps for at least the next two years," Erik Nielsen, chief economist at Uni-Credit, told The Wall Street Journal last month.

The International Monetary Fund expects the eurozone economy to shrink by 3.3 percentage points this year, while the U.S. economy is tipped to grow by 1.5 percent.

On the bright side, Germany's BMW AG and Daimler AG recorded sharp rises in vehicle sales to China last year, The Wall Street Journal reported.

The U.S. Chamber of Commerce detailed the financial impact of any decoupling in a widely cited report issued on Feb 17.

"A new administration under President Joe Biden faces a difficult challenge in defining the next stage of economic engagement (or disengagement) with China. Deciding which areas do not pose a threat to national security－and should therefore be left open－is a complex task," the report said.

"Some argue that disengagement from China, through reshoring and investment in homegrown innovation, can boost economic activity in the United States. However, without an objective, fact-based examination of the costs and benefits of the U.S.-China economic relationship－and the economic impact of disentangling that relationship－that argument is purely speculative."

The report summarized the potential impact of decoupling on various sectors of the U.S. economy.

It said that if 25 percent tariffs were expanded to cover all two-way trade, the U.S. would forgo $190 billion in GDP annually by 2025.

If decoupling led to the sale of half of U.S. foreign direct investment stock in China, U.S. investors would lose $25 billion per year in capital gains, and models point to one-time GDP losses of up to $500 billion.

Turning to Chinese tourism and education spending, the report said that if future flows were reduced by half from their pre-pandemic levels, the U.S. would lose between $15 billion and $30 billion per year.

The Chamber, which is based in Washington, estimated that a complete loss of access to the Chinese market for U.S. aircraft and commercial aviation services could cost between $38 billion and $51 billion annually.

Lost access to customers in China would cost the U.S. semiconductor industry between $54 billion and $124 billion in output, risking more than 100,000 jobs, $12 billion in research and development spending and $13 billion in capital spending.

For the U.S. chemicals industry, due to tariffs alone, the potential cost of decoupling ranges from $10.2 billion in domestic payroll and output reductions, along with 26,000 lost jobs, to more than $38 billion in output losses and nearly 100,000 lost jobs.

The U.S. medical devices industry would see abandoned market share in China go to its competitors, boosting their economies of scale and handing them future revenue from the Chinese market, where rising incomes and an aging population are driving demand for such devices. U.S. lost market share is valued at $23.6 billion in annual revenue, amounting to revenue losses of more than $479 billion over a decade.

On March 2, China's top banking and insurance regulator said that while the country holds promise for foreign businesses and investors looking for profits, it is studying ways to manage capital inflows to prevent turbulence, as authorities are "very worried" about the risk of bubbles bursting in foreign markets.

Global markets are starting to see the side effects of fiscal and monetary policy steps taken in response to the pandemic, said Guo Shuqing, head of the China Banking and Insurance Regulatory Commission.

"Many people buy homes－not to live in, but to invest or speculate. This is very dangerous. Financial markets are trading at high levels in Europe, the U.S. and other developed countries, which runs counter to the real economy," Guo said.

"Financial markets should reflect the situation of the real economy. If there's a big gap in between, problems will occur and the markets will be forced to adjust. So, we are very worried about the financial markets, particularly the risk of the foreign financial assets bubble bursting."