In the News: US Tariffs Delay; China's Bad Loans Mount; Shanghai Wants RHQs; and Shenzhen Designated Model City

As China exports more to the U.S. than it imports from them, it is unable to retaliate against U.S. tariffs with equivalent tariffs of its own. However, China has suspended U.S. agricultural purchases and allowed its currency to devalue, much to U.S. chagrin. Possible future actions include restrictions on rare earth metal exports which are essential components of many products such as iPhones and electric vehicles, potentially hitting U.S. technology companies hard. The U.S. meanwhile has been allowing businesses to lodge requests to exclude certain imports from tariffs. However the process for exclusion from the three rounds of tariffs currently in place has been a slow one. As of mid-July, the USTR had only completed 60 of the total 2,900 requests for tariff waivers on List 2 imports – the second round of tariffs imposed in August 2018.

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Bad loans in China's banking system rise as capital adequacy falls

Bad loans in China's banking system increased in the second quarter according to data from the China Banking and Insurance Regulatory Commission. Meanwhile, capital adequacy ratio, the ratio of banks' capital to their risk, declined in the quarter. Total non-performing loans (NPL) in the banking system increased 3.6% from Q1 to $316.6 billion at the end of Q2, while core tier 1 capital adequacy ratio fell from 10.94% in Q1 to 10.71%. Tier 1 capital marks a bank's available capital to absorb losses without ceasing operations.

The capital adequacy ratio measures a bank's available capital as a percentage of its credit exposures and is used to protect depositors. In general, a higher ratio is better for the economy as banks have more cash to cover the cost of unforeseen risks. China's central bank has a minimum ratio requirement of 10.5% for standard banks and 11.5% for systematically important banks. Although the authorities are still finalizing a definitive list of the country's systematically important banks, there is expected to be 30 such banks including the four largest commercial banks which global regulators have already applied the designation to: Industrial and Commercial Bank of China, Bank of China, China Construction Bank, and Agricultural Bank of China.

China's sovereign wealth fund took over HengFeng bank on Aug. 8, the third time since May that the state has nationalized a troubled lender. In the past two years, fines for irregularities in the banking and insurance sector exceeded the total amount of the previous 10 years, Xinhua reported. Bad debt has plagued China's banking system for years, but the government's effort to tackle the problem has been made more difficult recently due to the slowing economy. In March, China set a mandatory target for banks to increase lending to small companies by 30%, the first time it has ever done so in an annual work report, and ordered the loosening of NPL ratio tolerance for small companies by 3%. These measures encouraging lending to small companies carry the risk of accumulating bad debt in the banking system, but it seems that this is a risk the government is willing to take to stimulate a faltering economy. 

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Shanghai introduces new measures to attract MNCs

Shanghai's municipal government announced new measures to further attract foreign investment into the city, especially targeting multinational corporations (MNCs) and their regional headquarters (RHQs). Highlights include the reduction of asset requirements for parent companies of RHQs from $400 million to $200 million and the removal of the requirement currently in place that RHQs be wholly foreign-owned enterprises.

The measures are designed to attract more RHQs to the city, the Shanghai government said. Requirements to set up holding companies such as previous domestic investment and paid-in capital will also be scrapped. The city government is also working with the State Administration of Foreign Exchange to allow foreign employees of RHQs to receive stock options on the A-share market for the first time, a move likely designed to attract global talent as A-share options are often included in employees' pay packages.

Around 700 RHQs can be found in Shanghai today, the most in mainland China but still far behind Hong Kong and Singapore. As Hong Kong's status as an international financial center undergoes serious challenges due to the ongoing protests, these new measures look to bolster Shanghai's credentials as a leading destination for RHQs. From January to July, 4,105 foreign-invested projects including 26 new RHQs were launched in the city, an increase of 58.3% from the same period last year. In 2018, it successfully lured the U.S. electric vehicle giant Tesla to build its first factory outside the U.S. in Lingang – an area recently added to the city's free-trade zone, doubling its size. Shanghai has said it wants to be a global financial center by 2020.  

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Shenzhen to see extensive reforms as model for high-quality development

Shenzhen, China's booming high-tech capital, will be given special status as a model city for economic strength and high-quality development for the rest of the country, the State Council announced. The document published Aug. 18 includes goals for Shenzhen to be one of the world's leading cities in innovation, public service and environmental protection by 2025, and a national model of development and entrepreneurship with international influence by 2035.

The document outlines a range of reforms to be implemented in Shenzhen. International organisations will be encouraged to set up offices in the city, while foreigners with permanent residency will be encouraged to establish technology companies with simplified exit and entry procedures. The city's role in the Greater Bay Area is also highlighted, with plans to grant it new privileges in yuan internationalization and increased links with the financial markets of Hong Kong and Macau, including in fund recognition.

Although specific details were in short supply, the document nevertheless signals Beijing's strong backing of Shenzhen as the high-tech driver of the Greater Bay Area strategy and a model of development for other Chinese cities. Several leading Chinese technology firms are based there, including Huawei, Tencent and ZTE. Its stock exchange is the country's second largest and has a special Nasdaq-type "Chinext" board for high-tech startups which will see its registration process improved according to the latest announcement. 

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FTZ Negative List shortens: Special Administrative Measures for Foreign Investment Access in Pilot Free Trade Zones (Negative List) (2019 Edition)