Is China facing a Japanese bubble trap?

THINK ASIAN BY ANDREW SHENG

AS the world debates whether the renminbi (RMB) is undervalued, the real concern is whether after the RMB revalues, China will repeat the mistakes of Japan during the 1985 post-Plaza Accord period.

In that decade, the yen rose from roughly 240 yen to one US dollar to as low as 80 by August 1995 and then depreciated to 147 in June 1998 before joint intervention stopped the depreciation worsening the Asian crisis.

During this period, Japan suffered the worst asset bubble with the stock market falling by more than 80%, land prices falling by over 60% and the banking crisis took nearly a decade before it was finally resolved.

The Japanese public debt rose to nearly 200% of GDP, one of the highest in the OECD countries and Japan had almost zero growth for nearly two decades, as interest rates were kept near zero.

The worst part of the Japanese dilemma is that with a huge overhang of the public debt and an aging population, Japan may face both a decline in population and also an implosion in the wealth holdings if interest rates were to go back to global levels.

Note that unlike the US, which has a lot of foreign debt owed in US dollars, the high level of Japanese debt is yen debt owed to its own citizens.

There are many foreign commentators who think that after the recent increase in credit in the Chinese banking system, equivalent to nearly 40% of GDP, with a broad money to GDP ratio of 180% of GDP, that China may be facing a Japanese-style meltdown.

What is the truth and what is the correct analysis?

In the period 1950-70, Japan enjoyed high growth, high capital formation, rapid monetization and rising property prices, very similar to what China is going through.

The interesting point is that monetization did not appear to be highly inflationary, so in the run-up to 1989 at the height of the asset bubble, the Bank of Japan was initially reluctant to raise interest rates.

Exactly like what happened with the US subprime bubble, there was also insufficient regulatory action to stop banks exposing themselves to real estate loans. Koyo Ozeki is Japan analyst for PIMCO and his analysis in December 2009 is very illuminating (www.pimco.com).

The amount of bank lending equivalent to nearly 40% of GDP also went into Japanese real estate between 1985 to mid-1990s.

In the case of Japan, most of it went into commercial real estate. Real estate loans to individuals for mortgages only accounted for 20% of the total credit growth.

What was interesting was his comparison of Japan (1985-91), US (2000-2007) and China (2003-2009).
During these periods, Japan and US grew roughly by 3% per annum, whereas China grew by 10%.

Real estate bubbles during this period were roughly 2 times in price growth for China and the US, but 5 times in the case of Japan.

He felt that since in China “there is overwhelming shortage of residential property that meets its new living standards; it will likely take a considerable amount of time for supply to catch up to demand.”

He “sees little risk in the foreseeable future that increase in loans to the real estate sector will pose a threat to the financial system”, but also recognizes that “a rapid increase in lending could lead to a rise in bad debt in the future.”

What were the Japanese policy mistakes during the bubble period and what can we learn from this?
One of the most distinctive features of the Japanese experience was how long it took to bring the banking crisis under control.

It was almost eight years after the bubble burst in 1989 before the first serious failures of banks forced the government to use public funds to prevent the meltdown in the banking system.

Hiroshi Nakaso, formerly from the Bank of Japan, wrote probably the best technical analysis of this experience for a paper for BIS in 2001.

Part of the problem was that no one understood the scale of the losses because there was a paradigm shift.
Richard Koo, the chief economist of Nomura Securities, called this a “balance sheet deflation”.

No one understood how serious the real estate bubble had on the balance sheet of the banking system.

I have argued that the real estate bubble is the elephant in the room – no single government department is in charge and current fragmented monetary and regulatory theory grossly underestimates the importance of real estate as collateral for companies and bank loans, income for local governments and wealth of households.

So when the real estate bubble burst, the damage to household, corporate, government and bank balance sheets is huge, but the effects may take a while to recognize in accounting terms.

Ozeki (2008) noted that it took the Japanese government a long time to recognize the asset deflation because most people assumed that the property prices would turn around after such low interest rates.

Secondly, the Japanese banks had large latent profits from their holdings of corporate shares that everyone assumed that they could cushion themselves from the asset losses. But the more the banks sold the shares, the lower the stock market prices became, creating a downward spiral in confidence and growth.

Thirdly, the cumulative bad debt problems were as large as 25-30% of GDP, in addition to actual write-offs amounting to 20% of GDP.

No one has an accurate number on the massive deflation of the Japanese real estate bubble.

Assuming that the US real estate/GDP ratio of 225% of GDP was the ratio for Japan in 1989 and prices deflated by 60%, then the wealth loss could be as high as 130% of GDP. Because these were commercial real estate, most of the losses were borne by the corporations, and those who could not finance their losses transferred it to bad debt for banks.

Given the fact that the banks had capital not more than 10% of GDP, it was not surprising that the Japanese banking system could not by themselves get out of the bad debt burden without large fiscal help.

Most analysts identify the new credit in China as being given to local government financing vehicles. This is the topic that I shall discuss in the next article.

> Datuk Seri Panglima Andrew Sheng is adjunct professor at Universiti Malaya, Kuala Lumpur, and Tsinghua University, Beijing. He has served in key positions at Bank Negara, the Hong Kong Monetary Authority and the Hong Kong Securities and Futures Commission, and is currently a member of Malaysia’s National Economic Advisory Council. He is the author of the book “From Asian to Global Financial Crisis”.

Sime Darby dethroned

PETALING JAYA: Sime Darby Bhd has been dethroned as the largest company on the FTSE Bursa Malaysia KL Composite Index (FBM KLCI) and now occupies third place after having shed close to RM5.89bil in market capitalisation over the last one month.

Instead, Malayan Banking Bhd (Maybank) now reigns as the largest company on Bursa Malaysia with a market cap of RM50.54bil as at May 27.

Second spot is held by CIMB Group Holdings Bhd with a market cap of RM47.89bil.

Over the last four weeks, Sime Darby’s shares have shed some 98 sen, and it now has a significantly lower market cap of RM47.05bil compared with RM54.15bil six months ago.

The selldown in Sime Darby was perpetuated by the discovery of RM964mil in provisions, which caused investors to lose confidence in and rush to dump the stock.

Maybank’s market cap has in fact increased by RM2.2bil over the last six months on the back of operational improvements.

It recently reported third quarter to March 31 net profit of RM1.03bil, which was 105% higher than the previous corresponding period.

The nine-month cumulative period saw net profit rise to RM2.9bil, driven by higher growth in all sources of operating revenue and a lower loan loss provision.

Since May 13, the FBM KLCI has retraced 77.76 points to 1,269.16. On a year-to-date basis, it is lower by a mere 6 points from 1,275 on Jan 4. The FBM KLCI’s impact on Malaysia’s 10 largest companies has not been quite as bad.

On a six-month basis, five of these companies have still managed to increase their market cap despite the volatility.

MISC Bhd has been a winner and looks poised to become one of the world’s largest tank terminal operators, having entered into a conditional sale and purchase agreement with Vitol Group for the acquisition of a 50% stake in VTTI BV worth some RM2.4bil.

VTTI is one of the largest independent tank terminal operators in the world with a network of terminals spreading across 11 countries.

“This buy serves to expand significantly MISC’s existing tank terminal operations − currently two terminals, one each in Tanjung Langsat and Tanjung Bin. We understand that VTTI’s current tank terminal capacity of 5 million cu m is expected to rise to 8 million cu m by 2012,” said an analyst from AmResearch.

Significantly, IOI Corp Bhd has lost close to RM5bil in market cap at RM31.76bil. On Wednesday, IOI touched a 10-month low of RM4.67 in intra-day session following more selling pressure.

The efficient planter reported a decline in earnings from its plantations division in the quarter ended March 31, down 12% to RM282.02mil.

This was due to lower operating profit from the low crop season which also coincided with the hot weather, further aggravated by the recent El Nino phenomenon. The industry is expected to feel the heat of the weather anytime from six to 24 months.

Meanwhile, Axiata Group Bhd is enjoying a good run, with its market cap gaining some RM5bil to RM31.64bil, as net profit ballooned to RM921.5mil for the first three months from RM63.9mil a year ago.
This was boosted by higher sales from overseas units and disposal of shares in Indonesian subsidiary, PT XL Axiata Tbk.

XL Axiata has been performing better than expected on the back of the telco industry in Indonesia undergoing a revolution of data usage.

This phenomenon started when BlackBerry and iPhone handsets flooded Indonesia last year. There has been a surge in data revenue, mainly from Internet access charges, via the 2G platform.

By TEE LIN SAY
linsay@thestar.com.my

 SIME :  [Stock Watch]  [News]

Tapping young investors

OPTIMISTICALLY CAUTIONS BY ERROL OH

IN this week’s Monday Starters column in StarBiz, deputy executive editor Soo Ewe Jin wrote about Bursa Malaysia’s goal of getting more young adults to invest in our stock market. One suggestion from the exchange is that people should buy stocks for their children so as to kindle an interest in share investing at an early age.

It’s a modest step but the ideas behind it are important – that we should start young and that parents have a major role in shaping their kids’ attitudes towards investments. If we lose sight of these, it’s the equities market that may suffer.

To maintain its liquidity and vibrancy, our stock exchange needs a healthy proportion of buying and selling by individual investors. Last year, retail participation accounted for a third of the trading value in Bursa Malaysia’s securities market.

It’s an improvement from the 24% recorded in 2008, but still a long way from the 60% level seen about a decade ago.

In trying to draw in retail investors, Bursa Malaysia is targeting the youthful set. In the chief executive officer’s message in the exchange’s annual report 2009, Datuk Yusli Mohamed Yusoff wrote: “We are cognisant that we need the young generation investor base.”

Recent market research commissioned by the bourse found that there’s a generation gap in the Malaysian share investing arena.

The findings are presented in a booklet published as part of Bursa Malaysia’s Rethink Retail project.

According to Omar Merican, the exchange’s chief operating officer, the project’s aim is “to reach out to younger audiences to create more awareness on the capital market and how they can become more involved”.

The research has determined that investors aged between 20 and 29 make up almost 30% of the investing population but only 12% of share investors. Most of the other share investors (nearly 60%) are at least 40 years old.

It’s not that the young don’t have the money to invest in shares. They prefer to seek returns from other avenues – savings accounts, unit trust, investment-linked insurance and property.

Says Yusli in the booklet’s foreword: “We believe the future growth lies with the young Malaysian segment that is the untapped potential for the growth of this industry. There is, however, a challenge in getting more youngsters interested in viewing share investing as an option to building their investment portfolio.”

There’s a perception problem here. The research shows that the majority of young potential investors are intimidated by the risks associated with shares. They think investing in futures, options and foreign currency is less risky.

They see share investing in Malaysia as having “a strong speculative character”, and some liken it to gambling.

Just where did they get that notion? We should look at the dominant component of the share investing population – those who are 40 and above. And most of them are, in fact, parents.

Are these moms and dads teaching their children about investing in the stock market? Are they imparting the skills and knowledge that come through the experience of riding the ups and downs of the market?

If the parents cum share investors are not doing enough to help their children develop a firm understanding of share investing, the likely issue here is that they’re poor at engaging with and relating to the kids. Or maybe the parents don’t know all that much about investing in stocks.

Or could it be that parents think that share investing is so tough and perilous that don’t fancy the idea of the children going into it, in the same way that a smoker won’t encourage his child to start lighting up? If that’s the case, that’s just bad parenting – “Yes, I do it, but that doesn’t mean you should.”

There’s another possible reason for the young people’s aversion to share investing. They do passively learn about it from their parents, except that they largely pick up on the negative aspects.

The Rethink Retail booklet hints at that: “The speculative image (of share investing in Malaysia) is further fuelled with the emotional success and failure stories told by friends, family, colleagues and others”

And let’s not forget that some investors don’t rely on fundamentals and diligence. Instead, they trade based on tips and rumours. What conclusions will a child form about share investing when he often hears his parents spouting lines such as “Can still go in. They’ll push it up to RM4.30.” or “The general election is coming. The share price will surely fly?”

Bursa Malaysia has plans to convert youngsters into share investors.

In the booklet’s conclusion, the stock exchange says: “If we are able to reach out to potential investors, especially the young investors, we can change their perceptions of share investing and make shares an option to savings, deposits, property, unit trust and investment-linked insurance.”

Sure, Bursa Malaysia can do this on its own. Still, it wouldn’t hurt if the parents buy into the programme as well. But for that to happen, the parents must first believe that stocks are solid long-term investments as long as everybody plays by the rules. Now that’s the real challenge, isn’t it?

>Deputy executive editor Errol Oh is working on a pre-schoolers’ book on the stock market, tentatively titled The Stock That Sank Like A Rock. But he’s stuck because he can’t find simple, familiar words that rhyme with ‘Bursa’, ‘dividends’, ‘warrants’ (nope, ‘blackcurrants’ doesn’t work in this context) and ‘unusual market activity’.