Bumpy Months Ahead for U.S. and China

The visit of U.S. National Economic Council Director Lawrence Summers and Deputy National Security Adviser Thomas Donilon that started Sunday kicks off a historically busy period of U.S.-China exchanges on which a lot is riding in the world’s most important bilateral relationship.

Summers and Donilon will be discussing a range of thorny issues — including U.S. frustration over China’s currency policy and Chinese anger over U.S. involvement in the South China Sea — with senior officials including Vice Premier Wang Qishan and State Councilor Dai Bingguo, and probably Premier Wen Jiabao or President Hu Jintao, or both.

Then, in about two weeks, Wen travels to New York for a meeting of the United Nations General Assembly, during which he’s also likely to have a bilateral sit-down with U.S. President Barack Obama. Then in the first week of November is the next round of the U.S.-China Joint Commission on Commerce and Trade, which will cover the gamut of bilateral trade issues.

About a week later is the G-20 Summit in Seoul, followed by the APEC Economic Leaders’ Meeting in Yokohama, Japan, both of which are likely to see additional meetings between U.S. and Chinese officials. Then, around January, Chinese President Hu is expected to go to Washington.

The flurry of meetings is “possibly more than any other exchanges in any five-month period” in the modern history of the relationship, says John Frisbie, president of the U.S.-China Business Council, who has been involved with China since the 1980s.

While much of that schedule was set long ago, the interaction couldn’t be better timed. U.S.-China relations are in one of their periodic phases of tension, with issues like the yuan’s exchange rate and the South China Sea threatening to snowball if not handled carefully.

Frisbie and others say there is serious frustration in Washington that China’s currency has barely budged since Beijing’s high-profile announcement in June that the exchange rate would be more flexible. That anger is likely to be on display during back-to-back hearings on the yuan in the House and Senate next week, and, undoubtedly, in the run-up to the U.S. midterm elections in November. “On currency, the risks of legislation are definitely rising,” says Frisbie.

Meanwhile, China’s government and media continue to stew over U.S. Secretary of State Hillary Clinton’s decision to counter Chinese rhetoric on the South China Sea with a surprise statement at an Asean meeting in July that the region is part of U.S. “national interest.”

The move so shocked the Chinese delegation that Foreign Minister Yang Jiechi, by multiple accounts, lost his temper and lashed out at representatives of other Asean members, including Vietnam, which was hosting the meeting.

All of that’s not to mention Iran, North Korea, trade, climate change and indigenous innovation, among other less-than-simple issues weighing on U.S.-China ties these days. Whatever happens, it’s fair to guess that diplomats in Washington and Beijing won’t be having a restful five months.

– Jason Dean

(http://blogs.wsj.com/chinarealtime/2010/09/06/bumpy-months-ahead-for-us-and-china/)

Sony Ericsson Doesn’t Fear Chinese Knock-Offs

Mobile phone maker Sony Ericsson doesn’t think knock-off Chinese phones are harming its market share, but Chinese handset makers will be “serious” competitors long-term, the company’s chief executive said in Beijing this week.

China’s knock-off gadget culture has spawned all manner of quirky devices, like mobile phones labeled “Samsang” instead of “Samsung,” fake iPads and iPhones and sometimes handsets with wacky designs, such as bodies shaped like race cars or cigarette boxes.

Many of those phones, unlike handsets from legitimate Chinese handset makers, are made and sold without licenses from government regulators. The unlicensed phones are also being shipped to other countries, and market researcher iSuppli late last year estimated total shipments would be 145 million units in 2009, or 12.9% of the global market for legitimate cell phones. That has raised the prospect of growing illicit competition for even major handset makers.

But Sony Ericsson Chief Executive Bert Nordberg dismissed what he called “copy phones” at a Wednesday news briefing.

“I am very proud that we are worth copying. And that has increased a little bit, so we know that our brand is going up,” he joked. “I think I have 50 boxes in my office of the copy phones that we have collected.”

Nordberg, a Swede born in 1956, said he doesn’t think the knock-off phones have stolen much market share. “I think people want the real thing. You know, when I was young, I bought copy watches. It feels much better when I could afford a real watch.”

But competition from legitimate Chinese handset makers is a bit more worrying, as they are mainly low-end so far but are starting to win more deals with Western Europe network operators, who often stamp their own brands on the Chinese phones, Nordberg said.

“They will be a serious competitor, the Chinese vendors, long term,” he said.

Chinese companies such as PC maker Lenovo Group and telecommunications hardware makers ZTE and Huawei Technologies are pushing to sell more smartphones in China and overseas. Other local handset makers, such as Beijing Tianyu Communication Equipment, also known by the name of its K-Touch handset brand, are also gaining market share on their home turf.

– Owen Fletcher. Follow him on Twitter @owenfletcher

(http://blogs.wsj.com/chinarealtime/2010/09/03/sony-ericsson-doesnt-fear-chinese-knock-off-phones/)

PBOC’s Hu on the Yuan, U.S. and Global Economy

Hu Xiaolian, deputy governor of the People’s Bank of China, sat for an interview Tuesday with The Wall Street Journal. She is the most senior of five deputy governors under central bank head Zhou Xiaochuan and has been the front person for the new currency policy the central bank rolled out in June.

Previously she was also head of the State Administration of Foreign Exchange, the arm of the central bank responsible for managing China’s foreign exchange reserves. Edited excerpts from the interview:

On China’s plans to liberalize the use of the yuan for cross-border trade and investment

“The expansion of pilot programs of yuan settlement of cross-border trade is based on increasing market demand. Following the outbreak of the financial crisis, there have been large fluctuations in exchange rates of major settlement currencies. Companies have a real need to manage their exchange rate risk. Particularly for China in its trade with other developing countries, both sides want to use their own currencies to settle trade. Also, the policies adopted by the Chinese government in response to the financial crisis have increased international confidence in China and the yuan. In general, market demand is the driving force for the yuan to be used in cross-border trade and investment.

“In response to the market demand and to facilitate trade and investment, we will gradually lift the restrictions on the use of the yuan. In the old days when foreign exchange was in short supply, all trade and investment activities were required to be settled in foreign currencies. Now we want to assess the new situation, consider the real market need, and gradually lift these restrictions.

“There’s now demand for the yuan to be used in cross-border investment and we’ll consider that as a next step. That includes outward investment made by Chinese enterprises and also outside enterprises and institutions that have satisfied certain requirements investing in China. As long as there is a demand we will consider such changes.

“In our view there are many conditions that must be met before a currency can be regarded as an international currency. The yuan has a long distance to go before it can become an international currency.”

On U.S. pressure for the yuan to appreciate more quickly against the dollar

“My view is that the yuan doesn’t have a key role to play in rebalancing bilateral trade between the U.S. and China. I don’t think excessive argument and criticism on this issue will help, but I think it’s important to encourage communication for better understanding. Implementation of structural policies deserves more attention.

“We emphasize that the yuan exchange rate has moved close to its equilibrium level as measured by the current account surplus as a percentage of GDP…You can see the percentage has been declining. We also emphasize that if you look at trade, you need to look at trade with the rest of the world and not just one country.”

On the need to rebalance the global economy

“The Chinese government has taken a lot of measures to boost domestic demand and encourage consumers to consume. The growth pattern of the Chinese economy will gradually shift. We have been taking concrete action and we hope there will also be some change in the growth pattern of the U.S. economy. The U.S. economy should move away from overconsumption based on excessive borrowing and savings should grow. ”

On the management of China’s foreign exchange reserves

“When SAFE invests China’s foreign exchange reserves, there’s no difference with other central banks, that is, it focuses on safety, liquidity and return. These investment activities should not be politicalized.

“In international markets, China is a responsible investor. We invest for the long term. If there are misunderstandings, we will resolve them by communication.”

On the global economy

“The global economy is still recovering, sure. But the recovery will be quite slow and with some volatility.”

– Rebecca Blumenstein, Andrew Browne and Dinny McMahon

(http://blogs.wsj.com/chinarealtime/2010/09/01/pbocs-hu-on-the-yuan-us-and-global-economy/)

Microsoft on Bing, Piracy, Xbox in China

Microsoft has a huge potential market in China. The country is the world’s second-largest PC market by shipments behind the U.S., creating a widespread need for software, and Microsoft has healthy government relations with China. Research firm IDC expects PC shipments in China to grow 25% to 67 million units this year.

But tapping the China market has never been that simple for foreign tech companies, from eBay to Yahoo to Google. Rampant piracy plagues Microsoft’s Windows operating systems and other programs — as it does all software in China. Bing, Microsoft’s search engine, has gained little traction in the country. And China places limits on the sale of videogame consoles like the Xbox.

Simon Leung, Microsoft’s chief executive for the Greater China region, talked about how cloud computing can help stop piracy, how Bing competes with Google and Baidu, and how Microsoft can catch up with Apple in the smartphone race. Edited excerpts:

The Wall Street Journal: Where is Microsoft headed in China in the next few years?

Mr. Leung: China is going to become the largest PC market in the world very soon. And then if you look at China, [it is] the world’s largest mobile phone market, the world’s largest broadband market…If you really look at everything, there’s only one way to go, which is growth.

The whole country is moving toward cloud [computing, in which data are managed and accessed over the Internet]. We are in a great position to take advantage of that…you cannot pirate a cloud application.

WSJ: Does the piracy problem lie more with big Chinese enterprises than with consumers?

Mr. Leung: For the companies I think there are two issues. There’s pirated software, and there is something called mislicensing. To us it’s still a form of piracy…Sometimes they do it maybe purposely, and sometimes it’s unintentional. So we do have an issue more with mislicensing in the big enterprises rather than piracy exactly. But in [small and medium businesses] in general, it will be more on pirated copies.

WSJ: Are you satisfied with how Bing is doing in China?

Mr. Leung: I think you can only be satisfied when you get to a No. 1 market share…China is going to be a great potential market for us going forward. No. 1 is just the organic growth. No. 2 is more on the future in terms of mobile search.

WSJ: Has Google moving its China search service to Hong Kong this year opened up any market opportunities for you?

Mr. Leung: They are not the No. 1 market player. So we are going to have competition with or without Google.

WSJ: Do you expect to take market-share more from Baidu than Google, then?

Mr. Leung: Well, we want to take market-share from our competitors, yes. We will take market-share.

WSJ: Would you consider ending censorship of search results on Bing in China?

Mr. Leung: We do two things. One is we support freedom of speech and expression. But we also respect each individual country’s requirements. By the way, every country has some sort of requirement to censor.

WSJ: Do you hope to offer the Xbox in China?

Mr. Leung: We always hope that we get the Xbox in China, period, because it is a very good product, especially with [motion-control unit] Kinect coming up. If you look at the concerns that China has, they worry about people just staying at home and not interacting and all that, and not exercising, so if you look at Kinect, it actually solves a lot of these problems…You can get good exercise out of it.

WSJ: Piracy could hurt Xbox game sales if the console does launch in China. Would Microsoft’s revenue mainly come from the hardware?

Mr. Leung: No, actually it’s from both. There are different ways to address this issue. One of the things about [online video gaming service] Xbox Live is that you need to get access to the network, and then you can go and play it, so we can do authentication. The business model will be very different from just selling software that sits on a PC.

WSJ: Microsoft shares in the U.S. this year are down about 20%. What are you doing to turn around the decline?

Mr. Leung: The overall market is down, because of the U.S. economy. Our strategy has not changed. When we talk about our future, it’s actually the cloud…Of course there are some areas that we need to step up, Windows Phone being one of them. We’ve been very open about it. But again, the bulk of our revenue is coming from Windows and Office and our databases, Xboxes and all that.

WSJ: Apple has a big headstart in smartphones. How will Microsoft catch up?

Mr. Leung: Before, we basically provided a software platform, and people can innovate on the platform. The good news is that you’re very flexible, but the not-so-good news is actually, No. 1, the user experience is different from phone to phone. And No. 2, because different manufacturers can be very flexible in terms of the hardware, so again that will impact on the end-user experience.

Windows Phone 7 is actually quite different. We kind of mandate the same user experience, plus essentially we are very tightly tied to the chipset manufacturer. We can ensure there’s actually the same user experience, both from an interface perspective and a performance perspective. That allows our [original equipment manufacturers] to really refocus on the engineering on the form factors and all that, innovating that way.

– Owen Fletcher. Follow him on Twitter @owenfletcher

(http://blogs.wsj.com/chinarealtime/2010/09/01/microsoft-on-bing-piracy-xbox-in-china/)

China, Here Comes Fight Club

The country that brought the world martial arts is about to get a taste of American-style extreme fighting, with the introduction of the Ultimate Fighting Championship organization in Asia.

The fight organizer and promoter for the form of sports-combat called mixed martial arts announced that it would be setting up a foothold in Asia. The company didn’t specify where it would set up shop, but its new chief in Asia is Mark Fischer, a former exec with the National Basketball Association Inc., who lives in Beijing.

As part of its sop to Chinese audiences, the UFC is also touting the addition of an Inner Mongolian lightweight bruiser named Zhang Tiequan to a televised bout through its sister organization, World Extreme Cagefighting. The group said it will also leverage its existing ties with the China National Wushu Federation to drum up support and talent.

Mixed martial artists may combine elements from many styles of hand-to-hand combat or wrestling in their repertoire, or fights can pit combatants who specialize in one type of combat against someone who trained in a different fighting form.

To manage UFC’s Asian business, the fight group owned by Las Vegas-based Zuffa LLC is turning to Fischer with the hope that some of his magic touch in marketing the NBA can rub off on their fledgling Asian franchise.

Basketball has been one of the few American sports imports to become a winner in China.

Under Fischer’s direction from 2003 to 2008, the NBA managed to ink more than 20 marketing partnerships with leading brands in the country. Tsingtao, for instance, is now the official beer of the NBA in China. The NBA has actually set up a separate corporate entity for its China operations, which was valued at $2.3 billion when it was set up in 2008.

Other sports, which came to the party a little later, just haven’t had the hot hand when it comes to gaining acceptance in the Chinese market.

National Association for Stock Car Auto Racing Inc. executives went on a China junket in 2007 to drum up sponsors and gauge what potential interest might exist for its brand of high-octane, fuel-fired racing thrills. So far, the answer appears to be very little. Meanwhile, the National Football League set its sights on China in 2009 and has been staging exhibitions and rebroadcasting games in the country with Chinese color-commentary. However it, too, seems to be getting blitzed in China.

Sports like auto-racing, football, and even baseball suffer from a want of attention in a country where the focus is on winning medals and national glory.

Major League Baseball has a 10-year development program that it has recently put in place in the country, but there are doubts about how successful it can be, according to reports in state media outlets. The marquee stadium in Beijing, built for the Olympic Games in 2008, has already been demolished to make room for new real estate developments.

Some sports fans and industry experts are skeptical about the UFC’s prospects as well. “I think that it’s interesting, but not sure how much of a market exists here, since people are very much into wushu, taekowndo and other ‘traditional’ martial arts,” said one sports marketing professional. “UFC is a little out of the mold.”

Meanwhile, a 30-year-old Taiwanese fan of the UFC who was educated in the US, said the UFC bouts might be too much for Chinese fans. “I don’t know how the Chinese will react to the violence of the UFC, but it’s going to be exciting to see it come home after being treated by the wash cycle of western entertainment.”

– Jonathan Shieber

Related:
A Smackdown in Shanghai
Mixed Martial Arts Back in Hong Kong

(http://blogs.wsj.com/chinarealtime/2010/08/31/china-here-comes-fight-club/)

Moto Out-Apps Apple in China

Motorola, which has regained some credibility with the Droid/Milestone and its new focus on Android smartphones, also seems to be trying in earnest to do things right again in China, where it has lost significant market-share in recent years.

Aside from a relaunch Monday of Moto’s hit Ming series in China, the company has started a Chinese version of its application store called Shop4Apps which, unlike Apple’s Chinese App Store, is available in Chinese.

Moto’s application store, which can be used in addition to Google’s Android Market on Motorola smartphones (though the marketplace isn’t preloaded), also accepts payment in Chinese currency and via widely used payment methods in China like AliPay and through prepaid phone cards. Apple’s App Store, meanwhile, requires a dual-currency credit card, which many in China don’t have.

To be sure, Shop4Apps offers only 800 applications at the moment, but Motorola handsets can be loaded with Android-compatible applications from other sources. (IPhones have to be hacked, or “jailbroken,” in order to use non-App Store applications, but many in China are already jailbroken because they are brought in unofficially through the gray market.)

The contrast highlights another important area in which Apple has been slow to tailor its products for China, the world’s largest mobile market. Despite high demand for the iPhone in China, the company didn’t officially launch the device here until last October, and hasn’t yet said when the iPhone 4 will be released here. Though Apple has said it plans to open 25 Apple Stores in China by the end of 2011, it currently only has two. As a result of this sluggish pace, Apple has had significantly less lead time here than in the U.S. over Motorola and other competitors in promoting its mobile devices.

Apple did not respond to requests for comment.

Applications have become a vital part of smartphone use in the U.S., where consumer interest in games, social media and other mobile services has generated billions of downloads for the iPhone and other devices. Though China is still in early stages of 3G development, interest in apps outside tech-savvy early-adopter types has been relatively small in China.

According to state-run newspaper People’s Daily, software developers in China say there are five million Apple system customers in the country. But because finding and downloading apps from Apple’s App Store in China is cumbersome, many users get their applications preloaded by electronics sellers or from independent Chinese app stores, some of which allow consumers to add charges for downloads to their regular cellphone fees. Not all of these application offerings are licensed.

Developers say the fragmented application market, and the ease with which Chinese users can get pirated applications in China, have made it more difficult to capitalize on China’s growing smartphone use. In effect, it is driving developers to develop more for overseas markets.

Apple’s China App Store for example “makes very little money since everyone just loads up pirated software,” says Frank Yu, chief product officer at Bokan Technologies Co., a Beijing-based developer. Meanwhile, developers can develop in English and release their applications in more than 50 countries that are more profitable than China, he said.

– Loretta Chao

(http://blogs.wsj.com/chinarealtime/2010/09/01/moto-out-apps-apple-in-china/)

Turning Savers Into Shoppers

China is on pace to become the world’s second-largest economy this year after the U.S. For companies operating in a global landscape of contracting consumption, China has emerged as one of the world’s most hopeful consumer economies. The nation’s middle class is buying up everything fromcars and phones to makeup and apparel.

But despite all the growth, it turns out that China’s consumers aren’t living up to their shopping potential. China’s shoppers, who outnumber those in any other country, still only make up 5% of the world’s $35.9 trillion consumption total, according to the study, issued this week by the Economist Intelligence Unit, in cooperation with Bayer.

Compare that to 29% for the U.S., where consumers are still reluctant to open their wallets amid the slow economic recovery. Europe accounts for 26.2%.

What’s holding China’s big spenders back is a deep devotion to saving. Urban residents stash away up to 34% of their earnings, putting money away not only for themselves, but also for the generations ahead of them. Across the nation, people are concerned about air pollution and even environmental disasters, the EIU reports.

But the No. 1 concern, the survey showed, is health care, with 84% of rural respondents citing health as their greatest concern for the future, and 61% citing cost as the main health-care issue facing their household.

Among relatively well-off urban respondents, 60% said they were concerned about health in the future — though many of them worried about the quality of doctors and hospitals (49%), with fewer worried about cost (a third).

Still, the survey, in line with recent findings from consulting firm McKinsey & Co and market research company Nielsen, also showed that Chinese citizens offer one thing that’s hard to find across the world these days: confidence. The EIU found rural and urban dwellers say they are willing to spend, even to upgrade products — televisions and mobile phones — they already own.

– Laurie Burkitt. Follow her on Twitter @lburkitt

(http://blogs.wsj.com/chinarealtime/2010/08/25/turning-savers-into-shoppers/)

Shining Light On China’s ‘Gray Income’

If Chinese people don’t trust the figures generated by their National Bureau of Statistics, they may have only themselves to blame.

It’s become increasingly widely accepted among researchers that better-off Chinese people not only hide their money from the taxman, they also don’t honestly answer the survey questions that government agencies use to figure out household incomes. The clear implication is that official income figures are too low.

“Due to people’s increasing sense of privacy, there is some omission and understatement in the current income survey, and relatively few members of high-income groups are in the survey sample,” writes one researcher.

This statement comes not from a bomb-throwing critic, but an official within the statistics bureau: Wang Youjuan, who this week published a lengthy essay (in Chinese) on the bureau’s website. The essay carries a disclaimer that it represents only the opinions of its author, and not the National Bureau of Statistics.

Wang’s essay was a response to a recent, widely circulated paper by an outside scholar, Wang Xiaolu of the National Economic Research Institute in Beijing, entitled “Gray Income and the Household Income Gap” (in Chinese).

The NERI paper presents the results of an unusual survey that tries to overcome the biases in the official income figures produced by the NBS. “We contend that the present statistics on residential incomes have major distortions, especially in the part concerning the disposable income of high-income residents in urban areas,” the paper says.

To get around this issue, NERI instead surveyed thousands of people who were personally known to the researchers — and therefore presumably more likely to be honest. That has its own issues: “Our method is different from that of random sampling, and therefore the data cannot be used directly to calculate the general distribution of urban residential income,” Wang Xiaolu concedes in the paper. (This and other quotes are from an English translation of the NERI paper provided by Credit Suisse.)

But he uses some complicated statistical tricks to nonetheless come up with an income distribution based on patterns of consumption among the people surveyed. The headline-grabbing result: China’s average annual per-capita income for 2008 is nearly twice the 15,781 yuan (about $2,300) estimated by the NBS. And this is primarily because of unreported “gray income” among higher-income groups.

Wang Youjuan of the NBS said that number is clearly too high, and took issue with how NERI constructed its survey, and also with the model used to come up with the income. (Among other things, he thinks that people are likely to lie about their income to acquaintances as well as to strangers.) But he did not reject the approach out of hand, saying that Wang Xiaolu had ideas and techniques that the NBS could learn from. And he emphasized that the NBS is trying to fill in the gaps on its own.

“We are currently organizing a large nationwide sample survey of urban households, and we hope by increasing the sample size and using a simpler questionnaire we can get a higher response rate and more participation by high-income households,” Wang Youjuan writes. The NBS is also working on other surveys that would collect indirect data about nonresponding households and estimate how big the omissions and under-reporting are, he says.

The response of the NBS is notable for its scholarly politeness — the tone is of disagreement among colleagues — and Wang Youjuan closes by thanking Wang Xiaolu for highlighting issues in the income statistics that need to be addressed. The NBS itself produced two different estimates of national household income: Based on the survey, it’s a total of 14 trillion yuan ($2.06 trillion), but in the flow of funds accounts, it adds up to 17.9 trillion yuan.

The detailed and technical response is also notable for how it circles around the political implications of Wang Xiaolu’s work: that income inequality in China is much worse than it appears to be, and that no one really knows how many wealthy people got their money. Wang Youjuan notes that income tax records, which other countries use to check the results of household surveys, are not extensive enough in China to be used for this purpose.

“Such a concentration of hidden income in high-income groups demonstrates that much of it is not about simple statistical problems in the household survey but potentially income from illegal sources,” Wang Xiaolu writes. “The facts show that gray income has its origins in the misuse of power and is closely connected with corruption.”

– Andrew Batson

(http://blogs.wsj.com/chinarealtime/2010/08/27/shining-light-on-chinas-gray-income/)

Huawei Embraces Android in New Smartphone

Huawei Technologies, best known as a telecommunications equipment maker, plans to unveil its latest smartphone running on Google’s Android operating system next week as the Chinese vendor looks to beef up its portfolio of high-end phones.

The global market for smartphones — those with enough power for tasks like downloading video and sending email — has grown sharply this year thanks to the popularity of Apple’s latest iPhone and new devices from competitors such as Samsung, Sony Ericsson and Nokia. Market tracker iSuppli forecasts that smartphone shipments will rise 35.5% this year to 246.9 million units.

The news from Huawei, which has a record of beating Western rivals’ prices for communications equipment, raises the question of whether its Android handsets will compete on price in a largely high-end smartphone market. Glory Cheung, a spokeswoman for Huawei, said prices for innovative smartphones must be lowered for mobile broadband services to reach more users, and that Huawei’s new phone will be “highly competitive price-wise.”

But Huawei didn’t say how much it will sell the new phone for or where it will be offered. Huawei currently has nine Android smartphones available in China, South Africa and other countries in Europe and the Asia-Pacific, Cheung said. 

One of those phones, the Pulse, from network operator T-Mobile, launched in the U.K. last year. T-Mobile’s website calls it the first Android phone available on a pay-as-you-go price plan.

Huawei will announce details on its new Android phone on Thursday. The device was jointly planned and developed with Google and will come with Android 2.2, a new version of the operating system, Cheung said. Cheung didn’t say which operators Huawei’s new phone will be available through.

It will be a selling point for the new phone that it is among the first handsets to come with the new version of Android, said Daryl Chiam, a senior analyst at research firm Canalys.

But it will still face tough competition from other smartphones if it launches in North America or Western Europe. Huawei will have to work closely with mobile operators, which dominate those markets, on issues like customizing its handsets for its phones to succeed there, said Chiam.

– Owen Fletcher. Follow him on Twitter @owenfletcher

(http://blogs.wsj.com/chinarealtime/2010/08/27/huawei-embraces-android-in-new-smartphone/)

Limits to the Banking Shell Game

China’s state-run financial system sometimes resembles a sort of shell game, with assets shifted between institutions to give the impression of systemic health but obscuring who is ultimately responsible if things go wrong.

However, it now appears that Beijing thinks they might only be able to push it so far.

China Construction Bank, Industrial & Commercial Bank of China and Bank of China are planning to replenish their capital by raising billions of dollars via rights issues. Central Huijin Investment, the domestic investment arm of China’s sovereign wealth fund and a major shareholder in China’s biggest banks, has agreed to subscribe to those rights issues.

The problem is that Huijin currently doesn’t have any free capital, so between now and the end of next year Huijin plans to sell 182.5 billion yuan (about $26.84 billion) worth of bonds to raise the necessary funds. And since China still has a fairly shallow pool of bond market investors — or at least investors that can subscribe in large volume — a very large chunk of those bonds are likely to be sold to China’s major banks.

As we’ve noted before, this can start to look a little curious: CCB, ICBC and BOC need capital so they’re selling shares to Huijin, which is raising funds to buy the shares by selling bonds, which are being sold primarily to CCB, ICBC and BOC. So the banks are funding their own recapitalization. (The ball’s under shell No. 3, see?)

It appears that the potential absurdity of this situation is perhaps not lost on Huijin.

On Friday, Chinese business magazine Caixin cited a person at Huijin as saying that CCB, ICBC and BOC won’t be allowed to apply to buy more than 88.3 billion yuan’s worth of Huijin’s planned bond offering.

The report couldn’t be independently confirmed. A person from Huijin contacted by The Wall Street Journal said she was unaware of limits being placed on banks buying its bonds.

But supposing it’s accurate: Why only 88.3 billion yuan? Because that’s the difference between the volume of bonds Huijin is selling (182.5 billion yuan) and the amount of new capital those three banks are raising (99.2 billion yuan — the remainder is expected to go to other financial institutions). That way enough money will be raised from third-party investors to cover Huijin’s commitment to the banks, and the money the banks pay for Huijin’s bonds won’t get recycled back into their own coffers. Right?

Well, not really. The underlying conflict still exists. China’s banks currently look quite solid financially. But say, for instance, their financial performance were to deteriorate to a point where they had to stop paying dividends. Then Huijin — whose income comes from those dividends — would struggle to repay the interest on the bonds. And that, in turn, could result in a decline in the value of the Huijin bonds that the banks hold — which would lead to a further deterioration of their capital, possibly requiring them to raise more funds. All that is true whether or not the amount of Huijin debt the banks can buy is capped.

Ultimately the health of China’s financial institutions can’t be measured by how much capital they hold on their books, but rather is contingent on the government’s own fiscal health. It’s the government’s implicit guarantee of the major banks that imbues the to-and-fro of capital between the banks and Huijin with its own logic.

Just don’t look under cup No. 2.

– Dinny McMahon, with contributions from Kersten Zhang

(http://blogs.wsj.com/chinarealtime/2010/08/27/limits-to-the-banking-shell-game/)