Video

#SaxoStrats
Today's edition of the Saxo Morning Call features the SaxoStrats team discussing the continuing weakness of the US dollar as commodity prices recover ground and in the wake of key US equity indices hitting all-time highs Thursday.
Article / 28 July 2014 at 12:50 GMT

Profits, politics and panic in China

Managing Director / Asia-analytica Research
China
• Anti-graft campaign hits commercial sector
• Deal-making slows as executives keep heads down
• Corruption probe bad news for company tight on cash flow

By Pauline Loong

China’s corruption watchdog has a website that attracts up to two million page views a day. Prurient interest is one reason for its popularity. Fear for self and family and friends is another.

But the bigger motivation for businesses and investors is to keep track of who is about to be thrown into the government’s corruption meat grinder so as to stay one step ahead of any commercial fallout.

The anti-graft campaign has been showing signs of moving beyond party cleansing into something of an audit of the commercial sector – including private businesses vulnerable to a sudden credit squeeze.

Corruption investigations are never just about one man. In China’s pay-to-play business culture, bribes involving big bucks are almost always inextricably linked to flaws in the system involving political patronage and powerful vested interests.

When a top executive falls, he typically brings down all around him. In the rare, best-case scenario, the impact on the company is confined to personnel issues. The popular joke is that big companies need to have contingency plans to fill vacancies left after an inspection by the corruption watchdog to keep the business running.

CNPC, which is at the centre of the biggest corruption probe into the state sector in years, is even said to have a rule requiring its middle to top-tier managers to report to their department heads daily. Anyone who does not do so is considered “gone” and will be replaced the next day by a pre-approved successor.

But more typically, the arrest of a chief executive or even rumours of such a possibility hurt the bottom line. Deals are frozen or fall through altogether as people opt to keep their heads down for fear of attracting unwanted attention. Private companies are driven to the wall as credit lines are pulled. And stock market listed entities find themselves facing shareholder lawsuits on top of their other legal troubles.

china hosp




















Average profit margins have declined in China's healthcare sector. Photo: iStock

The healthcare sector is among the most visibly affected. The industry had enjoyed easy growth in China for years. But the average profit margins declined to around 10 percent in 2013 from 15 percent in 2012 while average net profits fell 2.1 percent from close to 20 percent growth in previous years, according to an analysis of more than 60 listed Chinese healthcare firms by the news agency Reuters.

This is unsurprising given the current fearful climate. The industry’s sales representatives say they are finding it hard to even get a meeting with doctors who fear it might invite the watchdog’s scrutiny. And then there is the inevitable pressure on operating cash flow as banks typically withhold short-term credit lines and suppliers withdraw credit to companies in the private sector whose executives are under investigation.

The construction company Huatong Road & Bridge Group, which narrowly averted what would have been a historic bond default last week, blamed its predicament on a liquidity squeeze following the announcement of a corruption probe into its chief executive.

In normal times, even companies performing below par would not be pushed to the wall by short-term funding difficulties. But these are not normal times. Delayed payment of bills and outright defaults, which have reached levels serious enough to warrant investigation by a five-ministry task force, have been weighing down even healthy balance sheets. Such is the pressure on operating cash flow in many industries that any break in credit lines is the death knell for companies reliant on short-term funding to stay afloat, as we pointed out in a previous post.

Take your pick of probes 

The widening of the anti-corruption dragnet into the commercial arena is highlighted by the big corporate names in the news this month:

• Ex-SASAC director and one-time chairman of PetroChina Jiang Jiemin charged with corruption.
• The chief executive of the construction company Huatong Road & Bridge Group (which narrowly averted what would have been a historical bond default last week) “assisting” with corruption investigations.
• The conglomerate Haichang and the Rave Sun Group both accused of using public funds intended to help the firms invest in foreign high-tech companies to buy French vineyards

And still ongoing are the headline-grabbing investigations into executives at the British drugmaker GlaxoSmithKline and Roche Holdings, and the high-profile probes into executives at the state-run oil company China National Petroleum Corp (CNPC). Even Fudan University, in Shanghai, was named and shamed for misuse of research funds.

With the anti-corruption drive gaining momentum rather than fizzing out as it has in the past, nobody who is anybody would want to be seen doing much of anything these days. No action will be seen as the best action, with all that it implies for business growth.

-- Edited by Kevin McIndoe 

Pauline Loong is managing director of Asia-analytica Research and Senior Fellow of the CIMB ASEAN Research Institute

Important notice: Nothing in this report is intended to be, or should be construed as, an offer to buy or sell, or invitation to subscribe for any securities or as advice relating to legal, technical or investment matters. This report has been prepared on the basis of information that is believed to be correct and from sources believed to be reliable. Asia-analytica makes no express or implied warranty as to the accuracy or completeness of any such information and makes no undertaking to update any such information. Opinions expressed are subject to change without notice.

5y
dubaidude dubaidude
Isn't the drive against corruption a good thing....in the long run?
No other country is doing it as aggressively...This should improve the image of China...within a few years.
5y
Martin O'Rourke Martin O'Rourke
I suppose that if you take it at face value, then an anti-corruption drive must be a good thing. Of course, when it's potentially used to settle scores or divert attention from other problems, then it's another matter altogether. China has certainly got form in this regard, as various counter corruption waves in the past have shown. Only time will tell how this one might pan out....
5y
dubaidude dubaidude
Of course, Martin. There is always a chance that scores 'may' be settled.

However, anywhere in this world it is unprovable and allegations always linger. Every decision in life that we make, has pros and cons. Just like this one in China. As far as I can see, only the people who have abused the system shall pay the price, however, if you are suggesting that through anti graft measures, people will be framed, that's another thing, though I doubt that very much in today's internet age, active media and judiciary.

However, there is ample evidence that anywhere in the world, if corruption is reduced, since it cannot be eliminated, it stabilises the economy and instils discipline and fear into most people.
5y
Pauline Loong Pauline Loong
Corruption is China is not about personal moral failings. In a society where there are no effective checks and balances on power and no accountability except (ultimately) to the Party, corruption becomes entrenched into the system. For China to truly eradicate endemic corruption, there has to be institutional restraints on power. A strong rule of law is the only foundation on which a truly honest society is possible.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Tradingfloor.com permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Tradingfloor.com and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Tradingfloor.com is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Tradingfloor.com or as a result of the use of the Tradingfloor.com. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. When trading through Tradingfloor.com your contracting Saxo Bank Group entity will be the counterparty to any trading entered into by you. Tradingfloor.com does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of ourtrading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws. Please read our disclaimers:
- Notification on Non-Independent Invetment Research
- Full disclaimer

Check your inbox for a mail from us to fully activate your profile. No mail? Have us re-send your verification mail