China Ramps up it’s Patent Industry, Surpasses USA

China Surpasses U.S. in Number of Patent Applications

By Sheri Qualters – The National Law Journal – December 12, 2012

Last year, for the first time, more patent applications were filed in China than in the United States. This surge reflects China’s increasing intellectual property maturity and growing pains, according to U.S. Intellectual property lawyers and experts.

In a December 11 announcement, the World Intellectual Property Organization reported that China’s patent office took in 526,412 applications, compared to 503,582 in the U.S. Patent and Trademark Office and 342,610 in Japan’s patent office.

Worldwide patent filings exceeded the 2 million mark, with 2.14 million filed last year. That’s a 7.8 percent boost over the 1.99 million applications filed in 2010.

“Sustained growth in IP filings indicates that companies continue to innovate despite weak economic conditions. This is good news, as it lays the foundation for the world economy to generate growth and prosperity in the future,” said WIPO director general Francis Gurry at a press conference in Geneva.

The numbers reflect a boost in innovation by Chinese nationals, said Stuart Meyer, an intellectual property partner at Fenwick & West in Mountain View, Calif. It’s not just U.S. inventors wanting to get protection in China because it’s commercially important, he said. “That’s a real sea change.”

Ultimately, such filing shifts could affect U.S. patent policy, which offers great protections for intellectual property producers, he said.

The balance is shifting a little bit because more U.S. companies are dealing with licensing intellectual property owned by foreign patentees, said Meyer. “We’re the ones that don’t need such rigorous protection because we’re on the other side of the coin. It changes the way we’re going to be thinking about this in the coming decades.”

The numbers are a milestone in the way innovation is distributed around the world, said Q. Todd Dickinson, executive director of the American Intellectual Property Law Association. “Clearly china is in growth mode in terms of research and development and patent filings track that closely.”

He also said China’s intellectual property system is maturing. “Clearly they’re using IP to protect indigenous innovation.”

The filings show that everyone wants to do business in China, but China also needs to improve patent enforcement, said Peter Toren, a partner at Weisbrod Matteis & Copley in Washington.

“I’ll be more impressed when I get the real sense that China is enforcing patent rights…I want to see them allowing companies to really enforce the rights they have,” Toren said.

 

Major Developments in China since last Leadership Change

How China Has Changed Since the Last Leadership Transition

Published: Thursday, 8 Nov 2012  

By: Rajeshni Naidu-Ghelani, CNBC

All eyes are on China this November as the country prepares for the once in a decade leadership transition within the ruling Communist Party.

The world’s second biggest economy has undergone a massive transformation within the last 10 years. From rapid urbanization and economic growth to social and political development, China has marked many milestones and firsts in the past decade — highlighting its significance on the global stage.

With this in mind, we look at six major changes that China has undergone since the last leadership transition in 2002. Focusing on factors like economic development to changes in consumer behavior, we look at how big of an impact China’s transformation has had on the rest of the world.

Rapid Economic Growth

The Work Bank

Riding the wave of rapid economic expansion, China’s growth engine has remained strong over the past decade. China’s economy grew from being the 5th largest in the world in 2002 to 2nd only to the U.S. by 2010. 

The country has seen an average annual gross domestic product (GDP) growth of 10.6 percent since the last leadership transition in November 2002. Yearly economic growth was in the double digits from 2003 to 2007 and hit a high of 14.2 percent in 2007 — levels not seen since the early 1990s. However, like the rest of the world, China was impacted by the global financial crisis in 2008 and saw its GDP fall to 9.6 percent that year. Since then, the superpower has been able to maintain strong economic growth of over 9 percent, but it continues to be plagued by fears of a hard landing. GDP in the second quarter of this year fell to 7.6 percent, hitting its slowest pace in three years.

Many economists now expect China’s annual GDP to fall below 8 percent in 2012, with even Beijing setting a target of 7.5 percent growth — marking China’s first drop to that level since 1999. Uncertainty over how the new leadership will deal with slowing growth is intensifying and several analysts have told CNBC that policymakers may be taking their eye off the ball when it comes to the economy to prepare for the once-a-decade leadership transition. The politics involved in the government change may be slowing the policymaking in China and deterring the government from making significant economic decisions, according to experts. 

Rising incomes

National Bureau of Statistics China

Economic development has led to rising incomes in China as workers demand higher wages to cope with soaring living costs in major cities.

In a 10 year period, the per capita income of urban residents rose from $827 in 2001 to $3,711 in 2011, according to the National Bureau of Statistics of China. That’s a nearly 350 percent increase. China’s average minimum wage has been rising an average 12.5 percent annually from 2006 to 2010, and the government announced earlier this year that minimum wages should grow by an average of at least 13 percent in the five years to 2015.

Rising wages has become a major concern for local and international manufacturers betting on “cheap” Chinese labor for growth. Many are moving production inland to save on costs, while others are looking into alternative manufacturing hubs in Asia like Vietnam, the Philippines and Indonesia. For example, Apple supplier Foxconn, in the news recently for labor unrest at its Chinese factories, announced in August that it would invest $10 billion in Indonesia to tap into one of the cheapest labor forces in Asia.

Stocks Outperform in a Decade

Thomson Reuters

China’s battered stock market, which was down more than 20 percent in 2011, and is lower by nearly 6 percent so far this year, has made headlines recently for being the worst performing major equity market in Asia — a sharp contrast to China’s growth story.

Still, taking into account the total gains made over the past decade paints a more bullish picture. The Shanghai Composite index rose 35 percent from 2002 to 2011, far outperforming the U.S. benchmark S&P 500 which only rose 9 percent in the same period. But, despite the substantial 10-year gain, it hasn’t been all smooth sailing for Chinese equities. The Shanghai Composite fell about 65 percent to 2,016 in October 2008 during the global financial crisis from a peak level of 5,725 in September 2007. While stocks continued to gain ground up until August 2009, it has been in a steady decline since.

Despite the downtrend in the last three years, several analysts are still optimistic about a turnaround in Chinese equities on the growing possibility of more easing by the government to spur growth. Japanese brokerage Nomura predicted in July that Chinese stocks could climb as much as 20 percent by the first quarter of 2013 after having bottomed in early June. Meanwhile, the notable head of Goldman Sachs Asset Management — Jim  O’Neill — said in September that Chinese equities present the “most attractive” investment opportunity in all of the BRIC markets.

Internet Explosion

China Internet Network Information Center

By sheer numbers, China is experiencing a technology boom unlike anywhere else in the world. Its internet population surpassed half a billion users in 2011 — making it by far the world’s biggest online market. That’s a more than 362 percent increase since 2005. Even then, the internet usage penetration remained at 38 percent in 2011, presenting further growth potential.

About four out of 10 Chinese use the internet, accounting for a total of 538 million users, according to state-run agency China Internet Network Information Center (CNNIC). That population is set to jump to 700 million users by 2015, according to the Boston Consulting Group (BCG), which is more than double the entire population of the U.S. The country’s fast growing online market provides a big opportunity for retailers and BCG predicts that China’s online retail sales will triple to more than $360 billion by 2015 to make it the world’s largest online retail market.

Smartphone makers are also looking to increase their presence in the country’s mobile phone market. Nearly 70 percent of China’s internet users connected to the web through their handsets in 2011, according to the CNNIC.

Mega Rich Get Richer

The Hurun Research Institute

China’s billionaire count has surged in the past decade, spurred on by the country’s rapid economic development.

In 2001, China had only one billionaire, but that number has jumped to 251 this year —according to the Shanghai based Hurun Report — making it second only to the U.S. in the world when it comes to most billionaires. Billionaires account for just 1.3 percent of wealth individuals with $30 million or more in China, but control nearly a quarter of the ultra-rich group’s wealth of $1.58 trillion, according to research firm Wealth-X. These billionaires are worth an average of almost $2.6 billion each.

China’s consumption and construction boom are two of the major drivers of wealth for the super-rich with a majority of billionaires counting on property as one of their main sources of wealth. The public listing of companies has also made business owners billionaires overnight. But recently, the stock market has also caused China’s billionaires to lose almost a third of their combined wealth with the benchmark Shanghai Composite falling 20 percent from August 2011 to July 2012, according to Wealth-X. In total, the population of China’s wealthy with assets worth $30 million and above shrank by 2.3 percent in the past year, while their combined wealth decreased nearly 7 percent to $1.6 trillion.

Consumption Boom

National Bureau of Statistics China

Consumer spending in China has seen double digit growth for a decade, creating a path for the country to become the world’s biggest consumer market by 2015, according to government authorities.

Its fast growing consumer class of about 130 million has given a big boost to markets from retail and housing to travel and other discretionary sectors. China’s consumer retail sales, for example, are expected to surpass $5 trillion in 2015, according to Commerce Minister Chen Deming. Rising incomes amid rapid urbanization are major reasons behind China’s consumption boom and the World Bank expects the growth to continue as income per capita climbs to more than triple to $16,000 by 2030 from about $5,000 now.

Businesses like carmakers, luxury retailers, and hotel chains have been flocking to the world’s second largest economy to target Chinese consumers. Italian fashion house Prada, for example, counts on China as its biggest market with 30 percent of its global sales in the fiscal year that ended in January 2012 coming from the country. The luxury retailer has 19 stores in China, but plans to open up to 15 more this year. The world’s largest premium carmaker BMW, meanwhile, increased sales of its flagship BMW brand in China by 55 percent in September compared to the previous year, while its Mini cars saw sales jump a whopping 121 percent in the same period.

But not all retailers have had a similar level of success in China. Home Depot, the world’s largest home improvement chain, struggled to win over Chinese shoppers with its U.S. style do-it-yourself model. The U.S retailer announced in September that it will close all seven of its big box stores to focus on specialty stores and e-commerce in China.

International Patent Litigation – Is There a Home Court Advantage?

Author’s Note: Did Samsung get a fair trial against Apple in Northern California? Can Apple get a fair trial in Korea or China?  All interesting questions with potential billion dollar outcomes depending on the answer.

Some in Asia See Bias in U.S. Apple Verdict

By Jessica Seah  The Asian Lawyer  September 3, 2012

On August 24 a California federal jury awarded Apple Inc. over $1 billion in its smartphone patent infringement suit against Samsung Electronics Co. Ltd.—the largest patent verdict ever. The same day, a Korean court issued a split decision widely seen as more favorable to Samsung, and, last Friday, a Japanese court ruled against Apple outright, ordering the U.S. company to pay Seoul-based Samsung’s legal costs.

The contrast in outcomes has not been lost on intellectual property lawyers in Asia.

“I am surprised Samsung lost all counts in the case in the U.S.,” says one Beijing IP partner with an international firm. “I think there is a clear home court advantage there.”

Other IP lawyers in the region expressed similar sentiments, with some noting that perceptions of bias in the U.S. Apple ruling could provide cover to courts in the region, particularly those in China, that have been accused of favoritism themselves.

Matthew Laight, an IP lawyer and the Hong Kong–based China managing partner for U.K. firm Bird & Bird, says that inexperienced Chinese judges in patent cases could potentially draw the wrong lessons from the Apple case.

“Chinese judges are just getting their heads around whether or not to grant injunctions in patent disputes,” Laight says, “so the result of the Apple-Samsung case may influence how judges see things.”

Many lawyers in the region noted that the U.S. decision was made by a jury. The Korean and Japanese cases were both decided by judges.

The Beijing partner says he found the U.S. ruling less reasonable than the Korean one, in which the three-judge Seoul panel found that both Apple and Samsung infringed each other’s patents and ordered a halt to sales in the country of certain products from both companies. Some observers have said that ruling was more favorable to Samsung because it had already discontinued the affected products.

Apple’s hipper image helped with the California jury, the Beijing partner thinks. Despite being the world’s largest technology manufacturer by revenue, Samsung was the effective underdog in the U.S. case.

“Samsung was pitted against the most revered and successful company in the world,” he says. “So there is definitely a local bias there, especially when decided by jury. I have my doubts against the jury really understanding such a complex case.”

The seven men and two women of the jury found that Samsung infringed all but one of the seven patents at issue—a patent covering the exterior design of the iPad. They also decided that Apple didn’t violate any of the five patents Samsung asserted in the case.

In an interview with Bloomberg, jury foreman Velvin Hogan rejected accusations of local bias. He said the jurors were “inundated” by evidence, and the fact that Apple was headquartered in Cupertino, California—not far from the San Jose courtroom in which the case was heard—made no difference.

Morrison & Foerster and Wilmer Cutler Pickering Hale and Dorr represented Apple, while Quinn Emanuel Urquhart & Sullivan acted for Samsung.

In Japan, Apple had claimed that Samsung infringed its patent on synchronization and sought $1.3 million in damages. District Judge Tamotsu Shoji in Tokyo rejected Apple’s claim, though Apple has other infringement claims pending in Japan.

According to Yoshikazu Iwase, an IP partner at Tokyo-based Anderson Mori & Tomotsune, the Japanese court decision was not surprising because “traditionally Japanese judges are conservative in enforcing patents” and local judges are usually “not directly affected by the decisions of other jurisdictions.”

Still, large Asian corporations are generally accustomed to litigating in the United States and have faith in the fairness of the courts there. Though there may be a sense that Apple enjoyed a home-court advantage in San Jose, says Jones Day Tokyo partner Michiku Takahashi, that stops well short of the kind of bias they worry about in China, where courts are not independent and are generally seen as favoring well-connected parties.

“Experienced Japanese companies are not too bothered about court bias, but comparatively they are generally more concerned about decisions made by Chinese courts, than, say, in the U.S. or in Europe,” she says.

Many lawyers believe the Apple-Samsung fight will trigger a wave of new patent litigation targeting big Asian companies. Geoffrey Lin, a Shanghai-based IP partner at Ropes & Gray, says that lawyers will start to go back to look at their clients’ business models to make sure they are closely protected by their patents.

“International technology companies, especially those that manufacture smartphones, are going to start looking at jurisdictions where there is a lot of trolling,” says Lin.

Takahashi says smartphone-related patent litigation has already become common in recent years. “There has been an increasing number of patent troll cases here in Japan, where non [technology] practicing entities are registering smartphone patents,” she says. “So the Apple matter may give even the larger Japanese phone companies more confidence to litigate when they feel their patents have been infringed.”

But Laight says that while the Apple-Samsung case has gotten a lot of attention, the dispute might not be a sole driver for an increase in patent litigation in Asia.

Asian electronics companies from Japan, Korea, and Taiwan have long litigated against each other both in their home jurisdictions and around the world. Laight notes that now Chinese companies are getting in on the act. Last year Shenzhen-based telecommunications firm Huawei Technologies Co. filed patent infringement lawsuits against its smaller Chinese rival ZTE Corp. in courts in France, Germany, and Hungary. The patents relate to data card and 4G technologies, and ZTE has allegedly used Huawei’s trademark on some of its data cards. ZTE has countersued, alleging that Huawei infringed its 4G patents.

 

 

Federal Reserve Approves First US Bank Acquisition in the United States by a Chinese Bank

On May 9, 2012, the Board of Governors of the Federal Reserve System (the “FRB”) issued an order (the “Order”) approving the acquisition of 80% of the shares of common stock of The Bank of East Asia (U.S.A.) National Association (“BEAUSA”), by Industrial and Commercial Bank of China Limited (“ICBC”). This Order marks the first occasion on which the FRB approved the acquisition of a U.S. bank by a Chinese bank since the Bank Holding Company Act of 1956 (the “BHC Act”) was amended by the Foreign Bank Supervision Enhancement Act of 1991 (“FBSEA”). The FBSEA, which increased federal supervision of foreign banks operating in the United States, requires the FRB to make a finding that a foreign bank seeking to acquire control of a U.S. bank is subject to comprehensive supervision on a consolidated basis (“CCS”) by its home country supervisor. The Order marks the first time that the FRB has made a full and unqualified CCS determination for a Chinese bank to acquire control of a U.S. bank, although it has previously made a so-called “limited” CCS determination in the context of Chinese banks establishing U.S. branches.

On November 8, 2007, the FRB approved an application by China Merchants Bank Co., Ltd. (“CMB”) to establish a branch in New York, New York, the first such approval for a Chinese bank since the FBSEA. The FRB made a “limited” CCS determination pursuant to a provision that allows the FRB to approve a branch application if the appropriate authorities in the home country of the foreign bank are actively working to establish arrangements for the consolidated supervision of the bank submitting the application, and all other factors are consistent with approval. The FRB’s approval of CMB’s branch application opened the door for other Chinese banks to apply for branches in the United States. Thereafter, branch approvals based on similarly limited findings of CCS were granted by the FRB to ICBC in November of 2008 and to China Construction Bank Corporation in March of 2009. The “limited” CCS determination available for a branch application is not available for an application to acquire a U.S. bank under Section 3 of the BHC Act, which requires the FRB to make a full and unqualified CCS determination.

The FRB’s evaluation of whether ICBC is subject to CCS was foreshadowed in the FRB’s August 31, 2010 determination that CIC, an investment vehicle organized by the Chinese government, qualified under the CCS standard in the context of a Section 3 application for CIC’s non-controlling, but greater than 5%, investment in the shares of common stock of Morgan Stanley. The FRB explicitly noted, however, that that finding was based on both the unique nature and structure of CIC and the noncontrolling nature of the investment under consideration in that application. In addition, the FRB noted that, in evaluating a proposal by a Chinese bank to acquire a U.S. bank, the FRB would evaluate whether that Chinese bank is subject to CCS.

In the Order, the FRB detailed its exhaustive analysis on the CCS of ICBC by the China Banking Regulatory Commission and other regulatory authorities including, among others, the People’s Bank of China, the State Administration of Foreign Exchange, China Securities Regulatory Commission and China Insurance Regulatory Commission. The Order also noted the International Monetary Fund’s most recent determination that China’s overall regulatory and supervisory framework adheres to international standards. In addition, the FRB noted China’s efforts on combating money laundering and terrorism financing and found that the anti-money laundering efforts by ICBC and the Chinese regulators are consistent with approval.

The Order should create the opportunity for other leading Chinese banks to acquire U.S. banks of a relatively modest size. Although the CCS determination is nominally bank-specific, in practice a CCS determination for one bank in a country is typically precedential for all similarly situated banks in that country. In addition, because the FRB takes the position that a CCS determination is required before a foreign banking organization can obtain financial holding company (“FHC”) status, the Order should pave the way for Chinese banks and their holding companies that are subject to the BHC Act to become FHCs.

 

Meeting the Future Chinese Leader, Xi Jinping

David Griffith’s Note: I went to the US-China Economic Forum yesterday in downtown Los Angeles as a guest of the Chinese Consul General to get a glimpse of the future Chinese leader, Xi Jinping, and I was encouraged by what I saw.  Xi appears to be a man who likes America and can in turn put a new face on China that Americans will embrace.  The American leaders there, Vice President Joe Biden, Governor Jerry Brown, and Mayor Antonio Villaraigosa looked very comfortable with the future president and their various counterparts from Chinese government at both the national and provincial levels.  Over 500 Chinese companies were part of a series of major trade announcements.  The event definitely confirms Southern California’s prominence in trade with China.

LOS ANGELES (Reuters) – China’s leader-in-waiting Xi Jinping on Friday swiped away fears that his country’s economic growth could stumble, and turned to courting American companies, film-makers and governors hungry for a slice of that growth on the final day of his U.S. visit.

At the end of Vice President Xi’s five-day trip, his U.S. counterpartJoe Biden announced China had agreed to make it easier for Hollywood to distribute movies to China’s expanding audiences. Xi (pronounced “shee”) told a business forum in Los Angeles that China would promote greater domestic demand and turn more to the United States to buy imports and send investment.

Despite recent economic slowing and persistent price pressures, Xi told the gathered business executives that China’s economic momentum would not falter as some economists warn.

“China’s economy will maintain stable growth,” he said “There will be no so-called hard landing.”

Xi is almost sure to succeed Hu Jintao as Chinese president in just over a year, and the final day of his tour of the United States featured commercial deals and reassuring talk intended to blunt American ire about the trade gap between the countries.

“We will further increase imports from other countries in the light of our economic and social development and consumer demand. We will actively expand imports from the United States,” Xi later told a midday meeting.

Biden, who accompanied Xi to Los Angeles, praised the Chinese Vice President‘s efforts to reach out to often wary Americans, but reminded him that rancor over trade imbalances and barriers had not evaporated in all the sunny goodwill.

“The crux of our discussion is that competition can only benefit everyone if the rules are fair and followed,” Biden told the midday reception for Xi.

The U.S. movie industry has long complained about China’s restrictions on the number of foreign films allowed into the country each year, a limit that they say boosts demand for the bootleg DVDs that are widely available in China.

The film announcement does not remove China’s quota system, but it might ease some of the ire.

The agreement allows more American exports to China of 3D, IMAX, and enhanced-format movies, and also expands opportunities to distribute films through private enterprises rather than the state film monopoly, the U.S. Trade Representative’s office said.

GETTING READY FOR NEXT DECADE

The two vice presidents both suggested that Xi’s diplomacy, deals and folksy public displays could pave the way for steadier ties between the world’s two biggest economies.

Xi said that he felt from his visit that “mainstream American opinion” supports stronger ties. “I can now say that my visit has been fully successful,” he said.

“We’ve established a personal friendship and a healthy working relationship,” he said of himself and Biden.

Xi is poised to become China’s next leader after a decade in which it has grown to become the world’s second-largest economy. Beijing wants to avoid tension with Washington while the Communist Party leaders focus on the power handover.

Xi’s visit to the United States was also intended to get both sides more familiar with each other for the decade that he could be in power. He will most likely succeed Hu Jintao as party chief in late 2012 and as president in early 2013.

Under Xi, China’s economic size and military capabilities are likely to grow closer to U.S. levels.

Washington and Beijing have often jostled over economic, political and foreign policy disputes from human rights to Taiwan and most recently Syria.

The U.S. trade deficit with China expanded to a record $295.5 billion in 2011, and many U.S. lawmakers complain China’s yuan currency is significantly undervalued, giving its companies an unfair advantage.

The Obama administration has also accused China of distorting trade flows by ignoring intellectual property theft, putting up barriers to foreign investors and creating rules that favor China’s state-owned behemoths.

Xi’s stop in Los Angeles was choreographed to blunt those complaints and make China’s case that its rapid growth presents the U.S. economy with opportunities, not threats.

Scores of executives from major U.S. and Chinese companies, from Intel to Microsoft, lined up to sign deals after Xi’s address at the economic forum on Friday.

They included “Kung Fu Panda” studio Dreamworks Animation’s venture to make films from Shanghai, and Chinese telecom giant Huawei’s pledge to award $6 billion in contracts over three years to Qualcomm Inc, Broadcom Corp and Avago.

“MISSION IMPOSSIBLE” FAN

More than the publicly stern Chinese President Hu, Xi has tried to put a friendlier face on his government during his U.S. visit, including revisiting the small town of Muscatine in Iowa where he visited in 1985 and stayed two nights with a family.

The 58-year-old also visited the International Studies Learning School in South Gate — a Los Angeles enclave of mainly Hispanics — where students learn Chinese.

At the school, Xi recalled his first visit to Muscatine: “They gave me the same impression that, like Chinese people, they are warm-hearted, friendly, honest and hard-working. Twenty-seven years have passed, but that remains my impression, and it has become a deeper one.”

Xi also offered a glimpse of his personal life, telling the students he enjoyed swimming and watching sports, including American basketball, baseball and gridiron football.

Showing his familiarity with Hollywood fare, Xi said it was difficult to find time to relax. “It’s like the name of that American movie — ‘Mission Impossible’.”

After their visit to the school, Biden told reporters the talks with Xi had been very forthright, and was also intensely curious about the workings of the American political system.

“This is a guy who wants to feel it and taste it, and he’s prepared to show another side of Chinese leadership,” said Biden. “He is intensely interested in understanding why we think the way we do, what our positions are, and the need to actually broaden this kind of understanding.”

Xi was due to watch part of an LA Lakers basketball game before he left for the next two countries of his international tour, Ireland and then Turkey.

 

China and Developing Countries Become Top Importers in 2012

David Griffith’s Note:  The economic shift of power from the developed world to the developing world is accelerating and the developing countries, including China, will surpass the developed world in the amount of imported goods in 2012.  This signals the emergence of the consumer and a growing middle class in the BRICs countries and other emerging economies.  China will surpass the US as the largest global importer in 2014.

By Stacy Curtin | Daily Ticker  December 5, 2011

More evidence emerged over the weekend that China is increasingly worried about slowing growth and the social unrest that could arise as a result. Always a concern, this is a particularly sensitive issues in a time of political transition as the top leaders of the Communist Party are set to change next fall.

“It is an urgent task for us to think how to establish a social management system with Chinese characteristics to suit our socialist market economy,” warned Zhou Yongkang, the Chinese leadership’s law-and-order czar. “Especially when facing the negative effects of the market economy, we still have not formed a complete mechanism for social management.”

These comments come on the heels of last week’s news that manufacturing in China fell to levels not seen since February 2009. As a result, many economists — including those at IHS Global Insights and J.P. Morgan — have lowered growth expectations for the rest of the year.

Gross domestic product averaged 9.7% in China from 2008 to 2010, but since the beginning of this year growth has been slowing. The country’s GDP slowed to 9.1% in the third quarter, from 9.5% in the second and 9.7% from the first.

Last week, the Chinese government also unexpectedly cut bank reserve requirements by 50 basis points, which will likely help banks increase lending in the months to come. “They are much more worried about the Chinese economy slowing very fast so they are putting their foot back down on the accelerator,” says Daniel Franklin, editor of The Economist’s The World in 2012, a publication focused on the trends and stories that will shape the year to come.

To his point, at the end of November, China announced another stimulus plan roughly two times the size of its initial program back in 2008, which did prevent a recession but has led to inflation and a country-wide debt crisis. The country is now set to spend $1.7 trillion on seven “strategic” or high-tech sectors.

But the question remains: Is this new spending program a short-term fix or means to restart sustained long-term growth?

The World in 2012: China

What is not in question these days is the fact that China, as well as other emerging markets, are not only producing much of the world’s goods, but are consuming more and more of the world’s goods too.

According to Franklin, a big shift is coming in 2012. Emerging economies are set to overtake the rest of the world as the biggest importers of goods.

“That is a dramatic change since 2000, when they imported barely half as much as rich countries did,”writes Pam Woodall in the magazine. “This rapid growth in developing countries’ buying power will boost the profits of companies in rich economies over the coming years.”

And by 2014, China alone will surpass the United States as the world’s biggest importer.

“Within ten-to-15 years emerging markets could produce half of the revenues of several big multinational firms,” writes Woodall. “This rapid growth in developing countries’ buying power will boost the profits of companies in rich economies over the coming years.”

 

Big Four in Hot Water in China

China Questions Big Four Auditors

THE MOTLEY FOOL  By Dan Radovsky  October 21, 2011

The Chinese government is sick and tired of hearing U.S. regulators question the validity of the auditing done on U.S.-listed Chinese companies. So it has done what it considers the best thing to do to squash those complaints. It has requested the world’s largest auditing firms to come in and recheck the work they did for those Chinese firms in 2010, and to do it quickly.

The Ministry of Finance and the China Securities Commission asked the “Big Four” accounting firms, KPMG, PricewaterhouseCoopers, Ernst & Young, and Deloitte, to also review the initial public offering, or IPO, work they did on behalf of Chinese companies wishing to be listed on the U.S. exchanges.

In addition, the firms have to inform the Chinese regulators whether any of the auditing work or client information was passed on to U.S. and other foreign regulators, something the Chinese government really would be upset about. The auditors have until the end of the week to complete this work.

What has brought on this desperate action by the Chinese? The get-rich-quick allure of investing in the new world of Chinese capitalism brought opportunities for many newly formed companies with little innovation and less financing to get listed on the U.S. exchanges. This made it easy, perhaps too easy, for naive investors to get in on the fun. As my Foolish colleague Alyce Lomax wrote, “The ‘Go-go’ China investment thesis made logical sense at first.”

The main problem with investing in U.S.-listed Chinese companies is the higher potential for fraudulent or inaccurate accounting. A case in point is that of Longtop Financial Technologies. At one time it had a market capitalization of more than $2 billion. But after the company was accused of fraudulent financial behavior, its auditor resigned. That auditor happened to be one of the “Big Four,” Deloitte.

According to Tim Hanson, another of my Foolish colleagues, Deloitte wrote in its letter of resignation that it found Longtop’s state-owned bank “complicit in helping Longtop deceive Deloitte and its investors.” This implied, according to Tim, that “fraudulent practices may be systemic in China’s financial system.”

This is obviously a perception that the Chinese regulators would like to change. It knows how bad publicity can negatively affect investment in China. And there are U.S.-listed Chinese stocks that certainly seem on the up-and-up (with a caveat regarding so-called variable interest entities): There’s Baidu (Nasdaq: BIDU), Country Style Cooking (NYSE: CCSC), Yongye International (Nasdaq: YONG), Guangshen Railway (NYSE: GSH), China Mobile (NYSE: CHL), and Renren (NYSE: RENN), just to name a handful.

The Big Four auditing firms are in a precarious position. Estimates put Chinese revenues for those firms at $1.5 billion for 2010, with growth at 20% over the previous year, so they can’t just ignore the Chinese regulators’ concerns.  But if they can’t do an audit of a Chinese company that would meet the standards that the U.S. regulators set, then their audits would have no credibility.

As Michael Pettis, a professor of management at Peking University, said, “I expect it is going to be a little messy.”

 

Is the Chinese Economy Contracting?

FORBE’S         Gordon G. Chang

The author is a Forbes contributor. The opinions expressed are those of the writer.

Year-to-year comparisons tell us the Chinese economy is growing in high single digits, but month-to-month numbers suggest it flatlined this summer.  Now, there is evidence indicating it is even starting to contract.

The National Bureau of Statistics estimated that gross domestic product increased by 9.5% in the second quarter this year, down from 9.7% in Q1.  Yet GDP is not the most reliable indicator of economic activity in China.  The official Q2 number was substantially above analysts’ estimates, indicating once again that the statistic is “man-made”—manipulated for political purposes—in the memorable words of Vice Premier Li Keqiang.

The most reliable indicator is undoubtedly electricity consumption.  In August, consumption of electricity was up 9.1% from the same month last year but down 0.1% from the preceding month.

The decline in August electricity consumption mirrors other figures.  August industrial value-added output, for instance, was off 0.5% from July.  Oil demand was down in August as were export orders.

The HSBC China Flash Purchasing Managers’ Index shows that manufacturing activity is slowing this month.  If confirmed in the final index, September will be the third-straight month of contraction.  Last month, the final HSBC index came in at 49.9, indicating a slight fall-off in activity.

To put this in context, this is the Christmas season in China.  Factories should be going at full tilt, and container ships are normally loaded to the gills.  But container lines are not overloaded this month.  Maersk, the world’s largest container-shipping company, reports its vessels on the Asia-to-Europe and Pacific routes are 90% full when they should be almost 100%.

Air cargo is also down.  Rates for air freight from Hong Kong to Europe this month are only 75% of what they were in pre-season June, indicating falling orders in China’s export belt in Guangdong province.  Carriers, even with the lower rates, are still having difficulty filling space.  Airlines are grounding cargo planes as a result.  In August, Hactl, which handles about 80% of air cargo from Hong Kong, posted its fourth consecutive month of decline in volume.  On Thursday, FedEx Corp, citing falling deliveries from China, lowered earnings estimates.

The Grinch is not only stealing Christmas, he’s plundering the rest of the Chinese economy too.  Last week, mining company shares, especially those of BHP Billiton and Rio Tinto, took big hits on forecasts of decreasing Chinese demand.  Cement prices in China are off, and shipbuilding orders have collapsed, down 30% year-on-year for the first seven months.  Some Chinese yards have yet to receive their first order this year.  Inventories are also up.

Analysts think strong consumer demand will pick up the slack, but shoppers may not save the economy.  Bellwether car sales are, in fact, flat.  In August, they were up 0.5% from July.  In July, they had plunged 11.2%.

And inflation?  The rate of inflation may have turned a corner in August, falling to 6.2% from July’s 6.5%.  The real rate is perhaps twice the official number, but the dip could be a reflection of slowing demand and the beginning of a trend.

CLSA’s Andy Rothman says there is still strong growth in China, but it’s hard to see where.  Of course, Beijing can go back to buying growth by pouring more money into the economy, as it did beginning in November 2008, but that tactic would not be efficient.  It now takes seven yuan of spending to create one yuan of output.

Moreover, increased government spending would only aggravate inflation and worsen the already-serious bad-loan problem plaguing the banks, which have lent to build “ghost cities” and other unviable projects.  And the unbalanced Chinese economy would end up even more out of kilter.

Everyone says Greece needs to face the music.  They’re right—and so does China.  Chinese government stimulus can delay the onset of symptoms, but that will only make problems worse in the long run.

In the meantime, this summer looks like it marks a turning point.  At this moment, the Chinese economy is starting to contract.

Enforcing Contracts with Chinese SOEs Still Challenging

Wall Street Journal On Line    By Andrew Galbraith   September 6, 2011

A spat over contracts between China’s biggest shipping company and foreign ship owners is calling attention to broader tension over the rise of a Chinese corporate sector that doesn’t always play by established global rules.

The move by China Cosco Holdings Ltd., the listed flagship of state-owned China Ocean Shipping (Group) Co., to halt or delay payments for vessels it leased at the height of the shipping boom in 2008 reflects in part the cyclical stresses in the global shipping industry. But some analysts, lawyers and executives in China say it also reflects a willingness among increasingly bold Chinese companies—often, like China Cosco, owned by the government—to snub existing norms of global commerce.

In recent years, foreign banks and other creditors have faced repeated difficulties getting payment on bonds or derivatives contracts with Chinese companies. In 2009, for example, China’s government encouraged state-owned airlines and shipping companies, including Cosco, to challenge losses from derivatives deals with foreign banks used to protect against sudden surges in the price of fuel. That same year, China-based Asia Aluminum Holdings Ltd. offered to buy back its debt for pennies on the dollar, eventually leading to losses for international investors.

Foreign companies that do business in China are routinely warned that contracts aren’t viewed in China with the same sort of legal sanctity that they receive in most developed economies. Jingzhou Tao, a Beijing-based lawyer with Dechert LLP, says that withholding payments is a frequent tactic used in China to force price negotiations. “A contract is not an unchangeable bible for Chinese companies,” Mr. Tao said.

Prices for leasing the cargo ships that carry commodities like coal and iron ore have plunged since 2008, when China Cosco signed the deals at issue. Industry executives say it is common for shipping companies to want to renegotiate long-term contracts as a result of economic swings. But it is unusual for financially solvent companies to unilaterally renege on contracts the way that China Cosco has done on some.

Representatives of Cosco Group and China Cosco didn’t respond to requests for comment Friday. During a conference call a week earlier after it posted a first-half loss, China Cosco Executive Director Zhang Liang called such disputes “normal” and blamed ship owners for “trying to use the media to make a bigger impact.” The company said it had renegotiated deals on 18 ships. A China Cosco official said Thursday that it plans to restructure its unprofitable dry-bulk shipping operations.

China Cosco, which has about 200 dry-bulk ships under charter and owns 234, appears to be trying to correct course. Some ship owners that had complained about the Chinese company’s failure to pay have said in recent days that they started receiving payments again.

On an earnings call Wednesday, DryShips Inc. Chief Financial Officer Ziad Nakhleh said the Greece-based company had been owed about $2.5 million by a China Cosco unit for three vessels, but that “Cosco has since resumed hire payments on all of the three vessels and we have no further issues with our counterparties.”

Angeliki Frangou, chairman and chief executive of Navios Maritime Holdings Inc., said Cosco stopped payments in July but has since met original agreements with no renegotiations. “We have been paid,” she said. “Cosco is a counterparty that we like to do business with and will continue to do business with. This was an incident that was very quickly resolved.”

But some in the industry remain frustrated and say the move could have lasting damage for Cosco’s reputation.

“They’ve paid up to date [and] I don’t want to be nasty,” said Raymond Ching, vice president at Hong Kong-based Jinhui Shipping & Transportation Ltd. “But obviously, withholding payments and giving us either no response or very, very absurd reasons—it’s just something that we won’t tolerate.”

Analysts and lawyers say big Chinese state-owned companies can be especially aggressive in dealing with foreign companies because of their government backing and the enormous clout they wield within China in industries that are often oligopolies.

“State-owned enterprises that are dominant in their own sector and in some cases more powerful than government departments are used to having things their way,” said Lester Ross, a Beijing-based partner at law firm WilmerHale. Mr. Ross said that Chinese companies in the minerals and cotton industries have a history of walking away from deals when prices move against them, and that foreign companies sometimes charge a premium for services to Chinese government companies because of the contract risks.

“These companies are only partly companies. They are also political entities,” said Carl Walter, a former Beijing-based banker for J.P. Morgan Chase & Co. who has co-authored two books about China’s state-owned enterprises. That means political imperatives, such as concerns over the value of national assets, can sometimes drive decisions by company chief executives, who at Chinese state-owned enterprises are appointed by the Communist Party. “When you do business with these major SOEs, you better make sure you make enough money to cover,” Mr. Walter said.

Arthur Bowring, managing director of the Hong Kong Shipowners Association, argues that while Cosco’s moves are worrisome for the industry, they won’t likely be that damaging to the company long term. He adds that in late 2008, Australian iron-ore producer Fortescue Metals Group Ltd. backed out of its obligations under some shipping contracts. After a period of arbitration, the company said in October that it had settled all disputes with shipping companies.

“People are now doing business with [Fortescue Chairman] Andrew Forrest again…and it’s almost like it never happened,” Mr. Bowring said.

Mr. Bowring said Cosco, which has been operating internationally for decades, is too experienced to think that it can apply Chinese rules to overseas deals. Still, he said that company relationships are viewed differently in China than in many other places. “Chinese culture will build a relationship before the contract,” he said. “The relationship is always something that can be talked about. The contract is just a set of papers that you keep in your bottom drawer.”

Buffett Backed China Battery Company Struggles

REUTERS August 23, 2011  By Alison Leung

HONG KONG (Reuters) – BYD Co’s profit warning and failure to deliver its promised electric car plan sent shares plunging to a more than two-year low, as the Chinese auto and battery maker backed by Warren Buffett struggles with steady sales declines and waning popularity of its top model.

Shares in BYD plummeted more than 14 percent on Tuesday after the company warned it could post a third-quarter loss.

The grim warning and ensuing stock drop has put a spotlight on the company’s strategy and on Buffett, whose investment in BYD has lost around $2 billion in value since taking a stake in 2009. His stake is still worth twice what he paid, though.

BYD attracted Buffett’s Berkshire Hathaway because of its battery technology, which former Berkshire executive David Sokol called a “breakthrough.” Sokol has since left the company under a cloud related to his personal investing activities.

Despite BYD’s F3 sedan being China’s best-selling car brand in 2009 and 2010, the company sold only 480 units combined of its F3DM hybrid and e6 electric model. It has also delayed the U.S. launch of its e6 until 2012.

Sales may improve in the second half with the launch of new models, BYD Chairman Wang Chuanfu said on Tuesday.

The company planned to export electric cars and buses to the United States and Europe next year and other overseas markets such as Hong Kong as early as 2011, the chairman said.

“We will start selling e6 to individual customers in China in the second half and to overseas markets next year,” Wang told reporters. “The fourth quarter is the traditional high season for car sales in China and with the new models coming to the market, our auto sales should be better in the second half than the first half.”

He expects BYD’s gross profit margin, which fell to 13.7 percent in the first half, to improve in the second half.

BYD warned Monday its net profit for the first three quarters may fall 85-95 percent due to fierce competition in China, the world’s largest auto market.

“I drove their car two years ago and I love it,” said CLSA analyst Scott Laprise, referring to BYD’s hybrid car. I thought this is the winner and I thought this could go anywhere in the world because of relatively low price.

“The premium part of the valuation is zero because they can’t deliver what they promised years ago,” Laprise said.

BUFFETT BAILING?

Buffett’s Berkshire Hathaway paid about $230 million in 2009 for 225 million shares in the company.

That stake was worth as much as $2.47 billion in October 2009 when the stock peaked at HK$85.5 each. The 9.6 percent stake is now worth about $467 million.

Wang said the company continued to maintain a good relationship with Buffett, but declined to comment on whether the U.S. investor would sell BYD shares.

Within Berkshire, the champion for the BYD investment has been Vice Chairman Charlie Munger, who held a personal stake even before the Berkshire investment and who has spoken of BYD’s Chairman Wang in glowing terms.

At investor meetings in April and July, Munger said he intended to stick with the BYD stake, which some took as a signal that Buffett would as well.

Buffett and Munger have also brushed aside concerns — raised by U.S. diplomats in cables released by WikiLeaks — that BYD has copied industrial designs from competitors. Diplomats have said that and other factors may keep BYD from releasing cars in the United States.

Buffett’s assistant did not respond to a request for comment on Tuesday.

LOWER FORECASTS, TARGETS

BYD’s guidance for a further deterioration and the forecast represented a 154 million yuan ($24 million) loss to a 90 million yuan profit for the third quarter, Bank of America Merrill Lynch said in a note.

The consensus 2011 profit forecast for the company stands at 1.7 billion yuan, according to a poll of six analysts by Thomson Reuters I/B/E/S.

Bank of America Merrill Lynch on Tuesday cut the target price on BYD shares by 15 percent to HK$17, after lowering its 2011 earnings forecast by 61 percent and its 2012 forecast by 31 percent.

BYD’s Hong Kong-listed shares, which have lost more than three-fifths of their value this year, dived 14.3 percent to close at HK$$16.18, their lowest since April 2009, compared with a 2 percent gain in the Hang Seng Index.

However, its Shenzhen-listed shares were up 1.2 percent.

The market has high expectations on BYD’s newly launched sport utility vehicle S6, and the coming G3 model, which will replace the popular F3, analysts said.

“This (profit forecast) was a surprise to the market,” said Steve Man, an analyst at Samsung Securities.

“Maybe on top of that the year-on-year comparison will be pretty easy starting from the third quarter. So people are hoping the company’s earning starts to turning around,” Man added.