Telefonica Announces Plans to Boost its Cash Position

Telefonica has announced plans to boost its cash position.

This will be done through asset sales, and moving to a dividend policy in 2012 paid by shares.

Regarding the sale of assets, the management board announced that it will pursue an IPO of Telefonica Germany as well as look at possible listings of some Latin American businesses.

It will also consider “selective asset monetisations”, with the accelerated sale of non-core activities.

Regarding the stock dividend, the management board proposed to switch to a final dividend for 2012 all paid in shares.

The company said over 60 percent of shareholders opted for the stock dividend last year. It reiterated the dividend for 2012 will total EUR 1.30 (plus EUR 0.20 per share in share buybacks), and for that, the board proposed to pay an interim dividend in cash of EUR 0.40 per share in November 2012, and the remainder in stock in May 2013 by means of a scrip dividend (new shares which are given free of charge to existing shareholders, lowering the value per share).

Regarding the dividend policy beyond 2012, the board also maintained a forecast for shareholder remuneration of at least EUR 1.50 per share in 2013, but said the make-up of this (the remuneration mix for the year 2013, dividend, share buyback or the combination of both) will be decided later, based on market conditions. The company said the measures are aimed at keeping its leverage ratio (net debt / OIBDA) below 2.35 times this year.

As for the feasibility of this objective, note that the leverage ratio for the past 12 months (with the OIBDA less the provision related to the redundancy program in Spain, which amounted to MEUR 2,671) stood at 2.55 times as of the end of March 2012. If net commitments related to workforce reduction are considered, the ratio of total net debt plus commitments over OIBDA (excluding results on the sale of fixed assets) stood at 2.74 times.

In the first quarter of 2012, revenues were up 0.5 percent to MEUR 15,511, but OIBDA margin decreased 3.4 percent points to 32.8 percent, mainly because of an increase in operating expenses (mainly in subcontracts, which counted for 45.24 percent of the increase, but also helped by changes in personal expenses and supplies, which increased 6.7 and 2.7 percent respectively on an annual basis).

OIBDA decreased 8.8 in reported terms, 7.4 percent in underlying terms (ex spectrum and write downs in Telecom Italia).

On the other side of the equation, Net financial Debt  increased 1.5 percent from MEUR 56,304 at December, 2011 to 57,131 at March, 2012.

CapEx increased in Q1, 2012 10.3 percent from Q1, 2011, but the slight increase in revenues (+ 0.5 percent year on year) made the CapEx / Sales (ex spectrum) ratio decrease by 3.2 percent points to 11.0 percent, meeting for now the guidance that the company set for the current year.

This has not been enough to compensate the decrease in OIBDA though, and resulted in an operating cash flow of MEUR 3,374 in the first quarter of 2012 (-16.3 percent year-on-year in organic terms;, -14.2 percent in underlying terms).

The net payments for financial investment and for dividends have made then the free cash flow after dividends negative (MEUR -542, compared with a positive of MEUR 188 in the same period of 2011). With a negative forex, the net financial debt has increased as stated.

Note that, in January, a loan facility with a Chinese financial entity was signed to finance telecom equipment purchases with a local supplier for an amount of MUSD 375 (MEUR 284). This accounted for 34.35 percent of the interim net debt increase.

The decrease in OIBDA, with the increase in Net Debt, have been the reasons for the higher interim leverage ratio.

The free cash flow per share has decreased 91.4 percent to EUR 0.02, and the basic earnings per share to decrease 25.7 percent to EUR 0.29.

Regards,

Carlos.

Entrepreneurship in Spain

The Spanish government has recently made a huge reform of the labour market. Was it necessary? Most probably. Is it enough? For sure it isn’t. What else needs to be done? Entrepreneurship and access to finance are two absolutely key aspects that M. Rajoy’s government HAS to boost up. Otherwise, the implications will be huge.

I have lately been analyzing SMEs’ (Small & Medium sized Enterprises) dynamics in various countries (Spain, Brazil, the UK and Germany), as a starting point for estimating the opportunity for some specific Cloud Computing services.

I found few 2011-15 projections for the number of SMEs in those markets, and I decided to go my own, using statistics for which there were sensible forecasts.

One of those statistics that I started to focus on was the credit that banking institutions (including commercial banks and the monetary authorities) give to the domestic sector (households and enterprises, excluding the government). And I found interesting comparison data, see the figure below (source: www.TheGlobalEconomy.com), which shows the bank credits averages of various countries for the period from 2000 to 2010.

But what struck me the most was the evolution over time of that bank credit as a percentage to the countries’ GDPs, see below (same source).

As per that source, “if the banking credit to the private sector is about 70 percent of GDP and more, then the country has a relatively well developed financial system. The amount of credit can even exceed 200 percent of GDP in some very advanced economies. In some poor countries, the credit could be less than 15 percent of GDP. In these countries, firms and households essentially do not have access to credit for investment and various purchases”.
According to that statement, all the countries above have “relatively well developed financial systems”, except India.
So far, so good. But something that stroke me was the progression of that ratio in Spain (remember, it was one the countries that I was looking at, to make my initial analysis). Banking credit in Spain has increased from a rough 120% — the same percentage as Canada at that time, and bit below the UK’s some 130% and Germany’s approximate 148% — to some 230%. That is a very steep curve.
Spain since 2007 then (when the country broke the 200% line), should be regarded as having a “well developed financial system”, well above Germany, and at the similar levels as the US. Is that so? Then, why does Spain have a mind wobbling 22-23% unemployment rate? Shouldn’t Spain be experiencing a high rate of SME creation, and then of innovation and of employment creation?

If you look at data from Eurostat (see below), the number of SMEs — and the employment, and the value added of SMEs — in Spain were expected to decrease from 2008 to 2011, showing a clear gap with the credit / GDP ratio above, a gap between the evolution of the credit / GDP, that has increased steeply, and the the number of SMEs (and employment, and value added), which is expected to significantly decrease.

So maybe the GDP has evolved in Spain in a different way than in other European countries, I thought.

But no, if you look at the graph below, the GDP in Spain has evolved in a similar way as in the UK, even in a very similar way as in Germany (starting in 2011-12, the differences in the GDP growth will be much higher).

So why is that difference? It seems quite evident that this huge increase in credit in Spain has gone to households, and has not been translated at all in creating new SMEs, innovation, employment and value added.

Look at the next graph below; when compared to the EU average, Entrepreneurship and Access to finance in Spain rate well below that EU average.

Compare these data with the ones of the only other country that showed a similar steep curve as Spain in credit / GDP, the UK (see below).

It looks like the British government can afford such a credit / GDP steep curve, given the country’s entrepreneurial nature of its citizens and to the access to finance; but it looks like Spain can’t.
Does anyone else have doubts about why one of Spain’s most emblematic companies — Telefonica — seems to be embracing Open Innovation (see the launch of Wayra’s program in London) at a much larger degree in the UK (O2) than in Spain (its home market)?

The Spanish government has recently made a huge reform of the labour market, hoping that SMEs (the main source of employment in the country) would be able to dedicate more resources to innovation, and would then create more employment in the long run; it has been the bluntest labour reform in the entire EU.
I have to say that, given the figures that I have provided above, this seems to be almost nonsense to me. Maybe the labour costs in Spain were too high (although certainly not higher than in Germany or France), but this reform of the Spanish labour market will go nowhere unless Entrepreneurship and Access to finance are highly promoted. And the Spanish government seems to be doing nothing about it.

Sad, isn’t it? Certainly, and I live in Spain.

Regards,
Carlos.

Apple’s latest announcements impact the markets

The market did not react well to the fact that, at Apple’s latest key note, the company did not present any new device. And Apple fell $5.40 (1.57%) on Monday, to $338.04.

It’s true. But the markets react to short term announcements, more than to long term strategic moves of companies. And despite this, the analysts did like Apple’s latest move into the cloud and social networking.

It’s a move that Google and Amazon have already made somehow, but a different one that cares much more about the end user experience. And one that is bolder towards the content owners. Probably this boldness, along with a real clarification about the needed new relationship to those content owners, had also something to do about Monday’s share decrease.

Still, this move by Apple is in line with the company’s wall gardens approach. An approach that, although it has proved very successful so far, also opens new possibilities for Google, who follows a open strategy. Something that may also have had an impact into Monday’s share evolution.

Another possible explanation to the company share decrease early this week may be that Apple had to finally give up about their plans to integrate the SIM in the iPhone 5, a move that, according to Gigaom, was planned for the Californian company to gain independence from the telecom operators, a move that those operators have reacted very strongly against.

By the way, given the cash management problems of Apple, and given the importance that Apple has given to its relationship with Twitter, I would not be very surprised that Job’s company shows at some point in time some interest in participating in the social networking company.

Enjoy,

Carlos.

A new Internet stock bubble?

I found last week a very interesting article by the Economist Intelligence Unit (EIU), who warns about a potential bubble related to the Internet companies.

It is argued in the article that this time is a different story than in 2000, when the dot.com bubble burst, because this time the companies at stake they all provide strong business models (except for Twitter), unlike what happened back in 2000.

But these valuations are very high … too high in too many cases.

Not just that, but I also found very dangerous the statements by some consultancies, proposing new valuation techniques, supposedly more adapted to the nature of the Internet companies. E.g. PWC proposes to use a “value per user” approach, which prioritizes growth over revenues. This seems really scary to me. I don’t have more information than the one provided in the EIU article. But one thing is to deal with very high valuations backed up by real economic results, and another very different thing is to try to justify valuations with totally intangible data such as users. How much is a user worth?

Another scary thing about this potential bubble is how global it is. There are an increasingly high number of Asian Internet companies (see the graph below, highlighted in dark blue). And a potential burst would not restrict itself to just one part of the world.

Anyway, here is the full article, for your reference:

World finance: A new Internet stock bubble in the making?

May 31st 2011

FROM THE ECONOMIST INTELLIGENCE UNIT

An increasing number of Internet companies have been going public of late, and their sky-high valuations are feeding a flurry of investor interest. With rumours of more (and juicier) initial public offerings (IPOs) in the pipeline, this year could see a boom in stockmarket listings of online companies. Such a scenario raises concerns that a new Internet stock-price bubble may be forming. If this proves to be the case, what’s in store?

LinkedIn, a business social-networking site, was valued at 578 times last year’s earnings when it went public on the New York Stock Exchange on May 19th. Much ink is being spilled over whether this excessive valuation, particularly in view of the fact that the company expects to make a loss this year, is the latest signal that a new Internet bubble is forming.

It does look like it, and this time it’s global (the dotcom bubble of around 1995-2000 was mainly a US phenomenon). Internet companies from emerging markets are causing just as much of a stir among investors, who are keen to capitalise on the huge opportunities offered by high-growth countries like China (which has the largest and fastest-growing Internet population in the world) and Russia. Renren, a social-networking site often hailed as China’s Facebook, is the latest in a string of Chinese Internet companies to go public in the US. It traded at a spectacular 72 times last year’s earnings when it listed in early May. Yandex, which is Russia’s most popular search engine and largest Internet company by revenue, listed on May 24th at a value 60 times last year’s earnings.

These are all extremely high valuations when compared to the average Standard & Poors 500 and NASDAQ price-to-earnings (P/E) ratios, which range between 15 and 17. Google, a US Internet giant, is currently trading at a slightly higher P/E ratio of around 20 times 2010 earnings, but this remains low by comparison, suggesting that investors are paying a big premium on these IPOs. Still, not everyone is convinced that overvalued stocks such as these are proof of bubble trouble.

Nothing to see here

The no-bubble argument hinges on the fact that, this time around, investors seem to be focusing on the IPOs of just a few industry leaders with solid business models and revenue streams rather than the many overly-ambitious (but low-revenue-generating) Internet firms of the 1990s. Thus, although stocks are overpriced, the excitement is contained to a handful of players who are likely to be successful in the long term, as was the case with Google.

In addition, traditional measures of a company’s value may not necessarily apply. PriceWaterhouseCoopers (PWC, a global professional services firm) argues that the P/E method of stock-price valuation itself is flawed when used for social media firms. Instead, PWC points to a “value per user” approach, which compares valuations with telecoms operators and broadcasters on the assumption that a customer base can be monetised, as a more appropriate measure. Because many social media companies prioritise growth over earnings, the argument is that a lack of earnings means a P/E ratio may be a misleading gauge of value.

Warming up backstage

But trouble may be brewing out of sight: although 80% of publicly-listed tech companies are trading within their historical valuation ranges and recent IPOs are few in number, valuations in the private market are skyrocketing too. There is a lot of hype surrounding the upcoming IPOs of high-profile Internet companies such as Facebook (which is valued at around US$76bn, more than Boeing or Ford), Zynga, a virtual gaming company valued at around US$9bn, and Groupon, which sells online coupons to its subscribers and is valued at around US$15bn-20bn. By contrast, Twitter, a highly popular social-networking site also tipped for an IPO in the near future, is valued at around US$7.7bn, although it has yet to find a profitable business model.

Although these companies are operating with healthy fundamentals (Twitter aside), their valuations may float a bubble into the public market. The question is if it will burst sooner rather than later. This will depend on whether these companies’ IPOs trigger an onslaught of listings by less-sound firms seeking to emulate their more successful peers and tap into investors’ strong appetite for anything Internet-related. If the rush to go public happens, history might repeat itself with another bust, and only a handful of winners will be left in the end.

Regards,

Carlos.

Network Sharing, or how can the Operators decrease CapEx

I already talked about Outsourcing in one of my previous postys (Outsourcing benefits both Operators and Vendors).

A second plank of the Indian model is infrastructure-sharing, in which several operators share the metal towers on which network antennae are mounted and which house their associated equipment, generators and so forth.

In 2007 three Indian operators, Bharti, Vodafone Essar and Idea Cellular, pooled 100,000 of their towers in a single company, Indus Towers. Not all the operators use all the towers (currently, over 40% of the total sites in the country are shared with an average tenancy of over 1.5 per site), but the arrangement saves the three companies having to find new sites and build their own towers.

Similarly, Reliance Communications has spun off its towers into a separate unit that will offer tower capacity to other operators.

This turns an operator’s assets into a source of new revenue, says Mr Gokarn, and allows the mobile operator to concentrate on serving customers.

Tower-sharing happens in other countries too, including Britain and America, says Capgemini; and some countries, including China and Bangladesh, have made sharing compulsory.

What is unusual about India is the extent of voluntary, market-led sharing as a way to reduce costs.

There are a lot of operational ideas from a cash-constrained, poor and very entrepreneurial environment that can immediately be brought back to the developed world.

Perhaps the most striking example is the agreement struck between Vodafone and Telefónica in March 2009 to share towers and other network infrastructure in four European countries.

And at the end of February this year, it was announced that French mobile network operators Orange, SFR and Bouygues Telecom have also signed a framework agreement for sharing 3G network installations based on April 2009 guidelines set out by regulator Arcep applying the law on modernising the economy.

The savings are much bigger in Europe because the cost of leasing tower sites is higher, which adds to the attraction of the deal, Telefonica and Vodafone expect to be able to reduce the number of the sites that make up their networks by about 25%. And three big European operators—France Telecom, KPN and Vodafone (again)—have recently decided to outsource the running of their networks in some countries to equipment-makers: Nokia Siemens Networks, Alcatel-Lucent and Ericsson respectively.

Enjoy,

Carlos.

Outsourcing benefits both Operators and Vendors

As we have seen in one of the previous posts (Differences in CapEx and OpEx spending in Developed / Emerging markets), the average of the (OpEx / Revenues) ratio is more or less the same among developed and developing countries, but the decrease in emerging markets shows a genuine worry and effort to decrease operational costs, and this is one of the basis allowing telco operators in those markets to have net incomes.

Indeed, e.g. despite an ARPU of only $6.50 and call charges of $0.02 per minute, Indian operators have operating margins of around 40%, comparable with leading Western operators, and Vendors run networks with 25% fewer staff than operators would need, achieving economies of scale.

Outsourcing is at the heart of this model, called the Indian model, which was pioneered and is now embodied by Bharti Airtel, India’s biggest mobile operator. All of Bharti’s information-technology (IT) operations are outsourced to IBM; the running of its mobile network is handled by Ericsson and Nokia Siemens Networks (NSN); and customer care is outsourced to IBM and a group of Indian firms. This passes much of the risk of coping with a rapidly growing subscriber base to other parties and leaves Bharti to concentrate on marketing and strategy. Unusually, it is not just the operation of Bharti’s network that is outsourced but the construction as well, under a scheme known as “managed capacity” that is now used by several Indian operators.

When moving into a new area, Bharti requests a certain amount of calling capacity and pays for it three months later at an agreed price per unit of capacity, according to BDA, a telecoms consultancy. That leaves it up to the vendor to handle the business of designing networks, putting up base stations and so on, giving it an incentive to build the network as frugally as possible.

Bharti’s operating expenses are therefore around 15% lower than they would be if it were to build and run its network itself, and its IT costs are around 30% lower, according to Capgemini.

The vendors, for their part, gain economies of scale because they build, run and support networks for several Indian operators. Ericsson says his firm can run a network with 25% fewer staff than an operator would need.

Expanding into rural areas is especially tricky because the capacity needed is initially very low, so Bharti typically agrees to buy a minimum amount. Equipment vendors make most of their profits when capacity is increased.

Another example of the spread of the Indian model was the agreement reached by Sprint, an American operator, to outsource the day-to-day running of its network to Ericsson.

“In markets where you are not sure about speed and shape of growth, the model makes sense,” Ericsson says. But in mature markets where demand is easier to predict it can be better for operators to build new capacity themselves.

Enjoy,

Carlos.

Differences in CapEx and OpEx spending in Developed / Emerging markets

I recently was interested in making some predictions for the spending of telco operators.

For that, I was curious about three things: the differences between the CapEx and the OpEx, the differences between developed and emerging countries, and the recent trends due to the financial crisis.

And I unsurprisingly found differences among regions with regards to both CapEx and OpEx reduction.

If we graph the countries’ network readiness (measured by their NRI, an index produced by the World Economic Forum) with the operators’  geographical sources of revenues, it is no surprise to find out that the Carriers in the developing countries are the ones with the highest need to invest (CapEx) in networks. In emerging countries, the average (CapEx / Revenues) ratio is 35%, compared to 14% in developed economies, and with a 8% increase, versus a mere 1%.

Regarding the (OpEx / Revenues) ratio, the average is more or less the same among developed and developing countries, but the decrease in emerging markets shows a genuine worry and effort to decrease operational costs.

These differences are useful not only in forecasting, but also in understanding the differences in the various OpEx reduction initiatives, like Outsourcing or Network Sharing.

The following figure shows the findings:

Enjoy,

Carlos.

TCO Analysis Revisited

Although TCO Analysis is something in which I was not involved in since many years ago, when I was in charge of a large team across the EMEA for Product Marketing in Nortel Networks, I recently was asked to provide support for this task again, from the perspective of a Management Consultant.

The issue of the vendors when they do TCO analysis is that they can’t look beyond their bits and bytes, and that they do not understand that any TCO analysis that they provide just with their internal staffing and data is absolutely useless. Because their clients simply do not trust them. If you were a telco provider, how would you react to a bunch of vendors that tells you that their products or solutions are the best because they help to reduce TCO i.e. by an astonishingly 25%?! Would you take them seriously?

The problem is the lack of trust.

This is a problem which could eventually be reduced if the vendor would compromise in the final savings, i.e. through a revenue-sharing approach with their clients. But that would need a long time to prove itself, and anyway it would still be based on a profoundly endogamic methodology, one that would still rely on the internal knowledge of the R&D departments of the vendor to try to identify the savings, something that would still be very questionable.

The methodology that I have recommended this time was based not on the internal knowledge of the vendor, but on the knowledge of external companies, subcontracting companies employed by the client.

The first phase would consist of the definition of a scenario of reference, i.e. deploying fiber from the CO to the ONT. That scenario of reference would have a processes’ model and a cost structure associated to it. And here lies the first difference with the traditional methodology followed by traditional vendors: the scenario of reference would need to be identified by the vendor, in collaboration with the client, but the processes’ model and associated cost structure would be determined through a set of external interviews. Those interviews would need to be done to external companies, companies that would normally work with the vendor client in similarly related tasks as the ones proposed by the vendor.

This first round of external interviews could be combined with a second round of interviews, during which the external companies would be asked to double check their initial output, based on the average of the ‘industry’.

The second phase would need to determine a series of scenarios where the client would like to evolve to. The definition of these evolution scenarios would be done by the vendor and the client jointly.

Then, the vendor would need to perform a second round of external interviews to determine the possible cost savings associated to each process of the model, for each evolution scenario. Here again, this second external benchmark could include a second round of interviews, again for the external companies to double check again their initial output, based on the average of the same ‘industry’.

There would be a third step, which could be combined with the previous one, in which the vendor would challenge the responses of the external companies in order to identify the rationale for the eventual cost savings.

The following figure shows this methodology:

 

Now that the cost savings have been determined, the next obvious step of this project should be to quantify the expected accumulated cost savings, working with data by the client.

But there is another advantage yet to this approach: the identification of the areas (processes) where most of the savings could be achieved should be invaluable information for the vendor, whose R&D department should focus on those areas that take most of the costs.

Enjoy,

Carlos.

Telecommunications Investment in China (4 of 4)

As per the Pivot report, the overinvestment and increasingly inefficient credit-driven speculation may well end up in a pull back of capital expenditures, whose hard landing may prove fatal to China and therefore to the rest of the world.

But, on the other hand, and as it concerns the Chinese telecommunications market, as we have seen in the first part of this analysis, Chinese carriers shift focus from network construction (3G deployments will end in 2010) towards generating revenue through new and better services.

As a result, China’s telecoms operators will continue to face a tough operating environment due to aggressive pricing, and the deployment of 3G infrastructure. All three major operators, China Mobile, China Unicom and China Telecom have reported that they are not likely to turn a profit in 2009 or 2010, as they invest significant funds, running into billions of US dollars, into the deployment of their 3G networks and services.

While network expansion into rural areas continues, which has led to a price war erupting as operators (particularly China Mobile) aim to secure their market shares, there has emerged similar competitive pressures in the 3G market. The mobile market leader announced that it would be increasing its handset subsidies nearly threefold in 2010 to more than CNY30bn (US$4.4bn), after feeling threatened by second-ranked China Unicom’s launch of the Apple iPhone in October 2009.

Indeed, with a 3G subscriber base of 1.655mn at the end of September 2009, China Mobile remains the market leader in the 3G sector. The operator plans to spend CNY120bn on handset subsidies in 2009, of which the majority would go on TD-SCDMA. It has been procuring new handset models, with the operator revealing that it wanted to have 100 different models available to subscribers. In the first half of 2009, it laid out CNY50bn on subsidising handsets, of which just under 12% went to TD-SCDMA handsets.

On the other hand, as its competitors have begun to deploy their 3G services, China Mobile remains concerned that its TD-SCDMA service will prove unpopular, and that may be a reason for the government push for the Chinese standard.

Nevertheless China still has a great potential for further development and promises tremendous opportunities in telecoms. But given the transition to more stable growth, it is extremely important to have an objective perspective of the market and to understand which market segments promise the best growth opportunities.

Indeed, this extremely competitive market is characterized by a multitude of complex, multi-layered, political, economic and cultural factors that must be carefully evaluated in order to be successful.

Telecommunications Investment in China (3 of 4)

So it’s not just about overinvestment. The presumably resulting near-crisis situation could be delayed if the efficiency of that credit was enough to keep on financing the country’s investments. But, according to Pivot, such efficiency is at stake.

If loans continue to grow at the current 35% rate, credit to GDP ratio will be close to 200% in China already in 2010, even with GDP expanding at 10%. This is a level similar to the pre-crisis Japan in 1991 and USA in 2008 (see chart 6), all this points to that credit in China is not going to be able to grow for much longer without risking a major crisis, if we compare that situation to historical patterns in other countries (Japan in 1991, and recently USA in 2008).

And, the report says, “the effectiveness of domestic credit in generating growth is collapsing. In the period from 2000 to 2008, it took on average $1.5 of credit to generate $1 of GDP growth in China. This compares very favorably with the peak $4 of credit for $1 of GDP in USA in 2008. However in H1 2009 in China this ratio was already at around $7 to $1”.

So, eventually, the decreasing efficiency of investments may ultimately lead to a pullback in capital expenditures.

The Economist agrees in that, in the short term, the revenue from some infrastructure projects may not be enough to service debts, so the government will have to cover losses. But in the long term such projects should lift productivity across the economy (and it mentions as an example that, during Britain’s railway-mania in the mid-19th century, few railways made a decent financial return, but they brought huge long-term economic benefits).

So the question seems to be: how long can China support the financing of those investments? After all, China’s government does not have much explicit debt (23% of GDP) and sits on $2tn worth of foreign exchange reserves.

And Pivot, again, points at a few issues with that argument.

Firstly, the size of the Government’s debt is vastly understated. In total, Pivot points to a set of off-balance sheet liabilities that are equal to $1.7tn, which would bring China’s public debt to GDP ratio up to 62%, a level that is comparable to the Western European average.

Secondly, Pivot argues that not all the country reserves can be spent to finance debt. And, as an example, the analysis firm identifies $500bn of “hot money”, c.f. money in circulation inside the country that cannot be used to finance debt because it can leave the country at any moment (as it in fact did in 2009).

In order to estimate the amount of money that the country can really spend, Pivot proposes to look at the ratio of reserves to the sum of local money and gross external debt.

We already know how many reserves there are.

As for the local money available, M2 monetary aggregate (a quantification of  the amount of money in circulation) in China is $8.4tn (which is higher than M2 of $8.3tn in the US) and it is currently growing at 28%.

And China’s gross external debt was $374bn as at end of 2008, which in Emerging Market space is second only to Russia in size.

As a result, and compared to a sample of Emerging Markets, China’s reserves in relation to its liabilities are not that spectacular (see next chart), so in that sense China is technically not in a position to “spend” its reserves.

The Economist grants that total government debt could be 50% of GDP. But it says that is well below the average ratio in rich countries, of around 90%. Moreover, the journal mentions that the Chinese government owns lots of assets, for example shares of listed companies which are worth 35% of GDP.

Anyway, it seems clear that China has significant off-balance sheet liabilities and cannot just “spend” all its reserves on CapEx without undermining its external position.