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Is a soft landing possible for China?
Heidi B. Malhotra
Similar to the countries affected by the Asian Financial Crisis, from which China escaped fairly unscathed, China has been experiencing unprecedented economic growth. History suggests China's strong GDP, foreign direct investment and healthy account surplus cannot be sustained in the long term.
Internal culprits include corruption and deceptive business practices, the almost paranoiac attitude of wanting to dominate the world’s economy, a legal quagmire that does not provide avenues for redress on default/non-payment of loans, elimination of local protectionism, inability of the banking system to respond to interest rate changes and inability of state-owned firms to respond to pricing signals, lack of labor mobility, labor unrest due to high levels of unemployment, a large impoverished populace, power and transportation problems and more.
An external factor is that China is skirting international labor market agreements, bypassing legal restrictions through deceptive practices and producing low-cost products through slave labor, among other things. China, unless it addresses the aforementioned and many other issues, will not face only internal turmoil, but also international hostility and possible isolation and protective measures.
Latest available figures indicate a slowdown in the economy. Investments in certain sectors are down, but unbridled growth in other sectors has continued. Tightening measures have targeted only specific sectors and neglected to view the economy at large, curbing investments in the cement, steel, aluminum and real estate sectors. Increased reserve requirements for banks address the ever-increasing non-performing loan issue and lending to certain sectors has been curtailed. The Chinese government’s goal is to avoid a hard landing, but the question remains, as so clearly stated by the Daily Online: “Which engine will drive the country’s moderate economic growth recovery? Export, consumption or investment?”
China’s banking sector is teetering along. Non-performing loans, a legacy of policy lending by state-owned banks to state-owned enterprises, are staggering. New loans to those with connections, to cronies and to those in power have continued. It is also no secret that publicly recorded non-performing loan figures are severely understated and it gives one the jitters to think how much is hidden behind the almighty Chinese “state secrets.” Raised reserve requirements will not be even close to what is needed to address banking sector dilemmas. John M. Mulcahy of the Asia Times believes that a capital injection of between $300 billion to $500 billion is needed to “put the collective bank balance sheet of China’s banks in order.” Although these banks hold highly liquid assets, given the staggering number of non-performing loans, they are insolvent under international accounting standards.
Regulations intended to strengthen the supervision of bank lending and risk management took effect on Feb. 1, 2004. Unfortunately, such regulations will be ineffective without addressing the Chinese legal system that discriminates against the creditor. Existing laws, that should protect the creditor, are ineffective and unenforceable. The laws do not afford protection to either lenders or creditors. Enforcement vehicles are generally not in place, and where in place, adjudicators will bow to those with the upper hand.
The Chinese banking sector is still a child of China’s governing body and loosening of the apron strings is not something it relishes. Therefore, China’s banking sector is still a far cry from becoming a liberalized, market-based sector.
One must give some credit to China’s intention to bail out its ailing banking sector. China’s Ministry of Finance injected US$45 billion into China Construction Bank and Bank Of China during 2004, using funds from its foreign exchange reserves. But, what about recapitalizing other Chinese banks? CCB and BOC are fully central-government-owned. What about those banks that have a mixed ownership (federal/local government and state-owned enterprises)?
China has not shown its intention to recapitalize these banks, but it was rumored that China hopes for foreign investors to appear on the horizon and inject the much-needed capital. After leaps and bounds, including ugly lawsuits, Newbridge capital is the first foreign bank to own 18 percent of the Chinese Shenzhen Development bank, beating HSBC, Citigroup, Standard Chartered, IFC (the private-sector arm of the World Bank) and others. The Economist is not optimistic about further foreign investments, not because of lack of interest, but because the Chinese authorities cannot relax their grip on the financial sector too quickly. The financial sector ensures employment and social stability through politically directed lending.
Let’s ask ourselves again, is an economic and financial crisis in China inevitable, or will the successful disposal of bad loans, establishment of an effective and viable regulatory and enforcement system, ruthless restructuring and changes in human factors change China’s insolvent financial and hiccupping economic sector into an effective and viable international player? A thought by the Taipei Times offers an appropriate final conclusion: Unlike in the banking crises that happened in other countries in Asia in 1997-98, the trigger for a Chinese banking and economic crisis is more likely to originate from internal rather than external shocks.
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