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Send comments to: William Gamble, J.D., LL.M. Tel 401-272-8906 Fax 401-272-8139 |
William Gamble, J.D., LL.M. |
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December 17, 1997 [home] Chinese Banks: The Darkness of AsiaBy: William Gamble, President For the past six months the Wall Street Journal has been reporting the problems of the Chinese banks. Part of this report culminated in an article dated Monday, December 15th, entitled "Shaky Stability: China Works to Avoid Southeast Asia's Woes." The premise of the article as follows: "For now China seems safe largely because-ironically-it hasn't liberalized enough to be exposed to Asia's ills." This premise is based on two assumptions. First "The inconvertibility of the yuan makes it difficult to speculate on the currency and to take capital out of the country." Second, "Its banks, though in a mess are government owned and thus not at risk of failing." I believe that the inconvertibility of the yuan and the banking problems will prolong and exacerbate China's economic problems. The result will not be the protection from the winds of economic change blowing through Asia. On the contrary, the unreformed protected Chinese system will becalm the Asian recovery. "With an estimated $200 Billion in accumulated nonperforming loans - five times the equity capital of all Chinese banks - China's banking system is essentially insolvent. At least 50% of China's state owned companies are in the red, constituting a far larger chunk of the economy than failing companies present in any other Asian country." (WSJ 11/04/97). Since according to the World Bank Chinese Bank's "accounting, risk management, and credit systems analysis are woefully inadequate; and the quality if their loan portfolio is unknown" The $200 Billion figure from Standard and Poor's may be just a starting point. The fact that none of these banks have been allowed to fail or that the banks are owned by the state seems irrelevant. Enormous amounts of money have been squandered in inefficient and insolvent state owned companies. The fact that the state is wasting state revenues is just as much a drag on the economy as democratic governments using taxpayer dollars to bail out commercial banks. In both cases it is the creditors, depositors and taxpayers who are at risk of losing money that could have been better used elsewhere. The cost of communist inefficiency is still being paid throughout Eastern Europe and the Former Soviet Union. China is no different. The fact that her banks are still state owned conduits for a bankrupt sector of the economy does not mean that the banks cannot fail. It is far worse. The banks have not only failed. Worse, they continue to fail. These are the undead, the vampires sucking the blood from the financial system. According to Moody's Investor Services the banks in Thailand "enjoy financial positives such as better profit margins, less opaque accountability and a freer management style." After the shake out, the remaining banks in Thailand that are fundamentally strong will be in an excellent position to continue and participate in the country's growth. In addition, "by letting foreigners take big stakes including full control will lead to better practices and stronger institutions." (Economist 12/13/97). In China there will not be a shake out. Like Korea and Japan an outmoded and inefficient system of allocating capital exacerbates the crisis and delays recovery. The inability of the Japanese to reform their system has resulted in a four-year-old recession that has no immediate hope of ending despite that existence of the lowest interest rates in history. With an economy growing at double digits, foreign reserves more than $134 Billion the Chinese and other investors have maintained that they are protected from the crisis overwhelming their neighbors. Although their foreign debt of 119 Billion "gave it an external debt comparable, for its size to Malaysia's," "eighty eight percent of China's external debt is medium and long term, and most foreign investment in China is for directly invested projects" according to China's central bank governor, Dai Xianglong. Stating China's present strength misses the point. Without further reform there is no place to go but down. The present 40 billion dollar annual direct investment is expected to drop by half as is the present rate of growth for exports. It would be fair to argue that with growth rates that exceed double digits, the economic environment of China could use a small slow down. My response would be that in other countries, specifically Thailand, a recession would squeeze inefficiencies out of the system. In China without the normal methods of restructuring such as bankruptcy, the problems could last for years. Without the phenomenal growth foreign investment could not only decline, but dry up. Without restructuring the problems tend to feed on themselves and failure like success begets more failure. For example, the delay in restructuring our own banking industry simply cost the taxpayers rather than increasing the faith in the system. The delays of the Japanese and the Korean in restructuring their financial systems will have a similar result. A similar problem exists for Russia. Unlike some of eastern Europe, Russia for political reasons, decided to dismantle the state bureaucracy and state businesses on a gradual basis. The result has been stifled economic growth and corruption. The corruption has been institutionalized because the governing officials who have the power to change the system are the ones who stand to benefit from the present system. China has created a similar situation, with one major difference. Russia unlike China is a democracy. Perhaps a young and shaky democracy, but a constitutional democracy none the less. People in Russia have a chance to express their grievances at the ballot box and they do. The opposition is Russia is powerful and very vocal. The Chinese have no such option. The result will undoubtably be increase civil unrest. According to the Wall Street Journal this is already occurring. "The nation is facing its most volatile mix since the late 1980s, when economic malaise helped fuel protests in Tiananmen Square." and" Street protests are breaking out regularly across China as the state sector implodes." Of course, the civil unrest will exacerbate the financial problems. Protecting the yuan also does not protect the system. It just gives the illusion of stability, which further delay economic reforms. In essence the yuan is pegged to the dollar. But the problems with this system were amply illustrated with the collapse of the baht. If China had a currency board system similar to Hong Kong, such a peg might be some help. However, such a method is impossible without a direct link to the rest of the financial system. With the present insolvency of the banks, an interest rate increase to protect a weakened currency will exacerbate the problem. China is not immune from the deepening economic morass sweeping Asia. It may in fact be one of the darkest holes. To avoid this fate it must follow the advice that George Soros just gave to the Koreans. "You must invite foreign companies to come in and be direct investors and owners of Korean companies, and companies that cannot meet their obligations must be allowed to go bankrupt." Unfortunately, it will probably do neither. By: William Gamble Emerging Market Strategies Company Tel. 401-272-8906 This article can also be found on the University of Virginia Darden School of Business Administration Alumni Forum and in the EMS Newsletter. Some of these articles are referenced in Professor Roubini of New York University Stern School of Business Administration Asia Crises Home Page and in the Providence Journal - Commentary Section.
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