China acts late on debt crisis

Peking refuses to panic in the face of looming disaster, writes Stephen Vines
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IF BRITISH banks had bad loans totalling pounds 158bn, or around 20 per cent of the country's gross domestic product, there would be nothing short of panic raging from one end of the City to the other.

Yet precisely this situation exists in China, where the banks are carrying bad debts totalling at least $200bn (pounds 121bn) - 20 per cent of GDP - but panic has yet to rear its ugly head.

China's banking malaise may be far worse - transparency is not exactly a hallmark of Chinese banking practices - but the problem is only now being addressed in any kind of serious way. On Wednesday, China's suave central bank governor Dai Xianglong is expected to announce a slew of measures to reform the country's creaking financial structure. These arise from a closed-door meeting of financial experts last week.

Although details of the meeting have yet to be disclosed, China's official media have been preparing the public for some shocks. Mr Dai has been quoted as saying that the bad-debt problem is getting worse and that "serious" measures would have to be taken. However, China can only solve the problem by shutting down debtor companies.

Foreign observers are sceptical whether the political will really exists to implement measures of this kind at a time of burgeoning unemployment, economic slowdown and fears that the deteriorating situation in the economy could lead to social unrest.

"It's impossible to over-estimate the importance or the enormity of reforming the state banks," a Peking-based foreign banker told Reuters. He estimated it would take at least a decade to tackle the problem, a relic of China's central economic planning era.

It appears that China's central bank plans to adopt a solution which will involve the four main commercial banks setting up asset management corporations. Their task would be to take over a proportion of the bad loans, parcel them into bite-size packages and sell them off at a discount or turn them into securities. Speculation centres on the China Construction Bank as being the pioneer in this experiment.

Unlike the other three big banks, the Construction Bank has been coy in revealing the level of its profits fall last year. The Bank of China, the country's main external trade bank, for example, owned up to a 41.5 per cent plunge in profits. The Construction Bank, on the other hand, gave the official Chinese media a profit figure of 2.21 billion yuan (pounds 164m) but qualified it by saying that "the actual profit" was only 850 million yuan, the difference being accounted for by unpaid loan interest. In other words, the bank was trying to present figures showing earnings which should have materialised but had not, and are unlikely ever to see the light of day.

This is typical of Chinese banking practices and demonstrates the enormity of the task facing Mr Dai and his colleagues. At one time, Mr Dai could cheerfully have turned to foreign bankers for support in cleaning up the bad loan problem. However, that option died a couple of weeks ago when China authorised the biggest bankruptcy in the nation's post-revolutionary history. The Guangdong International Trust and Investment Corp (GITIC) was allowed to sink with debts of some pounds 1.8bn.

Like many of China's other "ITICs", GITIC had attracted considerable foreign loan support. These corporations, modelled on the China International Trust and Investment Corp (founded by Rong Yiren, Deng Xiaoping's favourite pet capitalist), were supposed to be the bridgeheads through which a new style of market economy would flood China. In practice, they are a mixture of genuine innovative investment, clever financial card shuffling and a nightmare of shady deals and poor business practices.

However, it was assumed that, like CITIC, they all carried official blessing at the highest levels of government. This illusion was shattered when GITIC was closed down. Domestic investors were assured that they stood a good chance of getting some of their money back. Foreign investors were virtually told they could scramble for what was left.

The state-run Economic Daily cheerfully told its readers: "Foreign financial institutions should not think that the government will repay debt for closed institutions. They must be prudent in making loans."

Descending from some kind of Chinese never-never land, China's finance minister, Xiang Huaicheng, arrived in Hong Kong last week to say: "Overseas investors' confidence in China won't collapse because of GITIC's failure."

The markets have taken a rather different view. Shares in China-controlled companies listed in Hong Kong took a hammering. Bankers queued up to say that there would be a new and very high premium on loans to China.

Yet the old China magic still casts its spell on some bankers who believe that the Chinese market remains the last great frontier of untold riches. Among them is Hilmar Kopper, chairman of Deutsche Bank's supervisory board and an advisor to the Hong Kong government. "You should not lend on assumptions," he said. Apparently, however, his bank did just that and lent to GITIC what was a relatively small sum of money.

Other ITICs have since reported serious financial troubles and China now plans to reduce their number from around 240 to just 40. Liu Jinbao, the general manager of the Hong Kong branch of the Bank of China, says that although the bankruptcy is painful in the short term, in the longer term it represents a big step toward reforming the financial sector.

A great deal more short-term pain is expected. The problem is no one really knows how much pain the Chinese system can take without starting to break down.