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LSE head cautious, optimistic on investing in China

Monday, Sep 12, 2005, Page 11

Howard Davies, director of the London School of Economics, at an interview last Saturday. Davies warned potential Taiwanese investors in China about the liability they might be taking on. PHOTO: WANG MENG-LUN, TAIPEI TIMES

Taipei Times: Several institutions have forecast that the Chinese yuan might appreciate by 3 to 5 percent in about a year. What's your view on the future development of China's currency?

Howard Davies: It's possible, because the initial change in the currency regime only allows for a very modest movement.

I think their forecasts are that there will be more flexibility in the future.

If you look at Chinese financial reports over the last 15 years, you'd see they've started modest changes, by allowing foreign banks in and letting them do Chinese yuan business.

Some also said it could drop, but I believe it would be unusual because the Chinese do have a very sizable trade surplus with the US, in particular.

The oil price hasn't impacted China. It's more likely [for the Chinese yuan] to appreciate than to depreciate. Also, it requires a high cost to maintain a lower Chinese yuan.

They've been buying US dollars to keep the currency down, and that's quite expensive. I don't think they want to carry on doing that. I'll expect they want to unwind the situation.

About Howard Davies * Oct. 2003 until present: Director of the London School of Economic and Political Science * 2004: Jointed the board of Morgan Stanely as a non-executive director * 1997-2003: Chairman of the Financial Services Authority, the UK's single financial regulator * 1995-1997: Deputy governor of the Bank of England, the UK's central bank * 1992-1995: Director general of the Confederation of British Industry * 1987-1992: Controller of the Audit Commission * 1982-1987: Worked for McKinsey & Company in London * 1985-1986: Special adviser to the Chancellor of the Exchequer * 1980: Obtained a master's degree in management sciences at Stanford Graduate School of Business, California * Other experience includes working at the Treasury, the Foreign and Commonwealth Office, and two years as private secretary to the British Ambassador in Paris.

TT: Serving a similar role as the UK's Financial Services Authority (FSA), Taiwan's Financial Supervisory Commission has been positioned as the top regulator of the financial market. But now the commission has planned to take the show on the road by year's end to promote the nation's market. What is the ideal model for such a financial supervision body?

Davies: It's very difficult in the long run for one agency to serve as the regulator and the promoter of a financial system.

"It's obvious that the Chinese financial system is in many respects already a very well-developed and complex system. In fact, it is already bigger in relation to its total economy. But there are risks, as the banks have a large proportion of non-performing loans."

Howard Davies, director of the London School of Economics (LSE)

In the past, when banking regulation was part of the Bank of England, it did have a twin role of regulating the banks, and also was regarded as the cheerleader for the banks.

But the trouble is, in reality sometimes there are conflicts. Ten years ago, London was a wonderful place with 450 banks.

But actually we could have up to 550 banks by admitting 100 Russian banks who all want to have a presence in London.

But as all these Russian banks were bankrupt, if we had admitted them, it would have left us a major problem in our financial regulation, although we would have boosted the number of banks. So this is why we set up the legislation, to separate it.

The FSA now has the responsibility for overseeing the financial stability and maintaining confidence in the UK financial market, protecting consumers' financial services, and fighting financial crimes, which is about money laundering.

The more independent your regulator is, actually the stronger your financial system will be. In the long run, the financial system will be healthier if that's the case.

TT: The Taiwanese government is putting in efforts to push forward financial reform to consolidate the crowded banking sector. But it has met with strong opposition from labor unions, with one even calling a strike. What is your view on such a conflict?

Davies: My observation is that state-owned banks are always in the end very expensive things.

We are lucky in the UK, that although the government in the 1960s and 1970s nationalized a lot of things -- like electricity, gas, car, aircraft, and ship industries -- we never nationalized a bank. The state-owned banks end up being unprofitable.

I support any government privatizing its banks. I don't know many details [about Taiwan], but in the UK, all privatization was coupled with employee shares. People were given discounts in shares.

When we privatized British Telecom, the union was totally opposed to privatization.

But then, 95 percent of the union members subscribed for shares as the union suddenly realized that the company does not represent the government any more.

They'd have a better chance of making profits, so they were happy to buy shares. That's the way we saw, by giving people a stake in the [privatization] business.

TT: When there is question about investing in China, more often than not a rosy picture is painted, saying that the populous developing country holds a lot of potential for making profit. Is it really all about opportunities, or are there any undercurrents or traps there? In other words, what is the other side of the coin?

Davies: It's obvious that the Chinese financial system is in many respects already a very well-developed and complex system. In fact, it is already bigger in relation to its total economy.

But there are risks, as the banks have a large proportion of non-performing loans (NPL).

That is a legacy of political lending in the past, where a lot of lending in China was driven by political priorities, or used to develop certain areas.

Some of it was not lent based on a proper credit system. A big OECD (Organization for Economic Cooperation and Development) report which has just been published has drawn attention to the corporate governance in China.

We've seen a very unusual picture in China. Over the last five years, the economy has grown by 10 percent a year but the stock market has fallen by 10 percent per year.

I can't think of any previous example in history where an economy has been going up for a long period of time and the stock market going the other way.

You have to be careful about the liability you might be taking on if you want to invest there. But in general, I am optimistic.
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