You won't find any Enrons here in China. That declaration Friday came from the very top: Premier Zhu Rongji (
For one can't help but wonder if he could say the same about China's entire financial system.
Even after 50 years in government, there're certain things about which the 73-year-old doesn't tire of speaking. One is China's debt, or the lack thereof. During his post-National People's Congress press conference, Zhu reminded the world that debt as a proportion of gross domestic product remains within safe limits. And at 16 percent of GDP, who could argue? Japan's debt, after all, is approaching 140 percent of GDP.
Trouble is, there's a gaping hole in China's we-have- negligible-debt argument. It ignores the fact that state-owned banks -- central government-run entities for which Beijing ultimately is on the hook -- have a whole lot of debt outstanding.
Beijing's debts are believed to be at least 70 percent of GDP. Worse, the banks are sitting on mountains of bad debt.
Beijing contends non-performing loans account for 26.6 percent of lending by its top four commercial banks, but private analysts think the figure is much higher, perhaps 50 percent. That said, it seems appropriate to give China's economy the Enron test. Is it a gigantic debt-crisis waiting to happen? Few serious observers think China's financial system will collapse anytime soon. It's still the world's fastest growing economy and its second-biggest recipient, after the US, of foreign direct investment. China's inclusion into the WTO is another plus that's likely to boost exports and investment.
Yet China boasts some Enron-esque qualities that warrant attention. Like the Houston-based energy company, China is a massive, bureaucratic operation that's big on spin, small on transparency. Its financial system has myriad problems covered up by impenetrable Communist-era accounting. It features loads of managers, regulators, auditors and credit raters who are either asleep at the switch or looking the other way.
How else can the nation's "big four" banks be technically insolvent, carry such low capital-adequacy ratios and run up a massive bad-debt book without triggering loud alarms? Some have raised flags. A recent book, China's Troubled Bank Loans, by Jianbo Lou examines the ``significant and increasing problem'' of bad loans at state-owned banks. The China Dream, by Joe Studwell, questions why Westerners, so seduced by its future market potential, have been so willing to ignore China's risks. And Makoto Ikeya, chief analyst at Rating & Research Information Inc, last October released a report titled ``Chinese NPLs: A Struggle Against Chaos.'' Some household-name think tanks also have taken a crack at the issue. The Brookings Institution's Nicholas Lardy has warned that "there's evidence that new non-performing loans continue to emerge at a prodigious rate." To Lardy, the question is this: How will China be able to bear the fiscal cost of restoring the banks to financial health and preventing households from suffering massive losses on their accounts? Beijing dismisses such questions. Its defense, and a powerful one at that, is that doubters are just picking on China -- again.
"There's considerable evidence that foreign investors have been overly sanguine about China plays, often to appease Beijing," argues Christopher Lingle, global strategist for eConoLytics.com. "Such dishonesty does no one any good."
China's big four -- the Industrial and Commercial Bank of China, the Bank of China, the China Construction Bank and the Agriculture Bank of China -- don't meet global standards for prudent banking. The Bank for International Settlements (BIS) recommends a capital adequacy ratio of 8 percent. The ratio among large Chinese banks is thought to be 6 percent, at best.
In 1998, China even issued 270 billion yuan (US$32.6 billion) worth of bonds to finance an improvement in banks' capital-adequacy positions. Today, things are far worse than they were then. The nation's growing share of non-performing loans is a major reason. Worsening deflation is another.
What's maddening about China's national balance sheet is that no one really knows how bad things are. For one thing, China counts bad loans differently. While most countries consider loans unpaid for three months as bad, China waits a year or more to do so. It also offers incomplete figures -- the 16 percent debt-to-GDP ones -- and claims that it's got plenty of room to borrow. Yet China's debt liability may be at least four times what it claims.
By letting state-owned banks do the bulk of the nation's lending, the central government figures it has a kind of statistical deniability where its debts are concerned. At the same time -- and here's where the Enron comparisons come in -- China has been farming out its non-performing loans to asset-management companies, or AMCs. They take debt off the books of the big four banks.
So far, so good -- until you look at what happens to the debt after it's been ferried away. Using AMCs works as long as (A) these entities fare better than the banks in recovering loans from deadbeat borrowers and (B) the banks being relieved of bad loans change their ways. If they make more bad loans, what's the point? Neither requirement is occurring to any significant degree.
China's socialist core, for example, means it's not keen on large-scale bankruptcies, whereby assets can be seized and auctioned. That's left AMCs to employ other, less lucrative tactics, like engineering debt-for-equity deals. Since Chinese shares aren't exactly booming, dodgy debt is being traded for wimpy stock.
True, asset-management companies have begun selling China's non-performing loans to investors. Yet China is only beginning to come to grips with its bad-loan woes. It has a long, long way to go, and the process could restrain economic growth in years ahead.
Observers like Lardy also worry that reports of AMCs financing their interest payments and other obligations by borrowing from China's central bank are true.
There's little evidence that banks are changing their behavior. China's commercial banks, after all, have always had a central mission: Funding state-owned enterprises. This capital is what stands between many state-owned operations and failure. Since China doesn't have a social safety net to absorb the huge number of job losses that would result from big bankruptcies, the banks are the safety net. And so, rather than privatize the big four, Beijing recapitalizes them.
Lurking in the back of many minds is the corruption question.
The Bank of China, which is trying to sell shares abroad, confirmed Friday that executives stole 4 billion yuan. The bank has been Beijing's linchpin for imposing free-market forces on its financial system. Such fraud at one of China's biggest banks validates concerns about the maturity of the nation's banking system.
China may not be about to crash, but there's reason to be skeptical about the economy's health, regardless of what Beijing says. If the Enron Corp debacle reminded us of anything, it's that an entity that sounds too good to be true probably is. That indeed may be the case with China's economy in the short run.
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