Monday, January 26, 2004
The frequency with which I am cited is getting embarrassing:
Tuesday, January 27, 2004
Central bank battles move against curbs on spending
Provincial governors want to see more lending and an eventual higher tax take
ANDREW K. COLLIER in Beijing
Prev. Story
--------------------------------------------------------------------------------
The nation's stop-and-go economic policies reflect a top-level conflict, with the People's Bank of China fighting a rearguard action to rein in rampant spending, analysts say.
The official 9.1 per cent estimate of last year's gross domestic product growth masks a divisive debate within the bureaucracy about the pace of economic growth and how it should be managed.
The People's Bank of China (PBOC), under Zhou Xiaochuan, has been a strong proponent of tighter fiscal policy, worried over a combination of inflation and potential damage from bad investments in areas such as property and heavy industry.
But the central bank appears to have lost the debate in favour of provincial governors eager for higher tax revenue and the State Council worried about a slowing economy that might encourage unrest among laid-off workers.
"There was a major debate over the summer on monetary policy, leading to the confusing signals," said Nicholas Lardy, of the Institute for International Economics.
Although Mr Lardy is waiting for more lending data before drawing final conclusions, "indicators suggest that the PBOC/China Banking Regulatory Commission was losing out to the pro-growth crowd led by provincial/local officials with much support from various elements at the centre".
Political scientist Victor Shih, of Northwestern University, said: "There is clearly a political force out there pushing for more lending."
The central bank's hardnosed stance was set early. Last June, it announced tighter lending guidelines on property projects. In July after the bank's biannual conference, Mr Zhou warned of "excessive growth" in money supply and called for better allocation of financial resources.
His call for greater control over the economy came as loans nearly doubled to 1.4 trillion yuan and investment in fixed assets - which could include ailing state factories - rose to a high of nearly 30 per cent of GDP.
However, Mr Zhou's strict control over the banks has slowly been whittled away.
Last summer, the State Council called the property sector a "pillar industry", which many interpreted as a signal that the central bank's policies did not enjoy unconditional support at the highest levels of government. In December, in an abrupt about-face, the bank relaxed loan rules for purchasing cars, despite some analysts' concerns that sales were out of control. At the same time, it announced a 2.7 per cent cut in interest rates paid on excess bank reserves.
Analysts said the loosening of reins over the government's fiscal purse reflects several political factors.
One is the rising power of provincial governments, especially compared with the centralised regime of former premier Zhu Rongji.
The 16th Party Congress saw the number of provincial members of the Politburo outside the Standing Committee increased from five to seven. They are expected to seek a greater share of central tax revenue.
A policy to "build a prosperous society" was also announced at the party congress, widely interpreted as opening the fiscal floodgates to ease the burdens of economic change on displaced workers.
Another key issue is the role of Premier Wen Jiabao, the bureaucracy's potential strongman, but whose power is unclear in light of the continuing presence of former president Jiang Zemin.
Mr Shih said: "Mr Wen is waiting to see whether he is required to take a tougher stance on monetary policy. He would prefer not to, since raising interest rates would generate a lot of political opposition."
Tuesday, January 27, 2004
Central bank battles move against curbs on spending
Provincial governors want to see more lending and an eventual higher tax take
ANDREW K. COLLIER in Beijing
Prev. Story
--------------------------------------------------------------------------------
The nation's stop-and-go economic policies reflect a top-level conflict, with the People's Bank of China fighting a rearguard action to rein in rampant spending, analysts say.
The official 9.1 per cent estimate of last year's gross domestic product growth masks a divisive debate within the bureaucracy about the pace of economic growth and how it should be managed.
The People's Bank of China (PBOC), under Zhou Xiaochuan, has been a strong proponent of tighter fiscal policy, worried over a combination of inflation and potential damage from bad investments in areas such as property and heavy industry.
But the central bank appears to have lost the debate in favour of provincial governors eager for higher tax revenue and the State Council worried about a slowing economy that might encourage unrest among laid-off workers.
"There was a major debate over the summer on monetary policy, leading to the confusing signals," said Nicholas Lardy, of the Institute for International Economics.
Although Mr Lardy is waiting for more lending data before drawing final conclusions, "indicators suggest that the PBOC/China Banking Regulatory Commission was losing out to the pro-growth crowd led by provincial/local officials with much support from various elements at the centre".
Political scientist Victor Shih, of Northwestern University, said: "There is clearly a political force out there pushing for more lending."
The central bank's hardnosed stance was set early. Last June, it announced tighter lending guidelines on property projects. In July after the bank's biannual conference, Mr Zhou warned of "excessive growth" in money supply and called for better allocation of financial resources.
His call for greater control over the economy came as loans nearly doubled to 1.4 trillion yuan and investment in fixed assets - which could include ailing state factories - rose to a high of nearly 30 per cent of GDP.
However, Mr Zhou's strict control over the banks has slowly been whittled away.
Last summer, the State Council called the property sector a "pillar industry", which many interpreted as a signal that the central bank's policies did not enjoy unconditional support at the highest levels of government. In December, in an abrupt about-face, the bank relaxed loan rules for purchasing cars, despite some analysts' concerns that sales were out of control. At the same time, it announced a 2.7 per cent cut in interest rates paid on excess bank reserves.
Analysts said the loosening of reins over the government's fiscal purse reflects several political factors.
One is the rising power of provincial governments, especially compared with the centralised regime of former premier Zhu Rongji.
The 16th Party Congress saw the number of provincial members of the Politburo outside the Standing Committee increased from five to seven. They are expected to seek a greater share of central tax revenue.
A policy to "build a prosperous society" was also announced at the party congress, widely interpreted as opening the fiscal floodgates to ease the burdens of economic change on displaced workers.
Another key issue is the role of Premier Wen Jiabao, the bureaucracy's potential strongman, but whose power is unclear in light of the continuing presence of former president Jiang Zemin.
Mr Shih said: "Mr Wen is waiting to see whether he is required to take a tougher stance on monetary policy. He would prefer not to, since raising interest rates would generate a lot of political opposition."
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Monday, January 19, 2004
My friend Matt asked me about the Bradsher piece in NYT that states that China has a bubble economy now. Below is my view, followed by the article:
On the Bradsher piece, I am going to play Fred Hu for one moment. First of all, what is happening now (say money supply expansion) as a percentage of the total economy is not a big deal relative to the problem in the early 90s. So, the over expansion of money today is something that China has dealt with at least three times in the past. First, this means they know how to deal with it. Second, I don’t think the supply side of inflationary pressure is as great as it was in the early 90s. Thus, I highly doubt that inflation would reach even 15% (it reached 25+ % in the early 90s). I think China now faces a series of smaller bubbles in various sector rather than one giant bubble that threatens the economy. Things are overheated in real-estate (again real-estate investment as % of GDP has fallen since the early 90s), and there is a supply shortage in some areas, but I don’t think it is a serious problem yet. On the flip side, even the bursting of several mid-size bubbles can threaten the credibility of banking reform. Currently, the Big Four are toting to foreign investors that NPLs from new loans is very low, in the 2% range. However, much of this rides on the current economic expansion. I am sure that NPL will go up if the bubble bursts in the real-estate or stock market. It might not go up by 20-30% like in the early 90s, but a 5-10% jump will greatly undermine investor confidence in these IPOs.
By KEITH BRADSHER
3,003 words
18 January 2004
The New York Times
Late Edition - Final
1
English
(c) 2004 New York Times Company
DONGGUAN, China -- THE prospectus for China Green Holdings Ltd. looks a little like a seed catalog. Color photographs show the corn, cabbage, pickled plums and other vegetables that the company exports, mostly to Japan. There is even a helpful list of the growing times for broccoli, cauliflower and sweet peas; it is tucked between tables showing that the company earned $14.1 million on sales of $31.2 million in its last fiscal year.
Though China Green's business literally involves small potatoes -- cubed and shipped in plastic bags -- its initial public offering in Hong Kong was anything but. Retail investors put in bids to buy more than 1,600 times as many shares as were available for sale, making it the most oversubscribed I.P.O. ever in Hong Kong. The stock jumped 58 percent last Tuesday, its first day of trading.
Japan had its bubble in the late 1980's, when the Imperial Palace grounds in Tokyo became worth more than all the land in California. Thailand and Indonesia had their bubbles in the mid-1990's, when speculators and multinationals poured money into what seemed like a Southeast Asian miracle. The United States had its Internet and telecommunications bubble in the late 1990's, when stock prices looked as if they could rise indefinitely and unemployment kept hitting new lows.
Each of those bubbles ended badly, with millions of families losing their savings and many losing their jobs.
As 2004 begins, China's economy looks as invincible as the Japanese, Southeast Asian and American economies of those earlier times. But recent excesses -- from a frenzy of factory construction to speculative inflows of cash to soaring growth in bank loans -- suggest that China may be in a bubble now, especially on the investment side of the economy.
Bubbles can last years before they pop, but they seldom deflate painlessly when they do. Nobody knows how harmful a sharp economic slowdown would be to China, a country undergoing huge social changes, like the migration of peasants to the cities. The Communist Party rests its legitimacy on delivering consistent annual increases in prosperity.
The Chinese government is showing concern. In the last few weeks, the central bank has tried to dissuade banks from reckless lending while the government has bailed out two of the largest ones, to prepare them for possible hard times as well as planned stock sales. The State Council, China's cabinet, has warned that it will discourage further construction of new factories in industries like aluminum and steel, whose capacity has grown swiftly in the last three years.
Because China is now so important to the global economy and to global political stability, the possibility of economic trouble is starting to draw serious attention among economists and China specialists.
Huge billboards in Guangdong Province commemorate Deng Xiaoping's decision a quarter-century ago to allow capitalism to gain a foothold in a few cities here in southeastern China. Practically ever since, China's astounding economic growth has provoked warnings that the boom may not be sustainable. Year after year, China has proved the worriers wrong, although there have been a few missteps along the way, most notably when inflation surged temporarily and foreign exchange reserves withered in the early 1990's.
But even by Chinese standards, things have been moving at a blistering pace of late. Official statistics, which the government tends to smooth so as not to indicate big booms or busts, show that the economy expanded 8.5 percent last year, despite the fact that growth came to a virtual halt during the second quarter because of an outbreak of SARS. According to independent economists, however, the Chinese economy actually expanded at an annual pace of 11 percent to 13 percent through the second half of last year.
Strains are already showing. Blackouts have become a problem in a majority of China's provinces, as families with new air-conditioners and refrigerators compete with new factories for electricity. Auto sales soared 75 percent last year, as prices in a market protected from imports until 2001 drifted down toward global levels. Still, automakers are planning huge factory expansions in the hope that such growth will continue.
Most economists specializing in China now predict that sometime this year, growth will have to slow, at least for the investment side of the economy -- the building of new factories, for example. That could prove painful. The United States economy suffered severe weakness on the investment side in 2001 and 2002, when the market for telecommunications equipment became glutted. The upshot was tens of thousands of lost jobs in that industry, not to mention steep drops in the stock portfolios of millions of Americans.
But consumer spending is now strengthening in China, while household savings rates are high. China, like the United States, is likely to rely on consumers to prevent any coming slowdown from becoming too severe. ''We look for a hard landing in investment, a soft landing in overall economic growth and no landing in consumption,'' said Tao Dong, an economist in Hong Kong with Credit Suisse First Boston.
The risks to China, and indirectly to the world, fall into four broad areas. Those categories follow, starting with the most likely, a cyclical bust in the investment sector, and ending with what appears the least likely but also the most serious: political turmoil or some other loss of social stability.
Business-Cycle Risk
A quarter-century ago, Dongguan, in the Pearl River delta region of southern China, was an impoverished farming village where residents struggled to survive on limited rice rations. Today, its 14,000 foreign-controlled factories make it the world's largest single site for the production of microwave ovens, and it is a huge producer of everything from computer cables to furniture and computer displays.. The roads are jammed with freight trucks carrying boxes of components to assembly lines and the finished goods to ports in Hong Kong and Shenzhen.
Dongguan has formidable advantages as a place to do business, as Frank Jaeger, a German businessman, can attest. Eight years ago, he started a five-employee operation making computer cables here. He now has 1,000 employees, and is still expanding. And small wonder: factory floor space, built by municipal government contractors for businesses willing to locate here, costs 10 cents a square foot to rent each month excluding the installation of pipes and wiring, compared with $1 to $1.50 a square foot in some American factory towns and as much as $2.50 in Germany, Mr. Jaeger said.
Wages are also low, thanks to a constant flow of semiskilled migrant workers from even poorer provinces in China's interior. Mr. Jaeger's company, TCA Ltd., offers base pay of $60 a month, and an additional $40 a month in overtime and free room and board in adjacent dormitories, where the workers sleep six or eight to a room.
While the wages may sound low to Westerners, even with free room and board, they are high by local standards, holding down turnover and training costs. The workers, mostly young women who stay one to three years and then return to their home provinces to start small businesses or families, wear green and yellow company-issued windbreakers and sit in chairs at long metal tables under fluorescent lights, clipping wires, filing plastic and installing copper disks to make reliable electrical connections.
Other domestic and foreign businesses have noticed the same attractions, too. In fact, so many factories have been built that in industry after industry, from washing machines to cellphones, production capacity far exceeds domestic demand. Exports have not entirely absorbed the difference, so prices have plunged.
Business executives and economists often complain that factories are built with little attention to whether similar plants are being constructed elsewhere, or to how low prices will fall if all of them start churning out the same products at the same time.
Many former farmers in Dongguan have profited from land deals. Instead of putting the money in bank deposits paying negligible regulated interest rates or risking it in mainland China's tiny and fraud-riddled stock exchanges, they invest it in factories in their hometown.
''In China, overcapacity is not an issue that stops a businessman, because they always think they can do better,'' Mr. Jaeger said.
Domestic and foreign investors alike share that approach. Executives from multinational corporations see China as such an important market that they have little choice but to continue investing, in the pursuit of ever-greater slices of the market. ''Good companies, be they local or be they global, can increase their market share,'' said Pekka Ala-Pietila, the president of the Nokia Corporation, the cellphone maker.
The problem arises when too many companies make the same calculation and invest too much. Nearly half of China's economic growth is investment-related spending, an extraordinary figure that reflects public spending on highways and dams, as well as private-sector projects. Calculations by Smith Barney show that Japan in the 1980's, Southeast Asia in the mid-1990's and the United States in the late 1990's each had a few years of investment spending well above historical averages. In each case, overcapacity accumulated in many industries and, eventually, a bubble popped.
China has developed a special disadvantage, in that its economy has become so ravenous for commodities that it is pushing up global prices for products like oil, for which China has become the second-largest market, after the United States. With very low wages and real estate costs, factory managers find that materials are their biggest cost by far, and a sudden jump in their cost can leave businesses with no competitive edge.
The People's Bank of China, the central bank, has reported an acceleration in wholesale price inflation this winter. The big question is how quickly this will feed into consumer price inflation, which could antagonize politically important urban residents. If consumer prices start rising significantly, the central bank will come under growing pressure to let interest rates climb, which could make more factories less competitive as loans become more costly.
China still has some advantages that, at least in the short term, may forestall a plunge in investment. One is a banking sector willing to lend heavily to even the most indebted companies, provided that they have political connections. But in postponing the final reckoning in the current business cycle, China may be making an eventual bust even worse.
Protectionism Risk
China Green exports three-quarters of its fresh vegetables, and the prospectus for its I.P.O. warns that it relies heavily on sales to several Japanese companies. If there were a prospectus for China's economy, it would need to warn of a high dependence on sales to America.
China exported $125 billion worth of goods to the United States in the first 10 months of last year and imported just $22 billion. The resulting trade surplus equaled an extraordinary 9 percent of China's entire economic output during this period.
Rapid growth and a persistent imbalance in China's trade with the United States have turned Chinese exports into obvious targets during an American election year. In the last few months, United States trade officials have begun to take the legal steps needed to impose steep tariffs on Chinese products as varied as color televisions, furniture and bras.
To avoid a full-scale trade war, Beijing has followed Japan's example in sending official buying missions to the United States. Shopping for everything from soybeans to communications equipment, they have agreed in the last two months to buy $11 billion worth of goods, by Beijing's calculations. Some of these deals might have happened anyway, like the one to import General Motors auto parts for assembly into finished cars here.
So far, American trade restrictions have covered a tiny percentage of Chinese shipments to the United States. But any significant broadening could slow the Chinese economy in a hurry, and with it the economies of many Asian neighbors that increasingly send components to China for final assembly and reshipment to the United States.
Financial Risk
Lists of potential causes of a Chinese economic derailment tend to start, and sometime end, with a banking crisis. By plying borrowers with ever more loans, following lending criteria that credit ratings agencies contend are laced with corruption and political influence, Chinese banks have wound up with extremely high proportions -- as much as 45 percent -- of nonperforming loans.
The banks rapidly stepped up their pace of fresh loans last year. Exporters, foreign investors and speculators were depositing large sums of dollars. The central bank then exchanged the dollars for China's currency, known as the yuan or renminbi, at a fixed exchange rate, so as to keep the holders of those dollars from bidding up the yuan's value. The banks lent heavily from their expanding deposits, with loans rising 21.4 percent last year.
''The world economy is being kept afloat by the aggressive expansion of the U.S. budget deficit and Chinese loan growth,'' said Ajay Kapur, the chief Asian equity strategist at Smith Barney. ''Any reversal in these two trends has pretty serious outcomes for the rest of the world.''
Most Chinese savers have few alternatives to the state-owned banks as places to park their cash, and the banks appear to have informal but total government guarantees of deposits. As a result, they have not experienced significant losses of depositors, although that could change as ever more businesses engage in trade deals that can be used to transfer money to safer banks overseas if hard times ever return to China. Lately, concern has gone beyond the stability of the banks themselves to the economic effects of all the extra money sloshing through the banking system.
Chinese officials have said they would try to sterilize the effects of their purchases of dollars, by selling bonds to the public for yuan that the central bank then cancels or destroys. If the central bank actually sold extra bonds as fast as it bought dollars for yuan, it could theoretically leave domestic banks with no more cash on hand than they had before, and prevent the risks of faster loan growth, a rising money supply and, eventually, inflation.
But financial experts say the central bank is no longer able to sterilize the effects of its currency activities. The problem is that the Ministry of Finance, a separate agency in charge of budget policy, has limited the interest rate that the government can pay on bonds, so as to hold down the cost of servicing China's national debt. With inflation starting to rise, the bonds have become less attractive and the central bank has been struggling to sell enough new bonds each month just to pay off old bonds falling due.
The central bank has been able to soak up little if any of the billions of extra yuan it has been pumping into the economy lately to buy up dollars, said Liang Hong, a Goldman Sachs economist. At the same time, flows of ''hot money'' -- short-term investments being moved into China from overseas through a variety of channels despite China's capital controls -- appear to have accelerated.
''I'm really worried about their losing control of the money supply,'' Ms. Liang said.
Political Risk
To the West, the hallmark of the last quarter-century in China has been rapid economic growth. But for hundreds of millions of Chinese, it has meant something else: a respite from the wars and the domestic strife that had dogged the country for more than a century before, from the Taiping Rebellion of the 1850's to the Cultural Revolution in the late 1960's and early 1970's.
In the years immediately after the Tiananmen Square killings in 1989, China became relatively placid, perhaps in part from fear. But that calm seems to be fading now.
President Hu Jintao has gingerly tried to restrict some police powers -- like the ability to detain people without proper identity documents -- and is seeking slightly greater openness in Chinese society. Human-rights groups report a growing number of protests in China, mainly workers and retirees seeking unpaid salaries and benefits. At the same time, many on the mainland are acutely aware of the huge marches organized over the last seven months by democracy activists in Hong Kong, now an autonomous region of China.
Whether any of these forces become significant enough to rattle China's stability is anybody's guess. Peaceful change toward a more democratic system may still be possible, especially if it is fairly gradual.
But if the economy slows sharply, political instability could follow. That would be a serious problem, and not just for China, but also for the rest of the world.
Photo: Workers at a TCA assembly plant in Dongguan, China, earn base pay of $60 a month to build electrical parts. (Photo by Grischa Ruschendorf for The New York Times)(pg. 9)
Drawing (Illustration by The New York Times)(pg. 1)
Chart: ''Big Spenders''
Countries in the middle of economic booms tend to show above-average spurts in investment spending. The surges are often followed by sharp slumps as businesses seek efficient uses for all the new offices, factories and equipment they have accumulated. The Japanese economy in the late 1980's, Southeast Asian economies in the mid-1990's and the American economy during the Internet and telecommunications boom of the late 90's each had a surge in investment spending, followed by a bust. Will China's economy suffer the same fate?
Graphs track capital expenditures (percentage difference from the average capital expenditures as a percentage of gross domestic product) for China, United States*, Japan, and Southeast Asia from 1980 to 2003.
*Equipment and software spending only
(Source by Ajay Kapur [Smith Barney])(pg. 9)
On the Bradsher piece, I am going to play Fred Hu for one moment. First of all, what is happening now (say money supply expansion) as a percentage of the total economy is not a big deal relative to the problem in the early 90s. So, the over expansion of money today is something that China has dealt with at least three times in the past. First, this means they know how to deal with it. Second, I don’t think the supply side of inflationary pressure is as great as it was in the early 90s. Thus, I highly doubt that inflation would reach even 15% (it reached 25+ % in the early 90s). I think China now faces a series of smaller bubbles in various sector rather than one giant bubble that threatens the economy. Things are overheated in real-estate (again real-estate investment as % of GDP has fallen since the early 90s), and there is a supply shortage in some areas, but I don’t think it is a serious problem yet. On the flip side, even the bursting of several mid-size bubbles can threaten the credibility of banking reform. Currently, the Big Four are toting to foreign investors that NPLs from new loans is very low, in the 2% range. However, much of this rides on the current economic expansion. I am sure that NPL will go up if the bubble bursts in the real-estate or stock market. It might not go up by 20-30% like in the early 90s, but a 5-10% jump will greatly undermine investor confidence in these IPOs.
By KEITH BRADSHER
3,003 words
18 January 2004
The New York Times
Late Edition - Final
1
English
(c) 2004 New York Times Company
DONGGUAN, China -- THE prospectus for China Green Holdings Ltd. looks a little like a seed catalog. Color photographs show the corn, cabbage, pickled plums and other vegetables that the company exports, mostly to Japan. There is even a helpful list of the growing times for broccoli, cauliflower and sweet peas; it is tucked between tables showing that the company earned $14.1 million on sales of $31.2 million in its last fiscal year.
Though China Green's business literally involves small potatoes -- cubed and shipped in plastic bags -- its initial public offering in Hong Kong was anything but. Retail investors put in bids to buy more than 1,600 times as many shares as were available for sale, making it the most oversubscribed I.P.O. ever in Hong Kong. The stock jumped 58 percent last Tuesday, its first day of trading.
Japan had its bubble in the late 1980's, when the Imperial Palace grounds in Tokyo became worth more than all the land in California. Thailand and Indonesia had their bubbles in the mid-1990's, when speculators and multinationals poured money into what seemed like a Southeast Asian miracle. The United States had its Internet and telecommunications bubble in the late 1990's, when stock prices looked as if they could rise indefinitely and unemployment kept hitting new lows.
Each of those bubbles ended badly, with millions of families losing their savings and many losing their jobs.
As 2004 begins, China's economy looks as invincible as the Japanese, Southeast Asian and American economies of those earlier times. But recent excesses -- from a frenzy of factory construction to speculative inflows of cash to soaring growth in bank loans -- suggest that China may be in a bubble now, especially on the investment side of the economy.
Bubbles can last years before they pop, but they seldom deflate painlessly when they do. Nobody knows how harmful a sharp economic slowdown would be to China, a country undergoing huge social changes, like the migration of peasants to the cities. The Communist Party rests its legitimacy on delivering consistent annual increases in prosperity.
The Chinese government is showing concern. In the last few weeks, the central bank has tried to dissuade banks from reckless lending while the government has bailed out two of the largest ones, to prepare them for possible hard times as well as planned stock sales. The State Council, China's cabinet, has warned that it will discourage further construction of new factories in industries like aluminum and steel, whose capacity has grown swiftly in the last three years.
Because China is now so important to the global economy and to global political stability, the possibility of economic trouble is starting to draw serious attention among economists and China specialists.
Huge billboards in Guangdong Province commemorate Deng Xiaoping's decision a quarter-century ago to allow capitalism to gain a foothold in a few cities here in southeastern China. Practically ever since, China's astounding economic growth has provoked warnings that the boom may not be sustainable. Year after year, China has proved the worriers wrong, although there have been a few missteps along the way, most notably when inflation surged temporarily and foreign exchange reserves withered in the early 1990's.
But even by Chinese standards, things have been moving at a blistering pace of late. Official statistics, which the government tends to smooth so as not to indicate big booms or busts, show that the economy expanded 8.5 percent last year, despite the fact that growth came to a virtual halt during the second quarter because of an outbreak of SARS. According to independent economists, however, the Chinese economy actually expanded at an annual pace of 11 percent to 13 percent through the second half of last year.
Strains are already showing. Blackouts have become a problem in a majority of China's provinces, as families with new air-conditioners and refrigerators compete with new factories for electricity. Auto sales soared 75 percent last year, as prices in a market protected from imports until 2001 drifted down toward global levels. Still, automakers are planning huge factory expansions in the hope that such growth will continue.
Most economists specializing in China now predict that sometime this year, growth will have to slow, at least for the investment side of the economy -- the building of new factories, for example. That could prove painful. The United States economy suffered severe weakness on the investment side in 2001 and 2002, when the market for telecommunications equipment became glutted. The upshot was tens of thousands of lost jobs in that industry, not to mention steep drops in the stock portfolios of millions of Americans.
But consumer spending is now strengthening in China, while household savings rates are high. China, like the United States, is likely to rely on consumers to prevent any coming slowdown from becoming too severe. ''We look for a hard landing in investment, a soft landing in overall economic growth and no landing in consumption,'' said Tao Dong, an economist in Hong Kong with Credit Suisse First Boston.
The risks to China, and indirectly to the world, fall into four broad areas. Those categories follow, starting with the most likely, a cyclical bust in the investment sector, and ending with what appears the least likely but also the most serious: political turmoil or some other loss of social stability.
Business-Cycle Risk
A quarter-century ago, Dongguan, in the Pearl River delta region of southern China, was an impoverished farming village where residents struggled to survive on limited rice rations. Today, its 14,000 foreign-controlled factories make it the world's largest single site for the production of microwave ovens, and it is a huge producer of everything from computer cables to furniture and computer displays.. The roads are jammed with freight trucks carrying boxes of components to assembly lines and the finished goods to ports in Hong Kong and Shenzhen.
Dongguan has formidable advantages as a place to do business, as Frank Jaeger, a German businessman, can attest. Eight years ago, he started a five-employee operation making computer cables here. He now has 1,000 employees, and is still expanding. And small wonder: factory floor space, built by municipal government contractors for businesses willing to locate here, costs 10 cents a square foot to rent each month excluding the installation of pipes and wiring, compared with $1 to $1.50 a square foot in some American factory towns and as much as $2.50 in Germany, Mr. Jaeger said.
Wages are also low, thanks to a constant flow of semiskilled migrant workers from even poorer provinces in China's interior. Mr. Jaeger's company, TCA Ltd., offers base pay of $60 a month, and an additional $40 a month in overtime and free room and board in adjacent dormitories, where the workers sleep six or eight to a room.
While the wages may sound low to Westerners, even with free room and board, they are high by local standards, holding down turnover and training costs. The workers, mostly young women who stay one to three years and then return to their home provinces to start small businesses or families, wear green and yellow company-issued windbreakers and sit in chairs at long metal tables under fluorescent lights, clipping wires, filing plastic and installing copper disks to make reliable electrical connections.
Other domestic and foreign businesses have noticed the same attractions, too. In fact, so many factories have been built that in industry after industry, from washing machines to cellphones, production capacity far exceeds domestic demand. Exports have not entirely absorbed the difference, so prices have plunged.
Business executives and economists often complain that factories are built with little attention to whether similar plants are being constructed elsewhere, or to how low prices will fall if all of them start churning out the same products at the same time.
Many former farmers in Dongguan have profited from land deals. Instead of putting the money in bank deposits paying negligible regulated interest rates or risking it in mainland China's tiny and fraud-riddled stock exchanges, they invest it in factories in their hometown.
''In China, overcapacity is not an issue that stops a businessman, because they always think they can do better,'' Mr. Jaeger said.
Domestic and foreign investors alike share that approach. Executives from multinational corporations see China as such an important market that they have little choice but to continue investing, in the pursuit of ever-greater slices of the market. ''Good companies, be they local or be they global, can increase their market share,'' said Pekka Ala-Pietila, the president of the Nokia Corporation, the cellphone maker.
The problem arises when too many companies make the same calculation and invest too much. Nearly half of China's economic growth is investment-related spending, an extraordinary figure that reflects public spending on highways and dams, as well as private-sector projects. Calculations by Smith Barney show that Japan in the 1980's, Southeast Asia in the mid-1990's and the United States in the late 1990's each had a few years of investment spending well above historical averages. In each case, overcapacity accumulated in many industries and, eventually, a bubble popped.
China has developed a special disadvantage, in that its economy has become so ravenous for commodities that it is pushing up global prices for products like oil, for which China has become the second-largest market, after the United States. With very low wages and real estate costs, factory managers find that materials are their biggest cost by far, and a sudden jump in their cost can leave businesses with no competitive edge.
The People's Bank of China, the central bank, has reported an acceleration in wholesale price inflation this winter. The big question is how quickly this will feed into consumer price inflation, which could antagonize politically important urban residents. If consumer prices start rising significantly, the central bank will come under growing pressure to let interest rates climb, which could make more factories less competitive as loans become more costly.
China still has some advantages that, at least in the short term, may forestall a plunge in investment. One is a banking sector willing to lend heavily to even the most indebted companies, provided that they have political connections. But in postponing the final reckoning in the current business cycle, China may be making an eventual bust even worse.
Protectionism Risk
China Green exports three-quarters of its fresh vegetables, and the prospectus for its I.P.O. warns that it relies heavily on sales to several Japanese companies. If there were a prospectus for China's economy, it would need to warn of a high dependence on sales to America.
China exported $125 billion worth of goods to the United States in the first 10 months of last year and imported just $22 billion. The resulting trade surplus equaled an extraordinary 9 percent of China's entire economic output during this period.
Rapid growth and a persistent imbalance in China's trade with the United States have turned Chinese exports into obvious targets during an American election year. In the last few months, United States trade officials have begun to take the legal steps needed to impose steep tariffs on Chinese products as varied as color televisions, furniture and bras.
To avoid a full-scale trade war, Beijing has followed Japan's example in sending official buying missions to the United States. Shopping for everything from soybeans to communications equipment, they have agreed in the last two months to buy $11 billion worth of goods, by Beijing's calculations. Some of these deals might have happened anyway, like the one to import General Motors auto parts for assembly into finished cars here.
So far, American trade restrictions have covered a tiny percentage of Chinese shipments to the United States. But any significant broadening could slow the Chinese economy in a hurry, and with it the economies of many Asian neighbors that increasingly send components to China for final assembly and reshipment to the United States.
Financial Risk
Lists of potential causes of a Chinese economic derailment tend to start, and sometime end, with a banking crisis. By plying borrowers with ever more loans, following lending criteria that credit ratings agencies contend are laced with corruption and political influence, Chinese banks have wound up with extremely high proportions -- as much as 45 percent -- of nonperforming loans.
The banks rapidly stepped up their pace of fresh loans last year. Exporters, foreign investors and speculators were depositing large sums of dollars. The central bank then exchanged the dollars for China's currency, known as the yuan or renminbi, at a fixed exchange rate, so as to keep the holders of those dollars from bidding up the yuan's value. The banks lent heavily from their expanding deposits, with loans rising 21.4 percent last year.
''The world economy is being kept afloat by the aggressive expansion of the U.S. budget deficit and Chinese loan growth,'' said Ajay Kapur, the chief Asian equity strategist at Smith Barney. ''Any reversal in these two trends has pretty serious outcomes for the rest of the world.''
Most Chinese savers have few alternatives to the state-owned banks as places to park their cash, and the banks appear to have informal but total government guarantees of deposits. As a result, they have not experienced significant losses of depositors, although that could change as ever more businesses engage in trade deals that can be used to transfer money to safer banks overseas if hard times ever return to China. Lately, concern has gone beyond the stability of the banks themselves to the economic effects of all the extra money sloshing through the banking system.
Chinese officials have said they would try to sterilize the effects of their purchases of dollars, by selling bonds to the public for yuan that the central bank then cancels or destroys. If the central bank actually sold extra bonds as fast as it bought dollars for yuan, it could theoretically leave domestic banks with no more cash on hand than they had before, and prevent the risks of faster loan growth, a rising money supply and, eventually, inflation.
But financial experts say the central bank is no longer able to sterilize the effects of its currency activities. The problem is that the Ministry of Finance, a separate agency in charge of budget policy, has limited the interest rate that the government can pay on bonds, so as to hold down the cost of servicing China's national debt. With inflation starting to rise, the bonds have become less attractive and the central bank has been struggling to sell enough new bonds each month just to pay off old bonds falling due.
The central bank has been able to soak up little if any of the billions of extra yuan it has been pumping into the economy lately to buy up dollars, said Liang Hong, a Goldman Sachs economist. At the same time, flows of ''hot money'' -- short-term investments being moved into China from overseas through a variety of channels despite China's capital controls -- appear to have accelerated.
''I'm really worried about their losing control of the money supply,'' Ms. Liang said.
Political Risk
To the West, the hallmark of the last quarter-century in China has been rapid economic growth. But for hundreds of millions of Chinese, it has meant something else: a respite from the wars and the domestic strife that had dogged the country for more than a century before, from the Taiping Rebellion of the 1850's to the Cultural Revolution in the late 1960's and early 1970's.
In the years immediately after the Tiananmen Square killings in 1989, China became relatively placid, perhaps in part from fear. But that calm seems to be fading now.
President Hu Jintao has gingerly tried to restrict some police powers -- like the ability to detain people without proper identity documents -- and is seeking slightly greater openness in Chinese society. Human-rights groups report a growing number of protests in China, mainly workers and retirees seeking unpaid salaries and benefits. At the same time, many on the mainland are acutely aware of the huge marches organized over the last seven months by democracy activists in Hong Kong, now an autonomous region of China.
Whether any of these forces become significant enough to rattle China's stability is anybody's guess. Peaceful change toward a more democratic system may still be possible, especially if it is fairly gradual.
But if the economy slows sharply, political instability could follow. That would be a serious problem, and not just for China, but also for the rest of the world.
Photo: Workers at a TCA assembly plant in Dongguan, China, earn base pay of $60 a month to build electrical parts. (Photo by Grischa Ruschendorf for The New York Times)(pg. 9)
Drawing (Illustration by The New York Times)(pg. 1)
Chart: ''Big Spenders''
Countries in the middle of economic booms tend to show above-average spurts in investment spending. The surges are often followed by sharp slumps as businesses seek efficient uses for all the new offices, factories and equipment they have accumulated. The Japanese economy in the late 1980's, Southeast Asian economies in the mid-1990's and the American economy during the Internet and telecommunications boom of the late 90's each had a surge in investment spending, followed by a bust. Will China's economy suffer the same fate?
Graphs track capital expenditures (percentage difference from the average capital expenditures as a percentage of gross domestic product) for China, United States*, Japan, and Southeast Asia from 1980 to 2003.
*Equipment and software spending only
(Source by Ajay Kapur [Smith Barney])(pg. 9)
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Thursday, January 08, 2004
So, someone on the Chinapol list claims that the government's incentive to intervene in the banks have changed. But I am skeptical.
As a political scientist, I think the question of whether government incentive to steal from the cookie jar has changed is a key issue. I am skeptical that government incentive has changed significantly.
Essentially, the state banks have served top leaders extremely well to fulfill a number of policy and political objectives. In the 80s, banks were used to fuel rapid development on China's East Coast and sustain the SOE sector. In the early 90s, it was mainly used to bail out failing SOEs. In the past few years, it was used for developing Western China and sustaining growth. But behind these policy objectives, banks were also used for political purposes, to buy factional loyalty for various top leaders. I conducted a statistical analysis of provincial level lending and found that factional allegiance gave provinces extra loans throughout the reform era ( I am happy to provide the paper to those interested). Thus, bank loans, like fiscal pork in the US, continue to serve an integral policy and political role.
True, international investor interest in the state of the Chinese financial sector has placed some constraints on the government's ability to intervene in the banks. But I think the current strategy is actually to trump up a couple of "showcase" banks for investors, while continue to use ICBC and ABC for policy purposes. The ABC is a great example of this. Despite being one of the Big 4, little has changed in the policy role of the banks. The PBOC continues to bail out the bank on a yearly basis through "relending" operations. There are concrete plans now to form a regional bank just for the Northeast to deal with SOEs and other policy and political objectives. So, rather than the entire financial system reforming, the Chinese government is segmenting the market.
Also, as the total bank deposits grew rapidly, the Chinese government and politicians now need a smaller percentage of bank resources to fulfill policy and political goals. If anything, I think this goes a long way to explain why banks do better today. Western Development, for example, used up something like 600b RMB in banking and fiscal resources. This would have been a large % of bank resources ten years ago, but it is no longer such a big figure today. Thus, I am skeptical that the incentives have changed, but I am open to correction from those of you who have more regular contacts with Chinese officials.
As a political scientist, I think the question of whether government incentive to steal from the cookie jar has changed is a key issue. I am skeptical that government incentive has changed significantly.
Essentially, the state banks have served top leaders extremely well to fulfill a number of policy and political objectives. In the 80s, banks were used to fuel rapid development on China's East Coast and sustain the SOE sector. In the early 90s, it was mainly used to bail out failing SOEs. In the past few years, it was used for developing Western China and sustaining growth. But behind these policy objectives, banks were also used for political purposes, to buy factional loyalty for various top leaders. I conducted a statistical analysis of provincial level lending and found that factional allegiance gave provinces extra loans throughout the reform era ( I am happy to provide the paper to those interested). Thus, bank loans, like fiscal pork in the US, continue to serve an integral policy and political role.
True, international investor interest in the state of the Chinese financial sector has placed some constraints on the government's ability to intervene in the banks. But I think the current strategy is actually to trump up a couple of "showcase" banks for investors, while continue to use ICBC and ABC for policy purposes. The ABC is a great example of this. Despite being one of the Big 4, little has changed in the policy role of the banks. The PBOC continues to bail out the bank on a yearly basis through "relending" operations. There are concrete plans now to form a regional bank just for the Northeast to deal with SOEs and other policy and political objectives. So, rather than the entire financial system reforming, the Chinese government is segmenting the market.
Also, as the total bank deposits grew rapidly, the Chinese government and politicians now need a smaller percentage of bank resources to fulfill policy and political goals. If anything, I think this goes a long way to explain why banks do better today. Western Development, for example, used up something like 600b RMB in banking and fiscal resources. This would have been a large % of bank resources ten years ago, but it is no longer such a big figure today. Thus, I am skeptical that the incentives have changed, but I am open to correction from those of you who have more regular contacts with Chinese officials.
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Wednesday, January 07, 2004
Hi All, I have been away for a while, but the fun is back. Beijing has decided to bail out Construction Bank and Bank of China with a 45 billion USD injection from its foreign exchange reserve (see article below). But the implications are not clear. See my comment to Chinapol below.
From the NYT article and from two UBS reports I read, it seems that the forex injection is structured differently than you have described. Essentially, SAFE has placed 45 billion worth of dollars or US treasury into Huijin, which in turn invested it in CCB and BOC in exchange for CCB and BOC shares. The primary purpose of this exercise is to recapitalize the two banks. According to Basel rules, core capital of banks must consist of owner’s equity in the form of highly liquid assets, like cash and US bonds. I suspect this money will primarily not be used to reduce NPL ratio. Using US dollars to reduce NPL would have an expansionary effect on Chinese money supply. Another exercise will have to be used to reduce NPL ratio, particularly in CCB, since it is scheduled to be listed next year. The exercise which you described, the bond switch, seems more appropriate for reducing NPL ratio.
The question I have for the group is precisely where the money in the foreign exchange reserve comes from. Related, is there any direct connection between the foreign exchange reserve and the government budget? (besides investor confidence).
NYT Article:
January 7, 2004
China Announces New Bailout of Big Banks
By KEITH BRADSHER
HONG KONG, Jan. 6 - China announced a complex transfer on Tuesday of $45 billion from its soaring foreign exchange reserves to two of the four big government-owned banks, the third large bailout in the banking system in less than six years.
The transaction is intended to help shore up the financial institutions, the Bank of China and the China Construction Bank, so they can sell stock for the first time, the Chinese central bank said in a statement. The central bank admonished the commercial banks to do a better job of controlling fraud and limiting bad loans.
"When dealing with bad assets, they have to strictly investigate the responsibility of the related officials," the statement said. "They have to fight fiercely against those who have tried to run away from bank loans through illegal behavior."
Beijing bars Chinese journalists from reporting on the full extent of the banks' troubles, especially writers for mass-media publications read by many depositors. But with their promises of tough action against errant bank officers, the statements issued on Tuesday by the central bank and other agencies hinted at a concern about public perceptions of the bailout.
The costs of the American savings and loan bailout more than a decade ago - $123.8 billion in public funds and $29.1 billion in supplemental deposit insurance premiums from financial institutions - drew considerable complaints from politicians and the public in the United States. China has been eager to prevent a similar controversy. Its latest bailout, while costly, covers less than half of the nonperforming loans at two of the four troubled banks, and in an economy that is one-eighth the size of America's.
Tao Dong, an economist at Credit Suisse First Boston, said that "$45 billion is probably not sufficient, but a very decent number to start with." Mr. Tao said that while the latest bailout, split equally between the two banks, showed the government's interest in cleaning up the industry, what Chinese banks really need is to reform their lending practices so they stop making more bad loans. "Most important is having new credit-risk management established,'' he said. "Without that, any new money will be lost."
The need for another bailout underlines the problems that have vexed China's financial system even through two decades of rapid economic growth. The big four banks - the others are the Industrial and Commercial Bank of China and the Agricultural Bank of China - say that 20 percent of their loans are nonperforming. But Western analysts say that up to 45 percent of borrowers do not repay loans, although this share may be falling. By contrast, in the third quarter, loans at American commercial banks insured by the Federal Deposit Insurance Corporation that were more than 90 days past due or were nonperforming represented 1.24 percent of all outstanding loans.
Bankers said the Chinese banks' best chance of selling stock would be to list their shares on Western markets as quickly as possible - to take advantage of the mania lately with investors asking few questions and Chinese initial public offerings oversubscribed as much as 700 to 1.
"Why do you want to buy Chinese banks?'' a Beijing banker asked. "What makes you think these guys will do anything any differently in the next four years?"
China doubled the capital base of the four big banks in August 1998, by effectively giving them $32.5 billion through two complex swap agreements. In 2000 and 2001, it set up four asset management companies that bought $169 billion worth of nonperforming loans from the four banks at face value. The asset managers, owned by the finance ministry and indirectly by the central bank, have been struggling ever since to sell these loans for pennies on the dollar.
After each of those bailout actions, further loan losses quickly eroded the banks' capital bases.
Provincial and municipal governments put pressure on local bank branches to approve loans to politically connected individuals and to money-losing government-owned enterprises that employ large numbers of people. The four big banks are trying to address this problem by centralizing in Beijing their decisions on loans and by installing computer systems to monitor lending patterns.
The State Administration of Foreign Exchange said in a statement that it was transferring the money for the latest bailout to a new, specially created management concern, the Central Huijin Investment Company, which will then invest the money in the banks. The company's directors and supervisors will come from the foreign exchange administration, the finance ministry and the central bank, giving these agencies a continuing role in the two banks' ownership and financial management even after they sell stock.
Beijing's use of foreign exchange reserves caught the attention of currency traders, who have been looking for any sign that officials might allow the Chinese yuan to appreciate in value, as demanded by American, European and Japanese officials.
But a financial expert who insisted on anonymity said the two big banks were required to keep the money in dollars, which would make it easier for the central bank to continue preventing traders from bidding up the value of the yuan.
The central bank has been printing yuan on a vast scale to buy dollars and prevent its appreciation. It has then taken some of the extra yuan out of the financial system by selling bonds and withdrawing from circulation the money used to pay for them.
Enough yuan have nonetheless been issued to allow banks to lend more money in the first seven months of 2003 than in all of 2002. This has prompted fears that the banks may have engaged in another round of reckless lending that will produce a fresh wave of defaults.
The central bank now keeps the yuan in a tight range around 8.28 to the dollar. The financial expert said government officials had promised the two banks that they could exchange the dollars for yuan later if necessary at a rate of 8 to the dollar. This would act as a hedge against losses if the yuan does appreciate. It could also suggest an acknowledgement by Beijing of an eventual appreciation of the yuan.
Ryan Tsang, director for greater China financial services ratings at Standard & Poor's, said the accounting rules would let the banks count dollars as capital for purposes of meeting international capital requirements, without converting them to yuan.
Desmond Supple, an economist at Barclays Capital, wrote in a research report on Tuesday that the banks would be able to write off loans as uncollectible and make corresponding accounting entries against their equity without converting the dollars into yuan.
The State Administration of Foreign Exchange said the transfer to the banks was actually accomplished at the end of last year, which will allow the banks to show the extra capital in their year-end accounts. Several bankers said this might make it easier for the banks to pursue stock offerings by the end of this year. The foreign exchange agency said that even after deducting $45 billion, China's foreign reserves leaped $116.84 billion last year, to $403.25 billion.
Standard & Poor's and Moody's each welcomed the latest bailout as a sign that Beijing was addressing difficult problems in the banking industry instead of letting them pile up. "It's a very good development,'' Yen Wei, a vice president at Moody's, said. "It really demonstrates the government's commitment."
From the NYT article and from two UBS reports I read, it seems that the forex injection is structured differently than you have described. Essentially, SAFE has placed 45 billion worth of dollars or US treasury into Huijin, which in turn invested it in CCB and BOC in exchange for CCB and BOC shares. The primary purpose of this exercise is to recapitalize the two banks. According to Basel rules, core capital of banks must consist of owner’s equity in the form of highly liquid assets, like cash and US bonds. I suspect this money will primarily not be used to reduce NPL ratio. Using US dollars to reduce NPL would have an expansionary effect on Chinese money supply. Another exercise will have to be used to reduce NPL ratio, particularly in CCB, since it is scheduled to be listed next year. The exercise which you described, the bond switch, seems more appropriate for reducing NPL ratio.
The question I have for the group is precisely where the money in the foreign exchange reserve comes from. Related, is there any direct connection between the foreign exchange reserve and the government budget? (besides investor confidence).
NYT Article:
January 7, 2004
China Announces New Bailout of Big Banks
By KEITH BRADSHER
HONG KONG, Jan. 6 - China announced a complex transfer on Tuesday of $45 billion from its soaring foreign exchange reserves to two of the four big government-owned banks, the third large bailout in the banking system in less than six years.
The transaction is intended to help shore up the financial institutions, the Bank of China and the China Construction Bank, so they can sell stock for the first time, the Chinese central bank said in a statement. The central bank admonished the commercial banks to do a better job of controlling fraud and limiting bad loans.
"When dealing with bad assets, they have to strictly investigate the responsibility of the related officials," the statement said. "They have to fight fiercely against those who have tried to run away from bank loans through illegal behavior."
Beijing bars Chinese journalists from reporting on the full extent of the banks' troubles, especially writers for mass-media publications read by many depositors. But with their promises of tough action against errant bank officers, the statements issued on Tuesday by the central bank and other agencies hinted at a concern about public perceptions of the bailout.
The costs of the American savings and loan bailout more than a decade ago - $123.8 billion in public funds and $29.1 billion in supplemental deposit insurance premiums from financial institutions - drew considerable complaints from politicians and the public in the United States. China has been eager to prevent a similar controversy. Its latest bailout, while costly, covers less than half of the nonperforming loans at two of the four troubled banks, and in an economy that is one-eighth the size of America's.
Tao Dong, an economist at Credit Suisse First Boston, said that "$45 billion is probably not sufficient, but a very decent number to start with." Mr. Tao said that while the latest bailout, split equally between the two banks, showed the government's interest in cleaning up the industry, what Chinese banks really need is to reform their lending practices so they stop making more bad loans. "Most important is having new credit-risk management established,'' he said. "Without that, any new money will be lost."
The need for another bailout underlines the problems that have vexed China's financial system even through two decades of rapid economic growth. The big four banks - the others are the Industrial and Commercial Bank of China and the Agricultural Bank of China - say that 20 percent of their loans are nonperforming. But Western analysts say that up to 45 percent of borrowers do not repay loans, although this share may be falling. By contrast, in the third quarter, loans at American commercial banks insured by the Federal Deposit Insurance Corporation that were more than 90 days past due or were nonperforming represented 1.24 percent of all outstanding loans.
Bankers said the Chinese banks' best chance of selling stock would be to list their shares on Western markets as quickly as possible - to take advantage of the mania lately with investors asking few questions and Chinese initial public offerings oversubscribed as much as 700 to 1.
"Why do you want to buy Chinese banks?'' a Beijing banker asked. "What makes you think these guys will do anything any differently in the next four years?"
China doubled the capital base of the four big banks in August 1998, by effectively giving them $32.5 billion through two complex swap agreements. In 2000 and 2001, it set up four asset management companies that bought $169 billion worth of nonperforming loans from the four banks at face value. The asset managers, owned by the finance ministry and indirectly by the central bank, have been struggling ever since to sell these loans for pennies on the dollar.
After each of those bailout actions, further loan losses quickly eroded the banks' capital bases.
Provincial and municipal governments put pressure on local bank branches to approve loans to politically connected individuals and to money-losing government-owned enterprises that employ large numbers of people. The four big banks are trying to address this problem by centralizing in Beijing their decisions on loans and by installing computer systems to monitor lending patterns.
The State Administration of Foreign Exchange said in a statement that it was transferring the money for the latest bailout to a new, specially created management concern, the Central Huijin Investment Company, which will then invest the money in the banks. The company's directors and supervisors will come from the foreign exchange administration, the finance ministry and the central bank, giving these agencies a continuing role in the two banks' ownership and financial management even after they sell stock.
Beijing's use of foreign exchange reserves caught the attention of currency traders, who have been looking for any sign that officials might allow the Chinese yuan to appreciate in value, as demanded by American, European and Japanese officials.
But a financial expert who insisted on anonymity said the two big banks were required to keep the money in dollars, which would make it easier for the central bank to continue preventing traders from bidding up the value of the yuan.
The central bank has been printing yuan on a vast scale to buy dollars and prevent its appreciation. It has then taken some of the extra yuan out of the financial system by selling bonds and withdrawing from circulation the money used to pay for them.
Enough yuan have nonetheless been issued to allow banks to lend more money in the first seven months of 2003 than in all of 2002. This has prompted fears that the banks may have engaged in another round of reckless lending that will produce a fresh wave of defaults.
The central bank now keeps the yuan in a tight range around 8.28 to the dollar. The financial expert said government officials had promised the two banks that they could exchange the dollars for yuan later if necessary at a rate of 8 to the dollar. This would act as a hedge against losses if the yuan does appreciate. It could also suggest an acknowledgement by Beijing of an eventual appreciation of the yuan.
Ryan Tsang, director for greater China financial services ratings at Standard & Poor's, said the accounting rules would let the banks count dollars as capital for purposes of meeting international capital requirements, without converting them to yuan.
Desmond Supple, an economist at Barclays Capital, wrote in a research report on Tuesday that the banks would be able to write off loans as uncollectible and make corresponding accounting entries against their equity without converting the dollars into yuan.
The State Administration of Foreign Exchange said the transfer to the banks was actually accomplished at the end of last year, which will allow the banks to show the extra capital in their year-end accounts. Several bankers said this might make it easier for the banks to pursue stock offerings by the end of this year. The foreign exchange agency said that even after deducting $45 billion, China's foreign reserves leaped $116.84 billion last year, to $403.25 billion.
Standard & Poor's and Moody's each welcomed the latest bailout as a sign that Beijing was addressing difficult problems in the banking industry instead of letting them pile up. "It's a very good development,'' Yen Wei, a vice president at Moody's, said. "It really demonstrates the government's commitment."
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