Tuesday, February 10, 2004

This guy at CEQ asked me some questions on recent monetary policies, and here are my answers:

1) The CBRC issued a notice on 2/8 saying it will launching a probe into
loans made into overinvested industries like autos, steel, cement and real
estate, which are at risk for having serious overcapacity. Those being
investigated reportedly include state banks down to the rural credit
cooperatives. Can you tell me how you think a probe like this typically
works? And how successful do you think it will be?

The main purpose of this probe is to ensure that loans going into over-heated sectors were made according to regulations (both internal bank regulations and CBRC regulations). Very often, when a sector is over-heated, banks would rush in and give loans without doing all the necessary evaluation. As the CBRC edict states, the first step involves internal review by the banks, which is essentially useless. The second step involves on-site audits from local CBRC branches. It is expected that the local CBRC branches will mostly do the bidding of the central CBRC since CBRC is run vertically with little direct local governmental intervention. What is happening behind the scene, however, might be actual lending quotas on banking lending to various industries. This was a common practice in the past, and the government is trying to get away from it. However, CBRC still has full authority to impose lending quotas on the Big Four banks. You should ask around to see if this is indeed what's happening.

2) China has relied heavily on export growth and investment in fixed assets
over the years. What are some of the most severely overinvested parts of the
Chinese economy? Can you give me some examples of how overinvesrtment could
create serious problems?

Besides possibly causing inflation (over-investment also causes a supply bottleneck which exacerbates inflation), overinvestment was the cause of much of China's NPL problem. The perfect example was the real-estate bubble in 93-95. Essentially, local governments and companies borrowed heavily from banks to finance real-estate development expecting property prices to rise. When it didn't, banks were left with a lot of NPL and empty apartments. This is part of what the AMCs are trying to sell off at the moment. If the situation repeats itself, NPLs will get another major boost. Granted, even if there is a real-estate bubble (there is a debate on this) and even if it bursts, the magnitude of the problem as a % of GDP will not be as bad as in 1993. Loans to real-estate are no longer such a large % of bank lending, which has diversified to include consumer loans. Also, loans are now made to buyers, whereas loans before were made to real-estate developers. In the worst case scenario, I think the bursting of a real-estate bubble, even if there was one, would only increase NPL ratio by 5-10%.

3) Before the CBRC notice, Chinese Vice Premier Zeng Peiyan spoke of some of
these risks last week. Do you think China's leaders are starting to admit
this problem could be serious if left unchecked? Aside from probing
excessive and improper lending in these industries, what are some of the
other moves they can take?

In the past few inflationary cycles, targeted loan restriction usually constitutes the first step toward thwarting inflation. The problem with targeting specific industries is that money is fungible, so other companies can borrow from banks and re-lend to the over-heated sectors. The next step is more general efforts to control money supply, including raising interest rates and imposing a general credit quota on banks. The government is reluctant to raise interest rates because it would increase the cost of capital for restructuring SOEs and the cost of financing the deficit. Thus, it might resort to general credit control next. The debate on whether there is a inflationary problem is now just beginning. The Wen administration is not sure whether it wants to crack down on inflation yet because it is currently providing the benefit of enriching the farmers. Much of the current inflation stems from rise in food prices, which is good for farmers. I think the current administration is willing to see inflation rise to 5% before taking more drastic measures. This ambiguous attitude, however, sends the signal that more lending is still okay. Thus, despite the CBRC probe, I don't expect lending to slow down significantly in the first half of this year.

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