Elite Chinese Politics and Political Economy

Recently, the mainland media is awashed with more reports on the heroic Audit Agency and hinting at "big fish" not being caught.  Again, I think it is an attempt by the Hu-Wen team to unsettle Jiang's power base.  The auditor-general was recently quoted as saying that he has the premier's full confidence. 
The biggest target recently, the Planning Commission, is the strong-hold of Jiang loyalist Zeng Peiyan.  Zeng has been frustrating Wen's macroeconomic tightening by saying that the economy is not really over-heated.  The audit might have put the Planning Commission back on the defensive. 
The real test of how far Hu-Wen wants to take this "storm" is the current audit of Netcomm, where Jiang Mianheng is the CEO.  Will they report wrongdoings at Netcomm to the public, or will they merely blackmail the Jiang faction into giving up power with problems they discover during the audit?  I think there is more to come out of this.  Note also that this is happening in the run-up to the 4th plenum. Attached is an excellent article on China Daily, the official English newspaper, on this topic:

Audit report fallout stirs public interest2004-07-26 06:12

One month after Auditor-General Li Jinhua deliveredhis report to the National People's Congress StandingCommittee revealing embezzlement of public funds insome government departments, the "audit storm" isstill a hot topic of discussion. The following areexcerpts from media commentaries:Beijing News: In a joint survey of 5,200 respondentscarried out by China Youth Daily and the Xinhuawebsite, 76 per cent expressed concern forAuditor-General Li Jinhua's personal security.Such worry is not unwarranted, since his recent reportto the National People's Congress (NPC) StandingCommittee exposed some departments' misuse of publicfunds and will hurt the interests of some organs andindividuals who might seek revenge.Although now the National Audit Office (NAO) can carryout its work in line with laws, due to the incompleteconstruction of law-based administration, much work ofthe NAO still depends on administrative power.Without enough legal references or support forauditing from senior officials, it is difficult forthe NAO to carry on investigations. When they arepressured to release audit results in the face ofpotential retaliation, it makes them heroic in theeyes of the public.To ensure auditing is carried out in a stable way andto safeguard auditors' security, legal procedures mustbe put in place.With legal reference, the NAO will not depend onadministrative support, and disputes between auditorsand auditees would be settled through laws. Auditorscould release their reports in related NPC meetings,while the auditees involved could also defend on theseoccasions. Through such a mechanism, truth could bepursued in an unencumbered fashion.Progress has been made in auditing based on laws. TheNAO has carried out work in line with some legalregulations and submitted the results to the NPCStanding Committee for release to media.But it is improper that auditors and auditees maketheir arguments in the media. The argument mechanismshould be introduced in meetings under the NPC.When legal procedures are completed, people will nolonger need to be concerned for auditors' personalsecurity.China Youth Daily: Problems revealed inAuditor-General Li Jinhua's report should be swiftlydealt with.According to an official in a local audit bureau, theNAO has issued its subordinate a ban on givinginterviews to any media not approved by the NAO.An official in the NAO confirmed this, though herefused to answer other questions.To make administrative affairs transparent, providinginformation is an obligation of governmentdepartments. It also fulfills the people's right toknow. Thus the practice of government rejecting mediainterviews is usually criticized. But in this instancethe NAO's restrictions on interviews is not to blame.Strong responses to Auditor-General Li Jinhua's reporthave put the NAO and Li at the centre of the storm andstress.The State General Administration of Sports admittedtheir misuse of money, but gave no account on how tocorrect the problem. What's more, they cited manyexcuses and warned the media not to highlight the caseas if it was not them but the NAO and media who wereguilty of wrongdoing.A boss in the State Power Corporation, aproblem-ridden department exposed by Li's report, evensaid "the NAO's disclosing of their problems hasaffected employees' morale in fighting against thecountry's power shortages." Some officials in theadministration of Yangtze River embankmentconstruction and management expressed their belief theNAO was merely trying to bolster its own credibility.The "audit storm" has been blowing for a month. Exceptfor the blowing-off of some low-rank officials, suchas those being punished in the Dayao County ofSouthwest China's Yunnan Province for divertingdisaster-relief funds, most of the big fish are stillsafe and sound, while the NAO has become the target ofsiege and attacks.After he delivered the report, Li expressed that"non-intervention is the biggest support" to auditwork from the central government. He said his job hasnever been compromised by any State leader. Such"non-intervention" is widely hailed by the public.But in fact, support from the central government goesbeyond "non-intervention." Li said the State Councilhas ordered related departments to conduct thoroughinvestigations and administer severe punishment tothose responsible.But a month after the publishing of the report, whathas been done to solve the problems?It's time for related departments to make their moves.Dahe Daily: Since Auditor-General Li Jinhua deliveredhis report to the NPC Standing Committee on June 23,people have been eagerly awaiting answers to someburning questions. Will the law breakers be heldresponsible? Will those involved in corruption bepunished by law?Now, one month later, why is it that some of those bigfish have escaped unscathed?Those ministries who made fools of themselves in theaudit report either made excuses for their wrongfuldeeds or claimed the NAO was trying to boost its ownmerit.Over the past month the NAO and the auditor-generalhave been under tremendous pressure.A test of strength has been going on between the NAOand those problem ministries, and between Li Jinhuaand the officials who stand accused.People have every reason to worry about whether theNAO and Li will be defeated in this test.The NAO and Li rely on the power granted by theConstitution and law, and are backed by public opinionand support, as well as State leaders'"non-intervention." But those problem ministries andfigures depend on their long-cultivated power networkand the "hidden rules of officialdom."Past experience tells us that it is very possible thatmanipulated by certain departments and functioned bythe dark rules, problem ministries and shadowyofficials will be softly dealt with and the "auditstorm" will simply blow over in the end.If that turns out to indeed be the case, the publicwill justifiably feel ashamed and desperate.Some people suggest upgrading the NAO and itssubordinates so they can take an advantageous place inrank when supervising other departments. A highofficial in the NAO has suggested establishing anaudit institution to share equal status with theSupreme People's Court and the Supreme People'sProcuraterate, and report directly to the NPC and itsstanding committee.Determining whether these suggestions are workablestill requires observation and study. But theycertainly show people's concern over the battlebetween the NAO and those problem ministries.Normally, the NAO should not be beaten given it haspower granted by law, public support and Stateleaders' "non-intervention." Therefore, the "auditstorm" is a touchstone.The final result will clearly show which side standsstronger: rule by man or by law, the hidden rules ofofficialdom or governance according to law.(China Daily 07/26/2004 page6)

A reporter friend of mine asked me about the quality of Chinese statistics.  Here are my thoughts, which is basically the same as anyone who is using Chinese statistics.  "Can't live with it; can't live without it." It is better than nothing.  However, in some sense, the evolving Chinese statistical system makes it terrible for statistical analysis, especially usingtime-series data.
 
There is no doubt that the statistical system has come a long way, from Soviet-style command economy reporting to a hybrid system where statistics is reported by local governments and verified by random surveys conducted by the NSB.  The problem is that because the statistics is improving in quality all the time, it makes data across time not really comparable.  GDP figures from say 1992 were collected and calculated in a very different way thanGDP figures today. What is worse, the quality of data and the rate at which data improves vary across sector.  For example, I think banking and fiscal data is quite accurate in China, since it is difficult to hide anunbalanced balance sheet (with the exception of grassroots level budget;that's a big mess).  The government at least knows what is happening.They may choose to be ambiguous with the public. 
 
Investment and output data is more tricky, since you need firms and local governments to report it.  As you point out, "the numbers make a cadre;(thus) cadres make numbers." The central government has to randomly sample industries and regions to verify these figures.  As an analyst, there is not much we can do but to take all of ourfindings with a grain of salt.

Here is an interesting article sent by Matt Rudolph. As you can guess, I think
it rings true, but I am checking with Chinese sources. I must say that
in this fight, Hu-Wen haven't been totally "innocent" either. I mean
that they have no just "sit idly by" while Jiang and his cronies
attacked. First in May, Wen went after a steel company in Jiangsu and
the mayor Changzhou, which is the town neighboring Jiang's hometown.
Then, he had the National Audit Office audit a bunch of banks, provincial
governments and central agencies. In particular, the NAO issued a
stinging indictement against the Planning Commission, the power base of
Jiang crony and current vice Premier Zeng Peiyan. He also threatened
Jiang by auditing Netcom, where Jiang's son serves as CEO. Obviously,
Wen doesn't dare to actually expose Netcom, but the threat is there. In
this kind of fight, I think the faction with formal power (ie Hu-Wen)
will get the upper hand in this day and age. Jiang is no Deng. If Jiang
loses a major battle, the bandwagon will shift toward Hu-Wen's favor. If
there is a really hard landing, however, Wen might be in peril. However,
given his popularity in China, I think even Jiang would think twice
before removing Wen.

Leadership dispute over China growth
Premier Wen has heated debate with Shanghai party secretary over stringent
measures to cool economy
Straits Times 10 jul
by Leslie Fong


CRACKS are opening up within China's leadership over some administrative
measures put in place to cool the partially overheating economy.
WEN'S WAY

Premier Wen Jiabao said measures to cool the overheating economy, like curbs
on sectors such as steel and real estate, were showing results. He said both
central and provincial governments must continue with them, though
refinements were permissible.

According to sources in Beijing, Premier Wen Jiabao is facing criticism from
within the ruling Chinese Communist Party's Politburo for choking off
economic growth.

Leading the charge against him is Shanghai party secretary Chen Liangyu, who
mounted a full-frontal attack against the premier at a recent Politburo
meeting.

A source said that Premier Wen, who had been asked to give an update on the
economy, said measures like curbs on investment in sectors such as steel and
real estate were showing results.

He argued that both central and provincial governments must persist with
them though refinements were permissible if warranted by local conditions.

Mr Chen raised objections, saying these measures had hurt eastern provinces
like Jiangsu and Zhejiang badly and would retard overall economic growth in
the next few years.

He then presented his Politburo colleagues with reams of data on how these
measures would undermine Shanghai's growth specifically as well as a
compilation of adverse comments by foreign commentators on the prospects of
a soft landing for the Chinese economy.

He called for a re-think, adding, in what amounted to a warning, that
Premier Wen and his State Council, China's Cabinet, must take 'political
responsibility' for any damage done to the economy if they pressed ahead.

CHEN'S CRITICISMS

Shanghai party secretary Chen Liangyu said measures had hurt eastern
provinces badly and would retard overall growth. He offered data on how the
measures would undermine Shanghai's growth specifically as well as a
compilation of adverse comments by foreign commentators.

The source said the two then engaged in a long argument, with neither
conceding. In the end, Premier Wen said he was prepared to face the music if
the economy should nose-dive to a hard landing.

It was at this point that party leader Hu Jintao, who chaired the meeting,
intervened to say the administrative measures introduced were a collective
decision.

Government, at all levels, must carry them out resolutely, he ruled, as he
wound up proceedings.

The source said this was the most direct confrontation at the Politburo
level since Messrs Hu and Wen took over the reins of the party and
government in November 2002 and March last year, respectively.

It showed just how divisive the issue of reining in or moderating China's
recent explosive growth has become, with not just political leaders and
officials split into two camps but also economists and academics.

What makes the debate even more complex is a subtle power play between the
central government and regional authorities - and between the Hu-Wen camp
and those in the so-called 'Shanghai clique' led by strongman Jiang Zemin.

Indeed, China-watchers should not be surprised as tussles between Beijing
and local 'warlords' - national policies colliding with vested interests -
have long been a feature of Chinese politics.

Premier Wen's predecessor, Mr Zhu Rongji, determined to cool an overheating
economy in the mid-1990s, had to steamroller provincial detractors, leaving
them seething with resentment.

What was unusual in the latest episode was that Mr Chen, who is certainly
not the lone dissenting voice, chose to take Premier Wen on directly, and in
front of Mr Hu.

The speculation is that he had been emboldened by reports that just months
ago, Mr Jiang, who is Mr Hu's predecessor as party leader and still the
final arbiter on account of his control of the military, gave the permier a
hard time over the latter's management of the economy.

It is an open secret that the elderly leader has never been enamoured of the
Hu-Wen team. A source said in recent weeks that Mr Jiang had been hinting
darkly that a second five-year term for the two was not automatic.

It is also no secret that he often lent a willing ear to complaints about
them by provincial party chiefs and other vested interests within his
Shanghai clique.

But Premier Wen, a political survivor whose career has not suffered despite
his close association with ousted leader Zhao Ziyang, is no soft target
either.

Since May, he has seized every opportunity to tell the world that the
Chinese economy is headed for orderly, sustainable growth - he did so during
his recent European tour and when receiving foreign leaders, including those
from Singapore.

He also told his officials to capitalise on every bit of favourable economic
data to signal that the measures were working.

And in a less than subtle reminder to detractors in the provinces, he had
the People's Daily, the party organ, publish four articles between May 19
and 25, exhorting every cadre to toe the official line.

Yet though Mr Hu ruled in his favour in the latest Politburo clash, and
minutes of the proceedings have circulated to all high-level officials, the
debate is far from over.

Only last week, Mr Xia Bin, a senior analyst in the State Council's
Development Research Centre, told the Financial Times that the
administrative measures were hurting productive enterprises.

China risked a painful hard landing if it persisted with these measures, he
said, adding that it should shift its focus to using monetary measures such
as an interest rate hike.

Doubtless what he reportedly said was music to the largely foreign chorus
urging the Chinese government to raise interest rates and revalue the yuan.

Okay, it seems that the CBRC has made another move and the FT has reported on it. However, I think the article overstates the degree of change this entails. The PBOC and now the CBRC have monitored CAR since at least 1993. True, as the article states, loan-to-deposits ratio has been the most important yardstick for much of the reform period. However, there has been several attempts to get away from quantity management in favor of using "indirect" tools such as interest rates, CAR, and reserve requirements. China is certainly moving toward that direction slowly. I am at this point not convinced that CAR will be used instead of quantity management. This seems like another effort to bolster CAR on top of quantity management. Witness the most recent episode of inflation fighting, the Chinese government resorted to quantity management before even raising interest rates.

I am even more skeptical of the claim that the change would "remove the bias against private-sector borrowers." In fact, using risk adjusted CAR as the main yardstick would drive banks to buy up more government bonds in stead of lending to private borrowers, since government bonds have zero risk weight. Worse still, the CBRC might categorize loans to government projects as low risk assets and encourage banks to lend to government projects. This has been happening for decades, and it is unclear to me how the new regulation would discourage this sort of behavior. The Basel Accord is enacted with the need to balance risk and profit in mind. Without a system that incentivize managers to make profit, I don't think an emphasis on CAR, even if enacted, would make much of a difference to the efficiency of capital allocation.

See article below:

China must stand by its new bank rules
By Stephen Harner
Published: July 7 2004 18:58 | Last Updated: July 7 2004 18:58




Abrupt declines in bank lending in China have raised fears of both a credit crunch and a hard landing for the Chinese economy. Local governments and some Beijing think-tanks have urged the State Council to rescind its orders for banks to curb lending to over-heated sectors such as steel. Yet that would be futile. China's banks have stopped lending not so much in dutiful compliance with State Council orders as in a near-panic response to the "new paradigm" regulatory regime brought in by the China Banking Regulatory Commission.

Advertisement

The CBRC's bold new approach is sending shock-waves through the banking sector. But it may be essential if China is to restore solvency to its financial system, remove the bias against private-sector borrowers and reverse the disastrous decline in productivity of capital investment seen in recent years.

The essence of the new regime is a shift from a "funds constraint" to a "capital constraint" system of controlling growth in banking system assets. It is a profound change. Since their establishment in the 1980s, Chinese banks - virtually all state owned - have basically functioned as aggregators of domestic funds (deposits) and dispensers of loans and investments. In the tradition of central planning, the primary goal of the regulator (which before the CBRC's establishment last May was the People's Bank of China, the central bank) was to ensure that bank loan growth did not exceed a prudent proportion - generally about 75 per cent - of deposits. For the banks, the "loan-to-deposit ratio" - the funds constraint - has been the only really "hard" regulatory target they have been required to meet.

The loan-to-deposit ratio requirement has driven a number of phenomena: the tendency to build vast, expensive, deposit-gathering networks; the relentless, relationship-driven drive for deposits; breakneck growth of loans when, as in 2002 and 2003, economic activity has been robust; and inattention to the credit quality or profitability of asset growth. The reality is that the loan-to-deposit ratio constraint has often not been a constraint on banking at all; rather it has driven periodic credit-driven boom cycles and economic overheating.

For a banking system accustomed to the loose-fitting and expansive world of business based on deposit growth, the CBRC's new "capital constraint" regime, effective from March 1, appears like a straitjacket. It requires China's commercial banks to meet requirements of 8 per cent for total capital adequacy and 4 per cent for core capital adequacy by January 1 2007. In the interim, the banks must "formulate and implement a feasible phase-in plan to comply with the regulations". It is in coming to grips with the new rules that China's banks have slammed the brakes on lending.

The new regulations require banks to calculate capital adequacy based on full provisioning for potential loan losses, more conservative risk weightings for various asset classes, and the requirement for capital to cover market risk as well as credit risk. They remove a bias in favour of the state sector by assigning a risk weighting of 100 per cent to loans to very large and large state-owned companies (the weights were 50 per cent and 70 per cent under the previous system). Local government projects too are now accorded a 100 per cent risk weighting.

Most importantly, the CBRC seems determined to enforce the regulatory regime, under which boards of directors are responsible for managing capital adequacy and must report to the CBRC every quarter. In extreme cases, of undercapitalisation, the CBRC can take over the bank.

During 2003 many Chinese banks raised additional capital. Many more plan to do so this year, by, for example, attracting investment from foreign banks. But even those banks that thought they had met capital adequacy standards are finding that under the new regulations they now fall a long way short. Having just made cash calls on old investors and promised returns to new ones, these banks are agonising about how to close the newly opened gap (issuing subordinated debt seems to be the first and easiest option).

If banks are to meet the CBRC's new standards, they will need a completely different management ethos and model: one based on asset quality and profitability. This, certainly, is the central objective of the CBRC's bold new regulatory regime. It is also the reason why successful implementation of that regime is critical for China's economy - and for that of the world.

The writer is a financial industry consultant in Shanghai and sits on the board of Hangzhou City Commercial Bank as an independent direct

# posted by Xiao Shih : 3:22 PM