Elite Chinese Politics and Political Economy

A reporter friend asked me what I thought of the up-coming G-8 summit. I frankly think Chinese leaders, like our own leaders, think much more about domestic politics when they go to these international meetings:

On the G-8, I think this will be important for Hu in terms of domestic politics. If Jiang has any claim to residual power, it is his deep experience in foreign affairs (at least according to his supporters and himself). Hu needs to establish himself as just as capable in dealing with outsiders as Jiang could to finally consolidate his power domestically. This will be a long process that will take at least until the 17th Party Congress. However, the G8 summit will be an important step for establishing Hu's foreign policy credibility. He will need to act with poise, firm without appearing xenophobic or paranoid. I don't think he will specifically raise the currency issue unless someone raises it first. He will reaffirm China's intention of seeking mutual prosperity through heightened economic and cultural ties with other countries. I think this will be an opportunity for Hu to establish personal ties with top leaders around the world as well. Other leaders will also need to learn about Hu, especially given that he will be around for (at least) another 8 years.

My friend Stephen Green at Standard Charter Global Research (based in Shanghai) just completed a remarkable paper on Chinese monetary policy. It goes through the evolution of Chinese monetary policy instruments in great details, but the conclusion is very remarkable. Basically, the more foreign exchange flows into a repressed financial system, the greater the spread is between central bank cost and income. So, with more inflow of forex, the money supply increases, which drives down interbank rates. So when the PBOC (central bank) decides to sterilize part of that inflow, banks rush to buy up PBOC bonds since they are not getting much of a return in the interbank market. Thus, PBOC is able to sell bonds at a relatively low rate, at 2.83%. At the same time, PBOC is getting over 3% for its foreign exchange assets based in USD, and they are constantly looking for higher returns through investing in asset-backed securities in the US. Contrary to the prediction of some economists ( I won't name names), the current situation, which requires the PBOC to issue billions in sterilizing instruments, is very sustainable! The beauty of financial repression.

The Government Mulls Over Another Bailout to “support the market”

Rumors of an enormous government effort to “support the market” are surfacing again. This time, the government will set up a fund to inject as much as 120 billion RMB into the troubled stock market. The Shanghai Stock Exchange dived below 1000 points for the first time since 1997 last week. Due to this rumor, the depressed market in Shenzhen and Shanghai immediately rallied. We know, however, that this bailout, even if it occurs, will be ineffective in providing long-term buoyancy to the stock market. Past efforts to inject more funds to the stock exchange have failed, and this one will fail also. As long as two fundamental problems—poor regulatory oversight and corporate governance and the giant overhang of legal person shares remain unsolved, the Chinese stock market will continue to stagnate.

We are all familiar with the pervasiveness of inside trading and poor regulation in China. This problem stems from a deeper problem that most of the listed companies are in fact state owned enterprises. By definition, the well-being of these state owned corporations depends on government policies. As a result, those with advanced knowledge of government policies have an enormous advantage in the stock market. Knowing this, would an average investor with no special connection pour his or her savings into this "guanchang" (as in government arena, as opposed to the market)?

Second, over 30% of a typical state owned corporation’s shares are held as legal person shares which are not tradable in the open stock market. Instead, these legal person shares are typically held by state owned corporations or government entities. Because of this over-hang, investors know that at some point in the future, the state might allow legal person shares to float in the market. This way, they expect a large influx of shares into the market in the future, which depresses current stock prices. This is a problem that new liquidity entering the market cannot solve. The only viable solution is “shock therapy” which allows all legal person shares to enter the market all at once. This would of course depress stock prices substantially in the short-run, but would form the foundation of a sustainable rally. Of course, the new bailout package, if true, shows that the leadership is not prepared to make such a politically sensitive step.

The stock markets have plunged continuously since Shang Fulin took office as head of the CSRC, and he is doubtless at his wit’s ends in trying to find a way out. However, injecting more money is definitely not a viable long-term solution. Zhou Xiaochuan’s success had as much to do with his willingness to implement tough regulations and to hire outside help (Laura Cha) as it did with his good political connections. The market involves millions of participants making independent decisions, so the only way forward is more transparent and fair rules, not more dependence on state bailout.

Replying to an earlier comment about Zhu and Wen ("This is rather beside the point of this particular posting. But judging by some of your previous posts, you see the hand of Zhu Rongji in some of the Wen administration's moves. In a recent Asia Society event in LA, William Overholt remarked that Zhu's work in cleaning the red ink from China's banks is but half-done. After Zhu left the premier's post, bad debts are accumulating again. How do you compare Wen and Zhu's skill in dealing with banks?")

Zhu and Wen definitely have different styles. While Zhu is hard-hitting and wants to solve the problem right at this minute, Wen takes a more circumspect approach. In a way, their styles are products of different times. When Zhu first became Premier, the Chinese banking sector was really in a bad way. Zhu then implemented a series of policies that both bolstered the power of the central government and provided short-term but effective fixes to the NPL problem. Setting up AMCs to buy NPLs at face value was precisely such a move (for more details, please see my article in December 04 issue of China Quarterly). Now, even though there are new NPLs, I am fairly convinced that the situation is not as dire as it was in the mid-90s, especially when calculated as a % of GDP. The government's willingness to auction NPLs as opposed to directly selling them to AMCs at face value is a sign of that. Another thing that the Wen administration did right was to split the PBOC into two parts (see an earlier posting on this issue), with the CBRC focusing on the NPL problem. This gave the CBRC the sole mission of controlling NPLs, whereas the PBOC had conflicting missions. The banking problems confronting Wen is still daunting, but much more manageable and does not require the drastic measures that Zhu took. Wen, however, seem willing to experiment with new measures, such as the foreign exchange injections to recapitalize banks and, ultimately, listing the banks. These moves can now be done in a carefully planned fashion, not the over-night moves that Zhu was famous for. However, if some exogenous shock causes the banking problem to worsen significantly, a hard-hitting style might become necessary again.

A reporter friend of mine asked me what the deal was with the party making such a big deal of Chen Yun's 100th birthday. For those of you unfamiliar with Chen Yun, he was the other CCP elder besides Deng Xiaoping throughout the 80s and the early 90s. Chen Yun was essentially in charge of the State Council for much of the 80s and clashed with Deng over some economic policies, especially monetary policies. I provide my interpretation below:

This looks like a campaign to consolidate the center's power. Chen is the symbol of party unity and centralization while Deng is the symbol of liberalization and decentralization. Also, Chen has always had close ties with Shanghai, since he himself is a Jiangsu native. Nonetheless, he did not lobby for preferential treatment for Shanghai and always asked Shanghai officials to serve the center's needs. This could be a sign of the new leadership's dissatisfaction with Shanghai. Besides Shanghai and Xinjiang, all of the other provinces have had major reshuffling of leadership in the past few years. Shanghai remains the only "independent kingdom" with an unbroken chain of successors outside of a minority area. I am waiting for a corruption case to break in Shanghai that will topple the entire Shanghai government. There is a lot of talk of Chen Liangyu being investigated, but thus far that is going no where. I would keep my eyes open about what happens in Shanghai.

As per the last posting about corruption in the AMCs, someone asked me how much money is lost to corrupt AMC deals. In truth, I have no idea, but here is my reply.

I really don't know how much is lost through this kind of corruption, but from my interviews, it seems that things are getting better. In 2001, foreign bankers demanded a really low price from the Chinese government because there was such an informational vacuum. So even legal deals approved by the State Council were sealed below market price. But as the market became more established and as Chinese real estate prices increased, deals became more transparent, and prices for NPLs rose. I have even heard of some cases where investors paid full face value for some collateral in Guangdong...etc. Also, the most recent transfers include much better quality assets that are expected to yield over 30% of face value.

The Washington Post carried this very interesting and detailed article about an Asset Management Company manager in Chengdu who sold AMC assets at a low price to friends and relative. Strictly speaking, selling NPLs to friends and relative does not add to the overall toll of NPLs; it merely decreases the amount that the government is able to recover. Sadly, selling at a low price to friends and relative is common practice. This guy is just unlucky to be caught, or it seems that his patron is losing power. The problem is that AMCs are given recovery quotas depending on the locality, so in localities endowed with good assets, it leaves them plenty of room to sell below market price because they would still reach the quota. In places with very few good assets, they have no hope of ever reaching the target, so they might as well benefit from selling at a low price to bribers.



By Peter S. Goodman
Washington Post Foreign Service
Monday, June 6, 2005; A01

CHENGDU, China -- As he rose through the ranks at China's largest
lender, Zhang Guilin helped build the bad debt crisis plaguing his
country's banks, the gravest threat to this fast-growing economy. Zhang
directed funds to cronies and political allies, authorities here say,
adding to a national toll of bad loans estimated at $500 billion.

Five years ago, Zhang was given a job as head of the local office of a
new government-formed company charged with cleaning up the very
financial mess he helped create. The new company took over the bad debts
at his old bank and tried to recover what it could by selling off the
properties pledged as collateral.

This asset-recovery company was supposed to help nurture a new era in
China's financial system. Instead, the campaign to fix China's banks is
foundering on the same cronyism and corruption that created the debt crisis.

According to those familiar with a state corruption probe, Zhang sold
many of the assets under his control, including an apartment complex and
hotel on a Chinese resort island and a 30-story office tower in the
center of this city, to friends and relatives at sweetheart prices,
justifying the deals by using an auction company owned by a long-time
associate.

As China continues its transition from communism toward an increasingly
freewheeling capitalism, central government officials are consumed with
eradicating bad debts and building healthy banks, with foreign money
slated to play a major role. Over the next two years, China plans to
raise tens of billions of dollars to help write off bad debts by selling
shares in its largest state lenders on stock markets in New York and
Hong Kong.

But the story of Zhang Guilin highlights the risks confronting foreign
investors as they jockey for a piece of these deals. It shows how
endemic inside-dealing remains in a Chinese banking culture that has
long run on personal relationships, the ease with which brazen
corruption can evade the scrutiny of regulators and the difficulty of
assessing the net worth of any financial institution in China.

"A lot of the management people have been taken directly from the
banks," said Yu Nanping, a banking expert at East China Normal
University in Shanghai. "They are disposing a lot of the bad loans they
created before, and they are covering up a lot of corruption cases."

Zhang headed the Sichuan branch of Huarong, one of four state-owned
asset management companies created to restructure deadbeat borrowers and
sell off collateral to erase bad debts. These companies were patterned
after the Resolution Trust Corp., the company created in the United
States after the savings and loan debacle of the 1980s, which left
taxpayers on the hook for an estimated $180 billion.

China's state banks transferred nearly $170 billion in bad loans to the
asset management companies in 1999 and 2000, then added $50 billion last
year. Last month Zhang's old bank, the Industrial and Commercial Bank of
China, signed an agreement that will transfer $30 billion more in bad
loans to Huarong. By the end of 2004, the four firms had collectively
written off or sold assets worth about $80 billion, according to state
figures. They recovered only 20 percent of the face value of their
loans. The state audit office recently disclosed 38 cases of
embezzlement and fraud at the asset management companies, involving more
than $800 million.

Zhang is now jailed at the Public Security Bureau in Chengdu, according
to sources familiar with the probe. Officials at Huarong and ICBC
declined to speak publicly. This account is based on documents filed in
Sichuan and Hainan provinces, interviews with four current and past
officials at ICBC, real estate developers, auction companies and two
sources familiar with the corruption probe.

Zhang grew up on the muddy banks of the Yangtze River, in a city called
Wanxian. His parents scratched out a living at a market stall. After
graduating from high school in 1963, he took a job at what was then the
nation's only bank, the People's Bank of China.

In 1984, as the government split off new banks, Zhang took a position at
the freshly minted Industrial and Commercial Bank of China. The next
year, he became the head of the Wanxian special region office, which
supervised branches in an area of nearly 9 million people.

Zhang's office had no computers, no air conditioning and primitive
toilets. He earned about $12 per month. But Zhang parlayed his position
into an ascendant career. He regularly tapped bank funds to entertain
associates, dining with the Wanxian mayor and party secretary, former
colleagues say, and he lent to the local factories they favored.

On several occasions, colleagues and angry managers at factories who
failed to secure credit wrote letters to provincial officials accusing
Zhang of taking kickbacks, according to three former colleagues and a
source familiar with the corruption probe. Each time, Zhang enlisted the
support of local officials to scotch any investigation.

In 1992, Zhang engineered a transfer to Yibin, farther up the Yangtze.
It was at best a lateral move. Yibin was much smaller than Wanxian. But
it was also closer to the provincial capital, Chengdu, and it gave Zhang
direct responsibility for approving more loans.

Local governments were then tapping state banks for capital to invest in
real estate deals. In 1993, Zhang handed a firm controlled by the Yibin
city government about $33 million for projects around the country.

Zhang "didn't care how many projects there were, and there was no
collateral," a former colleague said.

Reports of kickbacks again brought Zhang cross-wise with supervisors,
but useful friends snuffed out trouble. Among his most important
guardians was Xie Shijie, a former Sichuan province party secretary,
former bank officials said. Zhang ensured that a steady diet of credit
kept flowing to a loss-making factory run by the party secretary's son.
Xie has retired from public office and did not respond to messages.

This relationship played a critical role in elevating Zhang to
vice-chief of the ICBC branch for Sichuan province, a post he assumed in
1998. The job brought him to Chengdu, famed for its spicy food and
teahouses. Two years later, Beijing created Huarong, the asset
management company, and hired Zhang to run its Sichuan branch.

All over China during that time, previously unthinkable fortunes were
being made by anyone with access to property. Zhang, then five years
away from the mandatory retirement age of 60, recognized that this was
his last opportunity to enter the ranks of the rich, say his former
colleagues. He was then making only $200 a month, though the bank
provided an apartment and a chauffeured Audi sedan.

As investigators craft a criminal case against Zhang, two projects on
the resort island of Hainan in the South China Sea are occupying a prime
position in the probe. Americans best know Hainan as the scene of a
stand-off between Beijing and the Bush administration over the fate of a
U.S. reconnaissance plane that crash-landed there in 2001. Within China,
it is synonymous with a disastrous early 1990s real estate bubble that
left half-built skeletons towering lifelessly over the sea.

In the Hainan city of Sanya, a $5 million loan from ICBC built the
Golden Bay Garden, a complex of 12 eight-story apartment towers set on a
bay. That loan went bad, and the property was transferred to Huarong's
Sichuan branch. Four years ago, Huarong sold the property for a mere $1
million to Sanya Southeast Real Estate, a company controlled by one of
Zhang's long-time associates. That was less than half of its real value,
sources familiar with the probe said. A few weeks later, Sanya Southeast
flipped the property to another developer for more than $2 million,
doubling its money.

In 2003, Huarong sold another failed Hainan property, the Shuhai Hotel,
to a company controlled by another long-time associate of Zhang's,
according to sources familiar with the probe. Though the project was
worth about $6 million, Huarong sold it for only $60,000.

Investigators are also probing Zhang's handling of a 30-story office
tower in the center of Chengdu called Tianyi Plaza. The original
developer, Cai Wenbing, said in an interview that he struck an agreement
with ICBC to jointly develop the property in 1993, but the bank failed
to deliver its promised $10 million. Documents confirm Cai's account,
revealing that the bank then extended him a loan for the money and
promised he would never have to repay it. But when Zhang took over
Huarong, he disregarded that promise, suing Tianyi Group at the Third
Civil Court of the Sichuan High People's Court seeking the return of the
loan and persuading a judge to halt construction.

The following January, Huarong sold Tianyi Plaza to the lawyer
representing the bank, Zhang Xuefeng, for only $4 million, which was a
fraction of its worth, Cai said.

In April 2002, the Sichuan court ruled in Huarong's favor. Cai an
appealed. He said that later that spring, he got a call from Huarong's
lawyer seeking settlement talks.

According to Cai, the lawyer boasted: "We succeeded because we bribed
the judge," adding that after buying Tianyi Plaza from Huarong for $4
million, he had immediately sold it to another developer for $9 million.
"He said, 'We'll give you [about $600,000] and we'll give you a passport
and you go to America and shut your mouth,' " Cai said.

The lawyer has fled Chengdu, according to sources familiar with the
probe. The judge declined to comment. The case is tied up in court.

Zhang retired from Huarong last fall. But by then, the investigation
that now has him behind bars was already underway. On February 5, state
security agents found him at one of his seven Chengdu area residences
and took him away.

Special correspondent Eva Woo contributed to this report.

So, it seems that the deal between Citibank and China Construction Bank has collapsed. In January 2004, Citibank had won out over HSBC, JP Morgan, and Deutsche Bank to serve as chief advisor to CCB's impending IPO. Supposedly, Charles Prince himself promised that Citibank would acquire over 2 billion USD worth of CCB shares upon IPO, or roughly 10% of CCB shares. Although the Chinese press makes it seem like it is Citibank's internal problems that led to to the collapse of the deal. Citibank management instead might have done some clear-headed thinking and realized that a state-owned bank is still too risky a proposition in which to sink over 2 billion.

Although as "strategic investor," Citibank would have been entitled to send one and possibly two VPs to CCB, would they have had any power as outsiders and non-party members. Despite Guo's promise, it remains to be seen how much power outsiders will exercise in CCB and other large state banks. The market has also reassessed the risk of investing in CCB. Note that the current strategic partner with CCB, Bank American, will only sink 1.2 billion for a 5% share, half of what Citibank had supposedly promised. In truth, I share Citibank's circumspection because it remains difficult for the Chinese government to refrain from interfering in a large bank such as CCB. Citibank and other large foreign banks hoping to get into the Chinese market would do much better to invest in mid-size joint-stock banks and good city commercial banks since most of their business is on the prosperous coastal region. Frankly, much of the inland banking market is just not worth very much in the foreseeable future.


金融时报

国际在线报道：在承销中国建设银行(CCB)上市事宜上，花旗集团(Citigroup)已出局。此前，建行指责花旗违背了购买超过10亿美元股权的诺言。建行的上市规模达50亿美元，是亚洲最大的首次公开上市交易之一。

这一变化对花旗集团是一次沉重打击，它已与摩根士丹利(Morgan Stanley)一起为建行股票的海外上市工作了15个月。此前，花旗集团在全球范围内遭遇了一系列监管问题。

据悉建行已在过去几周告知花旗集团，不要参加有关首次公开发行的准备会议。建行的上市很可能年底前在香港进行。

这意味着花旗将可能不再担任建行的上市顾问。花旗出局后，预计将失去超过8700万美元的承销费。

知情人士表示，中国四大国有银行之一的建行想要惩罚这家全球最大的金融服务集团，因为建行认为，花旗未能兑现在建行首发前买入股权的承诺。

“他们已被‘取消(与会)邀请’，因为这家中国银行对花旗买入股份的承诺已失去耐心，”一位人士说。去年1月，花旗集团击败汇丰银行(HSBC)、JP摩根(JPMorgan)和德意志银行(Deutsche Bank)等竞争对手，赢得了建行上市顾问的资格。

据悉，花旗集团之所以在激烈的角逐中胜出，原因之一就是它提出在建行持有一笔“战略股权”，并帮助这家中国银行对业务操作进行现代化改造。

尽管进行了数月的谈判，花旗集团仍未能与建行达成交易。而且据悉建行已与花旗的竞争对手美国银行(Bank of America)进入了后期谈判。美国银行提出将出资约12亿美元，持有建行5%的股权。

美国银行的介入可能让花旗难以买到建行股份，即使它想这么做，因为据悉美国银行正与建行谈判一项排他性协议。

花旗集团昨天拒绝置评。花旗从未确认过买入股权的承诺，它成为战略投资者的承诺有多坚定也并不明朗。

建行昨天也拒绝发表评论。