At a recent seminar on India and China, Jairam Ramesh of the Congress party asked a senior Chinese banking functionary about how serious the non-performing assets problem was -- while most analysts feel that this is China's Achilles heel, Jairam pointed out, none of the presentations by the Chinese delegates suggested a sense of crisis!
Not surprisingly, the answer given by the Chinese official was really a non-one.
Two sets of information I've seen since, throw a whole new light on the problem. One is a report by credit rating firm Fitch, while revising upwards the outlook on China's long-term foreign currency ratings from stable to positive in October, and the other, a news story in the Business Week dated December 1.
The Fitch report first.
While talking of the very high investment to GDP ratios in the country, around 46 per cent at the moment, Fitch uses something called the Hodrick-Prescott filter to calculate the 'credit gap' in China, and concludes that the credit-to-GDP ratio is currently around 8 percentage points above the long-term trend, and so is a leading indicator of an imminent banking crisis in the country -- clearly, with a 8-9 per cent GDP growth, the investment growth is excessive, and points to large investments yielding sub-optimal returns.
More important, while previous Fitch analysis (May 2003) argued the Chinese government finances could absorb the cost of restructuring the banks (in the sense of recapitalising them), this could run into a problem given the fact that a lot of the new loans by banks are turning into NPAs as well, and it doesn't help that the loan growth is currently quite spectacular.
With domestic credit growth more than double the growth in nominal GDP, according to Fitch, a NPA rate of 5 per cent on new loans, for instance, would generate fresh losses equal to 1.5 per cent of GDP per annum -- a 10 per cent new NPA rate would generate losses of 3 per cent of GDP per annum, and so on.
The Business Week story doesn't talk of the normal type of NPAs, of private sector firms taking a loan and then not repaying it. What it talks of instead, is of a city -- that's right, a whole city -- in southern China that appears to have taken a host of foreign banks for a ride!
Since a very large part of the Chinese investment boom is really that of various local governments, the city of Zhuhai set up the Zhu Kuan Group in order to borrow from banks -- in turn, land from the city was transferred to Zhu Kuan, and became the collateral against which the loans were secured.
Money thus raised was used to develop grand infrastructure projects. With this mechanism, the state borrowed more than $750 million from financial institutions like Standard Chartered, Morgan Stanley, Lehman Brothers and local banks like the Bank of China (Hong Kong).
By November 1998, Zhu Kuan began defaulting on loans, and by June 2002, a new agreement was tentatively worked out between the city and the lenders.
What's got the lenders all agitated now, it appears, is that, in July this year, the city government transferred land worth around $125 million out of Zhu Kuan's control -- in other words, this land can no longer be taken by the creditors.
In August this year, the creditors asked for the company to be liquidated, through a suit in a Hong Kong court -- 17 of Zhu Kuan's 50 subsidiaries are located in Hong Kong.
While Zhu Kuan officials deny the land transfer is asset stripping, Business Week points out that the fight is being seen as a test of whether the former colony can enforce its standards on assets controlled by mainland companies -- Zhu Kuan has in fact asked the court to dismiss the case for lack of jurisdiction!
More important, with an independent legal and regulatory system in China almost non-existent, the Zhu Kuan episode reflects the serious problems western institutions are likely to face when the China boom slows down, particularly in cases where government-promoted firms are the defaulters.
In the Zhu Kuan/Zhuhai case, the city built all manner of projects that never really paid off. An $800 million international airport, for instance, never received Beijing's permission to land international flights, and so serves fewer passengers in a year than Hong Kong does in a week.
Similarly, good money, probably borrowed from some western financial institution, was used to develop a Formula 1 high-performance track, but for whatever reason, the Formula 1 approvals never materialised.
RSM Nelson Wheeler, which has been appointed by the Hong Kong court as the provisional liquidators told Business Week that Zhuhai authorities were not making company records and public documents available -- part of the shares of Zhu Kuan's Hong Kong listed arm were, for instance, transferred to a company outside the control of the group, a company which is controlled by the Zhuhai municipal government!
When the liquidators petitioned the Zhuhai Intermediate People's Court for an administrative review of the land confiscation, the court demanded a $1.2 million fee -- the customary fee, Business Week was told by Zhu Kuan's creditors, is $12!
What's the moral of the story? The easy one, especially for an Indian, is to say this shows India is a lot more stable than China as far as investments are concerned -- of course, US investors like Enron and GE who put in money into the Dabhol power plant will question such an assertion.
But two points are obvious.
With the country's growth future somewhat perilous, it's unlikely the Communist rulers will loosen their grip anytime in the near future.
More important, with so much asset creation, and a lot of which is clearly sub-optimal, China will have to continue to grow at an even faster pace if it is to service the debts assumed along the way. That also means China's export drive just cannot falter.
Whether that is possible with increased US-China trade tension, and powerful US pressure for China to revalue its currency, is something worth paying serious thought to.
What does this say of the future ? It's difficult to say, but I'd go along with the old Chinese saying: it's very difficult to prophesy, especially about the future!
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