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China's Money Mess


Yang Kaisheng has one of the most thankless jobs in finance. From a dingy former bank branch in Beijing, the determined Yang squeezes 80,000 corporate debtors who cannot service $60 billion in loans to the company he runs, China Huarong Asset Management Corp. In two years, Yang has worked out only 20% of those loans. Now he's trying to sell some $3 billion in assets from deadbeat companies. What's for sale? A motley mix, including half-built hotels and ailing factories. Yang, however, is optimistic. He has hired Ernst & Young to help pitch properties to foreigners. Asset sales "will speed up," he vows. For China's sake, they had better.

The 51-year-old Yang is on the front lines of the war to purge China's rotten state banks--indeed, its entire financial system--of the effect of decades of reckless state-directed lending. The government is simultaneously trying to improve the quality of publicly listed companies and tame China's stock markets, which are less a productive channel for its $1.6 trillion in savings than a vent for the pent-up national passion for gambling and a prop for state companies. The impetus for all these initiatives comes from the top--in particular, Premier Zhu Rhongji, whose five-year term ends in 2003. That's because the real goal is political. The Communist regime's legitimacy rests largely on its ability to keep the dragon economy roaring, and the country's shaky finances seriously jeopardize the long march to prosperity. China's problems are profound. But if Zhu's policymakers even succeed partially in creating a sound system of banks and markets, the effects could be remarkable: A functioning financial system based on personal and corporate capital could transform China.

Like most major changes in China, financial reform is proceeding by fits and starts. First came the 15th Party Congress in September, 1997, where leaders pushed financial performance and privatization. More meetings on the issues and the abolition--on paper, anyway--of state-ordered lending promised more progress. But the 1997-98 Asia crisis froze any concrete steps. The creation of the asset management companies in 1999 was the first real sign that Zhu meant business. Last year, the process accelerated visibly, in loan workouts as well as securities regulation. The People's Bank of China (the central bank), the China Securities & Regulatory Commission (CSRC), and various state financial bodies have all moved to improve transparency and simplify the arcane markets.

China's impending membership in the World Trade Organization, which is expected to be formalized this year, makes the cleanup all the more urgent. Within five years, foreign competitors will charge into a system whose function for the last half-century has been to lubricate the Communist regime's economic projects and channel money and power to local authorities. "Crunch time is coming," says Anthony Neoh, formerly Hong Kong's top market regulator, now chief adviser to the CSRC. The government estimates it will take the better part of 10 years to clean up the backlog of bad loans. They may come to about $400 billion, the equivalent of 40% of China's gross domestic product.

SERIOUS EFFORT. China's high-flying stock markets are in no less need of a cleanup. Their listings' high prices are driven by artificial scarcity of stock, swindles, and insider trading, analysts say. The markets' huge capitalization, says Nicholas P. Lardy, a senior fellow and China expert at the Brookings Institution, a Washington think tank, wildly overstates their importance because it reflects the total value of listed companies, not the tiny number of shares actually traded.

How real is the reform? One sign of seriousness is that Zhu and the State Council, China's cabinet, have quietly given the green light for China's huge state banks--which fund everything from black-hole state companies to mortgages for China's emerging middle class--to aim for eventual listings in Hong Kong and New York. These wouldn't be the first Chinese listings abroad; three energy companies, Petrochina (PTR), CNOOC, and China Petroleum & Chemical, all did so successfully.

It will be a longer road for the banks. One of the few institutions that has any chance of listing abroad soon is the Bank of China's Hong Kong office, which has hired Goldman, Sachs & Co. (GS) to manage an initial public offering. The Industrial & Commercial Bank of China (ICBC), China's biggest commercial bank, has hired Salomon Smith Barney (C) to merge its Hong Kong offices into a listed bank--a backdoor IPO. "The idea is to use the Hong Kong listing [of BOC] as a catalyst for the reform of the mainland operations and to eventually list [them] abroad. Everyone from Zhu Rongji on down is focused on this transaction and making sure Chinese banks are on a strong footing," says Fred Hu, chief economist at Goldman Sachs (Asia) Ltd.

Moving toward an IPO may provide the banks the discipline they need to reform. Yet Brookings' Lardy dismisses the idea of mainland units listing in the West as fantasy. China's own stock regulator has said banks must meet international accounting standards and disclose nonperforming loans to list, he notes. And Chinese statistics, says Lardy, show that the banks' loan portfolios have continued to deteriorate--even though Chinese officials say all loans are made on a commercial basis, now.

Even if Zhu's plans succeed, the result will hardly represent full-bore capitalism. If the banks sell shares, for example, the state will keep majority control--a disappointment to more radical reformers. Indeed, the government still owns about 70% of the shares of all listed companies. That raises questions about the viability of plans to list the banks in the U.S., where institutional investors want management based on performance, social responsibility, and corporate governance. It's not an abstract issue. Top pension funds, including CalPERS and TIAA-CREF, shunned the PetroChina IPO last year, citing China's human-rights abuses.

Cleaning up the financial system will also make Zhu's tightrope walk between capitalism and socialism harder. "The easy parts of the reform have been done," says a senior finance industry official. "It's more difficult now because [further reforms] are related to the political system and property rights." The state controls almost all of the sector, and the Communist Party vets top appointments. "The opening up of the financial industry after WTO will pose a serious challenge to the state's policy of allocating financial resources," says China Construction Bank CEO Wang Xuebing.

Meanwhile, investors outside the state apparatus--minority shareholders, for instance--are powerless against market manipulators. "We are very sophisticated in dealing with robberies and murders," says one regulator. "But the securities market is a totally different thing, and it is not very easy for our system to cope with sophisticated [white-collar] criminal activities."

HUSTLERS AND RETIREES. Authorities are also having trouble coping with the growth in individual investment. Two decades ago, two-thirds of individual savings was kept at home or invested in tangible assets such as pigs. Today, financial assets make up 80% of a much bigger pool of savings. Some 58 million Chinese have stock-trading accounts. Playing the market verges on an obsession, especially in coastal cities. Players flock to brokerages--young, nattily dressed hustlers, laid-off workers, retirees. More than 13 million new investors started accounts in 2000. Julia Duanmu, a 32-year-old Shanghai real estate agent, is typical. The frontier aspect of the bourse doesn't faze her. "I have some casual money, and if I leave it in the bank the interest rate is very low," she says. "I think I should take the risk." The risk is considerable. The hot finance magazine Caijing, for example, has chronicled the tale of novelist Lu Liang. He is believed to be in jail after convincing investors to put $241 million into a loss-making state chicken breeder he touted as a high-tech winner.

Yet the state is trying harder to protect investors. One of China's most reform-minded officials, CSRC Chairman Zhou Xiaochuan, just hired as his deputy Laura M. Cha, who helped clean up the Hong Kong stock market when she was vice-chairman of Hong Kong's Securities & Futures Commission. "Appointing Laura Cha to the vice-chairmanship of CSRC brings real practical market experience," says Andrew Sheng, chairman of the Hong Kong commission. CSRC may also hire Hong Lei, a former fund manager who blew the whistle on corrupt practices. Recently, authorities took a step toward merging the parallel "A" and "B" markets: The dollar-denominated B market, which had been reserved for foreigners, was opened to domestic investors to improve liquidity and keep foreign currency in China. Beijing also ended quotas blocking private company listings and plans to delist companies that show three years of losses.

Bank reform goes hand in hand with market regulation. Officials are debating licensing a bevy of small private banks to create lenders with clean balance sheets and put competitive pressure on the state giants. "Our task is to turn the [large state-owned] banks into genuine commercial banks," says People's Bank of China Assistant Governor Li Ruogu.

GRAND AMBITIONS. When Wang Xuebing took charge of China Construction Bank 12 months ago, its 38 provincial operations ran like 38 different banks. "Although they called me governor, they all governed on their own," Wang recalls. No more. Profits are the new focus. "When I asked about performance, the answers centered around loan growth," says Wang. "I want to know about profit." Aftertax earnings hit $928 million last year. Wang hopes to get the bank up to international capital standards by 2003. In three to five years, he's aiming for a respectable 15% return on equity, compared with 9% now.

China's bankers have grand ambitions. Jiang Jianqing, who runs the giant ICBC, dreams his bank will within a decade become "one of the best banks in the world--China's HSBC or China's Citibank." ICBC certainly has the customer base--420 million individual accounts and 8 million corporate clients. It has gone from no credit cards 10 years ago to 76 million today. Ranked by its $500 billion in assets, it is the No. 10 bank in the world, with 25% of China's banking market. After it hived off its bad loans, aftertax profits jumped 26% last year, to $420 million. For the first time, it is monitoring risk and credit--Banking 101 in most countries, but a whole new world in China.

The bank recently bought a 70% stake in Union Bank of Hong Kong Ltd. as a vehicle to list its international operations. "ICBC is actively preparing for the listing of the whole bank," Jiang says. Before that, he has to deal with nonperforming loans. Jiang is vague about how many nonperforming loans the bank retains after dumping $60 billion into Huarong Asset Management. But he's confident bad debt won't be a major worry in a few years.

EPIPHANY. Another key part of China's financial strategy is to give the hard-saving population an outlet for their cash, and that means a profitable new business for banks: mortgage and consumer lending, which nearly tripled from $11 billion in 1999 to $31 billion last year. Mortgages help build a middle class that has a vested interest in stability, and they're much less risky than corporate loans. Last year, one-third of ICBC's new loans went to consumers, mostly for mortgages, reflecting the government's epiphany that consumers can be a source of economic growth. This year it's shooting for 40%. Consumers, few of whom could buy their homes before, are delighted. Says a 31-year-old lawyer working for a Shanghai law firm who took out a mortgage for 70% of the $60,000 price of the flat he bought two years ago: "I wouldn't have been able to afford it if I hadn't had the loan."

Although it's too early to tell whether banks have cleaned up all bad lending practices, the government is trying harder to smoke out credit risks. Since 1999, authorities have been rolling out a program to put deadbeats into a national database. Also in 1999, the use of aliases--so-called false name accounts--in financial transactions was eliminated. Last February, a comprehensive credit-rating system was rolled out. Financial institutions are beginning to submit information on borrowers to a national database.

There are no magic answers for China's remaining problems. The acid test will be the asset management companies, which have assumed some $160 billion in problem loans from the big banks. Huarong's Yang boasts that he has put a number of companies into the black last year after swapping $12 billion in debt for equity. Next, Yang plans to push mergers. At China Cinda Asset Management Corp., President Zhu Dengshan says that the 392 companies in his stable swapped nearly $20 billion in debt for stock, cutting debt as a percentage of assets to 40% from 70% and saving $1 billion in interest payments since last April. The bad news: Some 330,000 people lost their jobs. And the asset management companies will still have to write off billions in bad debt and worthless holdings from companies that are beyond recovery.

The asset management companies hope to sell their stakes in these reformed companies eventually. "We don't want to be permanent shareholders," says Zhu. "We want cash back." Indeed, free-flowing cash will be the proof that China's financial plumbing is unclogged and that money is going into productive investments. If China can pull that off or even get it well under way, it will have achieved one of the most formidable policy feats in Asia. By Mark L. Clifford and Dexter Roberts in Beijing, with Alysha Webb in Shanghai


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