Banking Sector Needs a Little Control
02/15/2005
Dane Chamorro,
Bangkok Post
Reports that China's economy grew by 9.5% in the last quarter of 2004 raise the question of just how effective is Beijing's official ''slow growth'' policy.
This, of course, has been a topic of concern both inside and outside the country for most of the past year. Indeed, hardly a day goes by without a news article about the risks posed by China's economic growth, its currency peg, the threat of non-performing loans, the potential impact of the investment ''bubble'' bursting, financial scandals, etc.
Unfortunately, this debate misses the real point: China's hyper-growth and many of the undesirable side-effects stem largely from the same source - a dysfunctional financial system.
The primary concern overseas is that China's rapid growth has fostered afinancial ''bubble'' of the type that burst with the 1997 Asian Crisis,subsequently triggering the debt defaults of both Russia and Brazil. SinceChina has accounted for a quarter of the globe's gross domestic product growth in the last five years, the concern is real but misplaced: China's capital controls mean that its economy is not subject to the risk of capricious portfolio investment or currency speculation the way most Southeast Asian countries were in 1997.
China's real problem is a handicapped banking system caught somewhere between socialist state planning and the free market - and as Alexis deTocqueville, the 19th century author of Democracy in America, once quipped: ''There is nothing more dangerous than a little reform.''
Interest rates do not influence China's economy the way they should because, in an economy where most loans occur between state banks and state industry, there is no real cost of capital. And while Beijing may instruct bankers to curtail credit to real estate or cement companies, more often than not loan officers and bank presidents follow the wishes of the local party secretary or mayor, not a distant cadre - a time-honoured Chinese practice of ''feigned compliance.''
In spite of Beijing's ordered ''slow down'' fixed asset investment rose 28% in the first three-quarters of 2004 - while investment growth in some industries (cement, steel and aluminium) has exceeded 100%. It is not difficult to see why there is no shortage of capital.
Over-investment is driven by a combination of cheap credit, a political desire to maintain employment and thus social stability, an incentive system skewed towards asset growth, and an unhealthy relationship between local bureaucrats and bankers. The result is ghost buildings in almost every town and a looming over-capacity in many industrial sectors China's ridiculously over-banked economy subsidises these investments. In 1980, the country had just two banks - the People's Bank for domestic transactions and the Bank of China for foreign trade. Today, it has well over 100 financial institutions (not to mention a large informal lending market). The country's largest, the Industrial and Commercial Bank, has over 30,000 branches alone. Since a branch manager's performance is typically tied to asset (loan) growth, not profitability, there is always a ready ''piggy bank'' for asset expansion.
The only effective way to change this system is to partially reverse the reform policy as it applies to the financial sector: first, by drastically reducing the number of lending institutions, as is now being done withsecurities brokers, and, second, by reasserting central control over loan authority.
The proponents of greater openness and reform may cringe, but the hard fact is that China's banks are not capable of self-discipline or effectively managing commercial risk. A consolidation programme will allow Beijing to gain effective control of the economy without choking growth in China's dynamic private sector because most entrepreneurs finance their operations from the informal market.
China's economy has experienced remarkable growth since the late 1970s - a feat matched only by a few of Asia's ''Tiger'' economies such as Taiwan and South Korea. Like China, these authoritarian systems were dominated by state industry or its equivalent - South Korea's chaebul - and were overly-favoured by state lenders. The difference was that the banking systems in these economies were under fairly strict central management. As a result, Taiwan and South Korea's economic growth not only exceeded China's but was also far more efficient, being generated with approximately 40% less investment.
China's economy today is, of course, far larger and more influential than any Asian Tiger, and more than three times larger than it was just a decade ago - at current growth rates its economy will match Germany's by 2010. Yet central financial controls are weaker now than they were in 1993-94, when a similar over-expansion occurred and a rash of bankruptcies inevitably followed. Whether by deliberate design or informal delegation, China's financial system has liberalised beyond the capability of its practitioners to control it.
The world simply cannot afford an uncontrolled credit system in one of its largest and most influential economies. If China is going to continue to be the world's economic driver - without risk of the bubble bursting - it must get its banks under control.
Dane Chamorro holds an honours degree in international finance from Georgetown University's School of Foreign Service. A former diplomat officer, he is currently a consultant with Control Risks Group in China.
