Author Archives: Catherine Tai

Who is serving whom? How China exploits people’s savings

Who is serving whom in China's banking system?

While the world is increasingly dazzled by the Chinese government’s financial might, we often neglect the fact that the ammunition of its vast state-owned banks derive from the savings of its (emerging) middle class. Because China’s financial sector remains nascent and dominated by the state, the general public has little choice but to deposit their hard-earned money into state banks. This virtual monopoly allows the state to impose low interest rates that provide the government with low borrowing costs subsidized by the public. This lopsided arrangement is a significant source of public dissatisfaction, particularly when the government uses depositors’ money to bail out mismanaged state run banks.

Financial gymnastics by local governments

Under the current regulation, local governments are not allowed to issue bonds. As a work around, local governments establish investment companies that then borrow money from state-owned banks to support essentially off-book investment projects. At the national level, a similar process has taken hold: in the 80’s, the central government transferred responsibility for financing much of the state’s investments to state-owned and -controlled banks with the goal of improving the position of the central budget.  Victor Shih from Northwestern University extensively documents these developments in his book, “Factions and Finance in China.”

The risks associated with these off-the-books transactions—hidden on the balance sheets of banks rather than the public budget—have long been conveniently ignored by government officials, who are rather more concerned with short-term achievements and growth targets that will advance their careers. But a number of reformers and civil society advocates have begun to warn the government of the poor state of the investment companies, many of which do not appear to have the ability to repay their debts in the long-run. Reformers therefore call for a dramatic overhaul of China’s financial system to ensure long-term sustainability.

Local government investment companies have concentrated their loans on the property market and on infrastructure, particularly railroads, highways, and airports (the so called “iron rooster” trio). With most such investments, profitability and market demand take a backseat to the financing of public officials’ pet projects that help showcase their achievements and provide a stepping stone for promotion. In this way, depositors’ money is squandered at the will of powerful politicians.

Unsurprisingly, these projects have relatively low returns. As a result, the investment companies typically have low liquidity, and loans are repaid slowly. To get these long-term, unappealing loans off their balance sheets, banks repackage the loans into “trusts”—not  unlike the structured investment vehicles that produced the American Subprime Crisis—and sell them to investors. With relatively high returns and tacit endorsement of the local government, these trusts are highly popular with investors, who—unwisely—do not ask too many questions.

Professor Shih’s estimates of China’s hidden local government debt are staggering. Based on his research (“China’s 8,000 Credit Risks”), local investment companies’ total borrowing amounted to $1.6 trillion between 2004 and 2009—and Shih suspects that the problem is actually worse because he could not track lending from low-level governments. If accurate, this level of borrowing is equivalent to a massive one-third of China’s 2009 GDP and 70% of its foreign-exchange reserves.  Some in-depth reports from local sources in China point in the same direction. A Chinese financial newspaper with a circulation of over half a million, the 21 Century Business Herald, estimates that the local governments’ debt exceeds $1.2 trillion (8 trillion RMB). Even the Central Bank (PBOC) admits that local governments’ loans totaled more than $757 billion (5 trillion RMB) in May 2009.

The Financial Times expects only about 80 percent of this debt to be recoverable (resulting in losses easily exceeding $200 billion). Yet this number may well be optimistic. Local governments typically use land as collateral to obtain loans. Should the price of land collapse, many local governments will find themselves unable to pay their debts. This is almost certainly why the central government has had little success in containing property prices in its attempt to appease public outcry at the ever increasing cost of housing; self-interested local governments are no doubt complicit in propping up the value of land, their primary asset (for a more detailed discussion, see my featured service article).

The public is left with the bill

Should the property bubble pop and take down the banking system with it, it will be the general public who will have to foot the bill for state bailouts. Assiduously accumulating staggering amounts of foreign reserves, China would probably have the financial might to tackle the resulting non-performing loans. But China’s depositors will be saddled with a tremendous financial burden as a result of the state’s inefficient financial sector interventions and central-planned policy.

The state’s vast financial arm mesmerizes many around the world. Even Francis Fukuyama has lauded China’s efficiency in infrastructure construction. But we should not forget: these investments (often of questionable economic rationale) come at a great cost. For one, they are at the expense of the public’s future purchasing power as they are forced to accept low interest rates to subsidize the personal ambitions of local officials. For another, the state’s exploitation of the financial sector crowds-out private enterprise and market-driven investment projects.

Lacking an independent monitoring system and ignorant of market demands, many of the state’s investment projects will undoubtedly prove wasteful. Consequently, despite their many sacrifices, the depositors who will end up holding the tab are given no say in how their government decides to spend their hard earned savings.

Learning the Hard Way: China’s Distorted Real Estate Market

Soaring property prices have effectively priced the average Chinese citizen out of the housing market. Last year, a government official conceded that he could not afford an apartment on his humble salary. Fortunately for him, most government officials are provided with comfortable public housing—he need not worry. The emerging middle class does not have it so easy: for instance, statistics show that it is not at all unusual for an ordinary resident of Beijing to spend 80 percent of his income on monthly mortgage payments. This leaves little room for discretionary spending, thereby crippling the middle class’ purchasing power and standard of living while contributing to a widening wealth gap.

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The Fifty Cent Party: Chinese government enlists an army of bloggers

Chinese Censorship and Chinas Online Netizens Social Movements

While China’s government remains largely unaccountable to its people, the rapidly growing adoption of the Internet presents a glimmer of hope. Last year, for instance, China’s netizens successfully shed light on a number of social injustices. The resulting public attention frequently forces the government to back down and right wrongs. But such public cases remain the exception rather than the rule, due to the state’s extensive manipulation of public information—both online and off. The rule remains that the state’s views must dominate if at all possible.

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Sugar-coated Re-nationalization

Burgeoning public policy discussion in China.

Public participation in policymaking is an important development in China. (Photo: CIPE)

2009 marked China’s successful navigation of the global downturn. As the Chinese media reflects on the events of this past year, however, it is becoming increasingly apparent that the economy is in the midst of a new wave of nationalization—known locally as Guojinmintui, or “the state advances as the private sector retreats”—raising serious concerns over property rights.

State-owned enterprises, infused with government stimulus dollars denied to their disadvantaged private sector counterparts (see my previous blog article), have gone on an aggressive shopping spree to take control over a number of thriving private enterprises.

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Silencing the Masses: the False Hope of China’s Petition System

The Chinese communist party has grudgingly preserved China’s centuries-old petition system, providing citizens with a direct channel to the central government to air their grievances against local officials and promote a more harmonious society. While more myth than reality, this petition system of last resort is highly popular among the masses: citizens filed more than 10 million cases in 2004 alone.

Fearing an inability to satisfy the growing demand, Beijing readjusted its internal security strategy in 2004. Rather than improving the capacity of the petition system, it instead implemented a system of incentives and reprimands for local officials to cut down on petitions. Beijing, for example, will use the number of grievances filed within a region to influence the evaluation of its officials.

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A Stimulus Package with Chinese Characteristics: “the state advances as the private sector recedes”

A special report in the Financial Times, entitled “Rule of the Iron Rooster,” discussed the unintended consequences of China’s massive 4 trillion RMB stimulus plan: while this enormous fiscal expansion together with an overtly loose monetary policy has produced a boom in the equity and real estate markets, this “easy money” has also encouraged poor lending practices and produced waste that many – including Zhou Xiaochuan, the governor of the People’s Bank of China —  fear will result in a significant rise in non-performing loans.

Yet the stimulus plan may be producing an even more noteworthy negative consequence, although one that is very much by design. As core beneficiaries of the state’s numerous large-scale investment projects and enormous financial aid, the stimulus plan is significantly strengthening the dominance of state-owned enterprises and, in particular, reinforcing the influence of the colossal “Central Enterprises” — the 136 large-scale SOEs directly controlled by the State Council, whose management positions usually serve as rewards for the well-connected.

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China’s Numbers Game

The Chinese government has painted a promising picture of the country’s economic recovery. Last month, the government released its strong second quarter economic figures, posting a robust growth rate of 7.9 percent that is widely attributed to the enormous 4 trillion RMB stimulus plan and a loose monetary policy. Optimistic economists immediately revised the country’s annual growth rate upward.

Yet the story may not be quite so rosy: a number of sources have cast doubts on the accuracy of China’s figures. A blog article by Floyd Norris on the New York Times website, for instance, speculates that first quarter GDP growth was actually significantly lower by looking at the country’s recent energy consumption patterns. With energy consumption typically possessing a high correlation with GDP growth, the decrease in the country’s first quarter energy consumption suggests significantly weaker economy performance than that officially reported.

Last Wednesday, the Financial Times featured an article along these same lines with the headline “China’s Growth Figures Fail to Add Up.” This article adds further skepticism to the quality of the country’s official economic figures by demonstrating that the aggregate of provincial economic data far exceeds the numbers produced by the central government. Unfortunately, economic output is not the only area where local governments are overly optimistic: China’s stimulus plan has run into trouble as the contributions from local governments have fallen far short of their ambitious commitments.

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