Sunday, August 22, 2010

China's Paper Tigers: Inside LICs and associated dirty secrets

All this goo ga about the PRC being a world economic power is beginning to wear me down. Simple folks...China is not going to meaingfully replace the US anytime in the near future. All those reports about China flexing its military muscles and keeping the US off the China Sea is just drivel...

Why? let me assure you that I am no knee-jerk PRC basher...but there are too many dirty things swept under the carpet in the PRC that paint a less glowing picture...despite Arthur Kroeber's rather facetious article..Victor Shih bears repeating here...

I don't think the problem is trivial, especially in light that local governments seem determined to take on trillions in additional debt in the coming two years to finance ambitious investment plans. My main worry is that unless Beijing decisively restricts local investment projects, local investment companies will continue to borrow in large quantities in the coming two years.

Even relatively bullish investment bank report suggests that new non-performing loans in the banks can increase by 2-3 trillion RMB in the next couple of years. To be sure, this is well within the government's ability to handle and likely will not lead to any kind of financial crisis. However, this remains a daunting problem for the government and for current shareholders of China's banking stocks. This will require the China Investment Corporation to inject tens of billions of dollars into banks through Huijin. Additional asset management companies will have to be formed to take over the NPLs. This is a lengthy and difficult process involving numerous ministries and interests, which is expected to generate a great deal of uncertainty. If the expectation indeed is a couple of trillions in NPLs, it deserves careful watching rather than dismissal.

Finally, some investment bank reports suggest that the enormous sum of state assets must be considered along side of the debt. If debt ever becomes a problem, the Chinese government can always sell state assets to repay the debt. Here, I am in complete agreement with my colleagues. It will be a great day when the Chinese government decides to privatize trillions in state assets to raise money to repay local debt. The record of the Chinese government in privatization, however, is spotty at best. Even in the late 1990s, when the fiscal shape of the central government was at its weakest, only small SOEs were privatized, often through murky processes to insiders. 

Since then, both the central and local governments have done their utmost to maintain the dominance of large state-owned corporations through protectionism and subsidies from both the budget and the financial system. Instead of privatizing these firms and allowing them to compete on equal footings with private and foreign firms, they are given every advantage so that they can dominate the domestic and even the global markets. The financial system in particular channels the bulk of its resources to the state sector. Unfortunately, it does not seem privatization is anywhere near on the horizon. Instead, we can expect trillions more being poured into state entities, including local investment companies, in the foreseeable future.

Victor Shih is acknowledged here

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