October 9, 2011 8:14 pm
Cracks in Beijing’s financial edifice
By James Kynge
The last time – in late 2008 – that economic peril was stalking the US and Europe, China marshalled the might of its state-directed economy and engineered a muscular rebound that led the subsequent global recovery. This time, though, Beijing is feeling a lot less muscular.
The exertion of its last effort has sapped internal resources so thoroughly that the pertinent question today is not whether China can once again guide the global economy away from the rocks but whether Beijing retains decisive control over its own economic levers.
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The central frailty is financial. At no time over the past three decades of “reform and opening” has Beijing’s control over the supply and price of credit in its economy been so tenuous. The reasons for its enfeebled position derive from the state-centric nature of its 2009-10 stimulus. They also help explain why a repeat would be hard to pull off.
Back in early 2009 Beijing encouraged a local government borrowing binge to finance infrastructure spending. Then it tried to keep interest rates as low as possible, partly to reduce the service charges on local government debt, now officially estimated at RMB10,717bn ($1,681bn). But as bank deposit rates languished far below inflation, savers withdrew their money and deposited it with high-yielding shadow financial institutions.
The sustained haemorrhage of state bank deposits has swelled the unregulated shadow banking system to such a size that it now supplies more credit to the economy each month than the formal banks do, according to China Confidential, a research service at the Financial Times. This means that Beijing, which has wielded financial control as a key tool of Communist party power, now finds itself largely at the mercy of an unregulated collection of trust companies, private banks, kerb lenders and loan sharks.
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While the trust companies, the largest and most established segment of the shadow system, are mostly registered businesses with established offices, the multitude of “underground” operators exist in a netherworld of suitcase accounts and unsecured loans. Their colourful advertisements can be found on the back pages of city newspapers, often listing only a single mobile phone number next to alluring names such as “Easy Heaven Investments”, “Profits Quick” and “Treasure Beautiful Gold Credit”.
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Existing beyond the state’s remit, such institutions would be unwilling conscripts to any attempt by Beijing to reflate the economy through muscular intervention. But as long as they exist in their current profusion, the shadow banks also neutralise the regulators’ former capacity to order the big state banks to launch another low-interest credit splurge. This is because the formal financial system no longer orientates itself around the official 6.5 per cent one-year lending rate, choosing instead to chase rates of typically double that level offered by trusts or even the 30-70 per cent annual lending rates characteristic of underground banks.
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Indeed, it is a telling insight into the atrophied condition of the state-regulated financial system that the most profitable activity by state-owned banks in the first half of this year was not lending to businesses but funding trusts and underground banks, bank financial reports show. Still, it is understandable that banks would wish to maximise profits, especially at a time when deposits are draining away.
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In the first 15 days of September, for instance, the “big four” state banks suffered a net loss in deposits of RMB420bn – more than four times their lending in the same period – as savers fled to high-yielding shadow banks.
Finance is not the only area in which Beijing’s ability to launch a counter-cyclical economic stimulus has ebbed. The ability of local governments, if asked again by Beijing, to boost investments is questionable. Their 2009-10 borrowing binge used land as its main form of collateral.
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But now land sales are declining sharply year-on-year in most cities, as property developers are hit by cash flow problems caused by a mixture of dwindling real estate sales and the hefty burden of servicing debts with shadow banks.
The level of distress felt by local governments – and more particularly their roughly 10,000 investment companies nationwide – is clear from the fact they have begun to sell off prized corporate assets at an unprecedented rate. Local units of the State Assets Supervision and Administration Commission sold off RMB3.31bn in corporate assets between January and July this year, up from RMB2.35bn in all of 2010.
All this means that if Beijing wishes to launch another stimulus package, it may find itself unable to engineer a repeat of the swift and resolute response it mustered in 2009. Of course, it still has some weapons in its armoury. It could issue government bonds or launch a bail-out of banks and local government investment companies, possibly using some of its $3,200bn in foreign exchange reserves. But such methods would be unlikely to generate the type of immediate growth seen in 2009. They would also fail to address the reality that while a high-yielding shadow finance system exists, money will gravitate from state-run coffers into private hands – leaving fewer funds for a state-centric stimulus.
These are diminished days for China’s once-vaunted planners. Free market advocates are stepping up their censure. Zhang Weiying, a professor at Peking University, has called the National Development and Reform Commission – an agency dedicated to economic control – “a bunch of smart people doing something really stupid”. For Chinese, striking the balance between state intervention and a destiny decided by free market forces can be distinctly difficult.
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The writer is principal of ftchinaconfidential.com
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Copyright The Financial Times Limited 2011.
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