Capital Markets Transparency
and Security: The Nexus Between U.S.-China Security
Relations and America's Capital Markets
CHINA'S CAPITAL REQUIREMENTS
As Business Week noted in March of this year, "The Communist regime's
legitimacy rests largely on its ability to keep the dragon economy roaring."8 While
Chinese official reporting highlights the country's impressive foreign currency
reserves (roughly $165 billion) and somewhat inflated economic growth, Beijing
likely understands that a bullish medium-term outlook may not be warranted.9 Three
burgeoning financial concerns that will likely claim significant state resources
in the coming years are: 1) a prospective banking crisis that could undermine
projected development and potentially disrupt social stability; 2) looming
energy shortfalls and infrastructure demands; and 3) an underfunded pension
program.
Banking System
Depending on the source of statistics, the percentage of non-performing loans
in China's "big four" banks (i.e., Bank of China, Industrial and
Commercial Bank of China, Construction Bank of China and Agriculture Bank of
China) is between 25 and 40 percent. Merrill Lynch, for example, has offered
that 40 percent of all bank debt in China is bad -- only 15 percent of which
is recoverable.10 According to the Financial
Times, the bad loans equal a troubling 25 percent of the banks' assets.11
Nicholas Lardy of Brookings Institution, considered to be one of this country's
foremost experts on China's economy, has offered that three of these four banks
are technically insolvent by international standards.12 In
total, the country's non-performing debt may be anywhere from $450 million
to over $1 trillion when the extensive rural cooperative banking network is
factored. It has been estimated that any attempt by the government to recapitalize
its "big four" banks alone could raise China's debt-to-GDP ratio
to an alarming 48 percent by 2002.13
Perhaps one of the best sources for examining China's banking system is that
country's National Bureau of Risks. According to that government agency, "The
risk of accumulated non-performing assets has become a major factor affecting
the stable operation of the banking system."14 The
Bureau goes on to warn that risks attendant to the stability of China's banks
have increased some 47 percent since 1991.15 It
also cited growing non-performing debts as a central factor in increasing risk.
The South China Morning Post further validated stability concerns in November
of 2000, paraphrasing China's State Statistics Administration: "The escalating
non-performing loans by the big four state-owned commercial banks have dramatically
cut their capital-adequacy ratio to 5.51 percent in 1999, well below the international
accepted critical level of 8 percent."16
To date, attempts by Beijing to address its potential banking crisis have been
primarily cosmetic. Over the past few years, China has launched four asset
firms to manage roughly $1.4 trillion Yuan in bad debt accumulated by the "big
four" banks.17 Nevertheless, the structural
flaws underlying the problem remain largely intact. For example, despite attempts
to correct inefficiencies and production concerns in China's roughly 300,000
state-owned enterprises (SOE's), these firms continue to claim some two-thirds
of the available capital of China's "big four" banks while only accounting
for roughly one-third of national output.18 Due
to the prospective social backlash that would likely accompany the restructuring,
or closing down, of SOE's (i.e., massive lay-offs with inadequate severance
packages, etc.), the Chinese government has chosen to allocate billions of
dollars to recapitalize its primary banks, thereby compounding the non-performing
debt problem. For example, rather than using these capital infusions to stabilize
existing bad debt portfolios and lend to productive, revenue-generating firms,
the banks divert these resources to prop-up underperforming SOE's.19 Baring
systemic change, China will likely continue to "throw good money after
bad."
The PRC's banking crisis, however, is not limited to its "big four" banks.
According to Stratfor Global Intelligence Update, the most daunting short-term
banking concern in China is the insolvency of the country's roughly 40,000
rural credit cooperatives.20 With over 800
million rural inhabitants, these banks represent the principal means of funneling
capital to agricultural and other development projects in the countryside.
These cooperatives are also the primary savings institutions for rural Chinese.
The People's Bank of China reported last year that these banks have a combined
negative net worth, due primarily to bad loans.21 Stratfor
put a fine point on the problem: ì[I]t's not clear where the money is
going, who has been receiving the loans or how prudent the cooperatives have
been in extending them."22
Over the past few years, China has diverted some $7.6 billion to the cooperative
banks in an effort to staunch this burgeoning financial crisis.23 Rather
than using the funds to close insolvent banks, guarantee depositor accounts
and train employees to be more proficient lending officers, these capital infusions
have primarily gone to finance new development projects.24 In
addition to the long-term, troubling financial impact of continuing this indiscriminate
lending pattern, a prolonged economic downturn -- or short-term loss of depositor
confidence -- in China could precipitate a run on cooperatives akin to the
type witnessed in Beihai in 1997. Again, according to Stratfor, "a run
on credit cooperatives in Beihai eventually led to the collapse of all fourteen
cooperatives in the city."25
While the long-term economic repercussions of China's non-performing debt problem
are unclear, it is difficult to foresee the resolution of this banking crisis
barring large-scale capital injections. In addition to the estimated $450-600
billion required to restructure or write-off non-performing debt, China must
also dedicate billions to capitalize the "big four" as well as local
banks and cooperatives. These estimates do not factor in the cost of structural
adjustments and training programs required to ensure the long-term viability
of the PRC's banks and other financial institutions.
Energy Shortfalls and Pension Requirements
A second major claimant on capital resources in the coming years will be China's
intensifying energy import requirements. Although roughly 20 percent of the
world's population resides in the PRC, the country only possesses some two
and one-half percent of known oil reserves.26 In
1993, China became a net importer of oil. Last year, the PRC imported some
1.3 million barrels of oil per day.27 The
International Energy Agency estimates that figure will climb as high as eight
million barrels of oil per day by 2020.28 Although
Beijing recognizes its impending energy shortages and has taken steps to increase
domestic production and develop offshore and overseas supplies, the International
Energy Agency has also predicted that "China's long-term oil imports will
outstrip by three times the country's own forecasts."29
In order to meet future demand, China has dedicated enormous financial resources
to domestic and foreign energy projects. Over the next five years, it plans
to invest some $120 billion Yuan (roughly $14 billion) to explore and develop
several offshore oil and gas fields.30 Billions
more will be dedicated to the development of reserves in Western China and
a projected 16,000 kilometers of oil and gas pipelines to be laid by 2020.31 Moreover,
this past year, reports indicated that the country has also taken steps to
create a sizable reserve.32 Stratfor Global
Intelligence Reports has estimated the cost of a ninety-day reserve for China
at some $10 billion.33
Beijing's "prize" energy strategy, however, may well be the completion
of six major foreign oil and gas projects over the next decade. Indeed, "source
diversification" is apparently the central pillar of the government's
strategy to ensure access to these energy requirements. According to a 1999
profile of China's energy industry by Asian Pulse, "China plans to develop
50 million tons of oil and 50 billion cubic meters of natural gas from abroad
by 2010 by giving priority to developing oil markets in the Middle East, Africa,
Russia, South America and Central Asia."34
In fact, China's strategy for developing international energy sources may be
more expansive than indicated in many Western reports. Over the past several
years, China's flagship energy firm, China National Petroleum Company (CNPC),
and the country's second largest oil concern, China Petroleum and Chemical
Company (Sinopec), have assumed prominent positions in the international energy
market. As the National Security Forum recently reported,
"To compensate for heavy reliance on the Gulf, large Asian energy consumers
are moving aggressively to build wider energy networks. China is building energy
relationships worldwide, in Central Asia, Russia, Africa, the Middle East, and
even in Latin America. In less than four years, Beijing has established an energy
presence in twenty different countries. Since 1997, China's state-owned energy
companies have signed 47 contracts with 44 overseas oil companies and 130 exploration
contracts with 70 foreign oil companies in eighteen different countries."35
Not surprisingly, Chinese energy companies -- which often cannot compete with
Western firms -- have focused the bulk of their attention on countries currently
under U.S. or international sanction regimes. CNPC, for example, currently
has ties to Iraq, Sudan and Venezuela.36 imilarly,
Sinopec inked contracts with Iran in January 2001 reportedly valued in excess
of $160 million and as recently as last summer was active in Sudan.37
Irrespective of China's internal strategy for meeting energy requirements in
the 21st century, the bottom line remains clear: China will earmark tens of
billions of dollars to finance adequate energy supplies in the coming decade.
Another pressing claimant on capital facing the government will likely be the
country's expanding, near-term pension requirements. By 2003, China will have
some 90 million people over the age of 65.38 As
was recently noted by China Online's coverage of a detailed Merrill Lynch report
on the PRC economy,
"As alarming as [bad debt concerns] may sound, the government's social security
obligations are more onerous still. Unemployment compensation, medical coverage
and pensions -- benefits that have historically been supplied by SOE's -- are
currently "grossly underfunded"...to the tune of US $600 billion, or
60 percent of GDP."39
Additional Economic Indicators
A review of China's current macroeconomic outlook indicates that the PRC will
have difficulty generating internally the revenues required to restructure
the banking and state sectors, finance energy imports and capitalize its pension
system.
While capital requirements mount, state borrowing has intensified. For example,
the ratio of treasury bonds issued by China nearly doubled between 1991 and
1999.40 State debt, which stood at some 5
percent of GDP in 1993, rose sharply to an estimated 20 percent of GDP in 1998.41 While
such a debt-to-GDP ratio would be of little concern in Western economies due
to strong revenue streams, China's consolidated fiscal revenues were only 12.4
percent of GDP in 1998.42 According to the
Financial Times, China's budget deficit is likewise expanding and reached $13
billion (or roughly 2 percent of GDP) in 2000.43 This
figure will likely rise in the coming years as Beijing seeks to jump-start
its economy and maintain at least 7 percent growth figures through fiscal stimulus
packages and infrastructure development projects.
The business climate in China is also worrisome to some analysts. According
to the recent PriceWaterhouseCoopers "Opacity Index." China is the
world's most difficult place to do business due to the "lack of clear,
accurate, formal and widely accepted practices in the broad areas where business,
finance and government meet."44 This
might explain recent drop-offs in foreign direct investment in China -- which
The Economist described as the best single indicator of business confidence.45 Moreover,
capital flight continues to pose a serious problem for Beijing and the country's
production capacity lags well behind that of the West.46
Finally, and most troubling from the standpoint of the Chinese government,
economic growth continues to be driven by exports due largely to structural
and other economic inefficiencies. Put simply, any global economic downturn
would impede China's capacity to export. Given the PRC's overall economic fragility
and substantial capital requirements, the net effect of slower growth could
prove debilitating.
Conclusion
The true condition of the Chinese economy is a matter of animated debate among
policy analysts and economists. The objective of this review is a narrow one:
to highlight China's pressing -- and large-scale -- capital requirements. There
is likewise abundant evidence to suggest that China's domestic economy will
not generate sufficient revenue and other capital flows in the coming years
to meet the government's extensive demands. Indeed, combined with fiscal spending
obligations, some have estimated China's overall, near-term capital requirements
to be over 100 percent of its GDP.47
While China may not be "going broke," as characterized in one recent
report on China's macroeconomic outlook, barring massive, near-term infusions
of foreign capital, the chances of economic dislocation for the Chinese government
expand considerably.48 The impact of China's
three principal financial concerns (e.g., non-performing debt and energy- and
pension-related capital claimants) has not been lost on the government. Beijing
recognizes these and other requirements and has made the development of alternative
sources of capital a high priority.
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