Sunday 2013-11-17

Red Capitalism by Carl Walter and Fraser Howie

The relationship between government and finance has been "mixed" since Croesus started minting coins and the Medici started making loans using double-entry accounting. The authors are continually "shocked" to find that China's government benefits directly from its involvement in the financial sector, which means we have to read this book more as fictitious allegory in order to gain understanding.

Then, there are the audited financial statements of China’s banks, all available online since the respective listings of each bank. Reading these statements has been highly educational. We strongly encourage others, including China’s regulators, to do the same.

Once embroiled in finance and international trade, the int'l econ trilemma means that governments are always bouncing between the advantages and disadvantages of int'l finance. Which means this all boils down to the following age-old question:

As the head of an SOE once wisely commented, “It doesn’t matter who owns the money, it only matters who gets to use it.”

And in that, Walter and Howie seem to have done good work in introducing us to all the names of the possible who.

GITIC’s bankruptcy, still the first and only formal bankruptcy of a major financial entity in China, threw unwanted light on the Party’s financial arrangements. It called into question the central government’s commitment, if not its capacity, to stand behind its most important financial institutions. GITIC in the 1990s was, after CITIC, the nation’s largest and most prominent trust company and acted as the international borrowing “window” for Guangdong, its richest province. In 1993, prior to issuing its first (and only) US$150 million bond in the US, GITIC received the same investment-grade rating from Moody’s and Standard & Poor’s as the MOF. Its senior managers were well known among foreign bankers for their active participation in cross-border foreign-currency and derivatives markets. One of its subsidiaries was publicly listed in Hong Kong and its chairman had been the subject of a BusinessWeek cover story.2 All foreign bankers were “close” friends with Chairman Huang and all had drunk his premium wines in the club at the top of the company’s 60-storey tower in Guangzhou. GITIC was a National Champion before there were National Champions.
The banking system has thousands of entities if the 12 second-tier banks, the urban and rural banks, Postal Savings Bank, and credit cooperatives, are included. But the heart of the system includes just four: Bank of China (BOC), China Construction Bank (CCB), Agricultural Bank of China (ABC) and, the biggest of them all, Industrial and Commercial Bank of China (ICBC). In 2009, state-controlled commercial banks held over US$11 trillion in financial assets, of which the Big 4 banks alone accounted for over 70 percent (see Table 2.1). These four banks controlled 43 percent of China’s total financial assets.
In China, the banks are the financial system; nearly all financial risk is concentrated on their balance sheets. China’s heroic savers underwrite this risk; they are the only significant source of capital “inside the system” of the Party-controlled domestic economy. This is the weakest point in China’s economic and political arrangement, and the country’s leaders, in a general way, understand this. This is why over the past 30 years of economic experimentation, they have done everything possible to protect the banks from serious competition and from even the whiff of failure. In spite of the WTO, foreign banks consistently constitute less than two percent of total domestic financial assets: they are simply not important. Beyond the pressures of competition, the Party treats its banks as basic utilities that provide unlimited capital to the cherished state-owned enterprises. With all aspects of banking under the Party’s control, risk is thought to be manageable.
Only the Emperor in his palaces atop the walls could see into the courtyards both large and small; those below were constrained to act within their allotted space. Cut off by walls from other courtyards and, indeed, the rest of the Palace, within their own space people were free to pursue the activities assigned to them. Only the Emperor had the authority to intervene and only he could understand the larger design of their work. The workings of the Forbidden City in Imperial times serve as a metaphor for China’s government and political practice today.
The experience of the past 30 years shows that China’s banks and their business model is extremely capital-intensive. The banks boomed and went bust with regularity at the end of the 1970s, 1980s and 1990s. Now another decade has gone by and the banks have run out of capital again. Even though they appear healthy and have each announced record profits and low problem-loan ratios for 2009, the Tier 1 capital ratios of the Big 3 are rapidly approaching nine percent, down from a strong 11 percent just after their IPOs in 2005 and 2006. Of course, the lending spree of 2009 was the proximate cause. As an analyst at a prominent international bank commented: “The growth model of China banks requires them to come to the capital markets every few years. There’s no way out and this will be a long-term overhang on the market.” But it is not just the lending of 2009 or even their business model that drives their unending thirst for capital; it is also their dividend policies. The data in Figure 2.7 show actual cash dividends paid out by the Big 3 banks over the period 2004–2008, during which each was incorporated and then listed in Hong Kong and Shanghai. The figure also shows the funds raised by these banks from domestic and international equity investors in their IPOs. The money paid out in dividends, equivalent to US$42 billion, matches exactly the money raised in the markets. What does this mean? It means international and domestic investors put cash into the listed Chinese banks simply to pre-fund the dividends paid out by the banks largely to the MOF and Central SAFE Investment. These dividends represented a transfer of real third-party cash from the banks directly to the state’s coffers. Why wouldn’t international investors keep the cash in the first place?
In its 2009 budget report to the National People’s Congress (NPC), the MOF confirmed that, overall, local governments ran major fiscal deficits. The report stated that total local revenues amounted to RMB5.9 trillion (US$865 billion), of which RMB2.89 trillion (US$423 billion) derived from tax-transfer payments from the central government. Set against this, local-government expenditures were RMB6.13 trillion (US$900 billion). The life of a provincial governor or city mayor is dominated by a scramble to raise capital in support of local development and new jobs.
the government could have simply incorporated each provincial telecom authority (PTA) and sought to do an IPO for each...
the creation of this structure made possible the raising of further massive amounts of capital simply by injecting new PTAs (or any other “asset”). The valuation of such assets was purely a matter of China’s negotiating skills, flexible valuation methodologies employed by the investment banks and demand in the international capital market. In the case of the acquisition in 2000, foreign investors paid a premium of 40–101 times the projected future value of China Mobile Hong Kong’s earnings and cash flow.