How to Survive China’s Looming Banking Crisis
There has been much talk recently of a potential crisis in China’s banking system, and several financial ratings agencies and analysts have suggested all is not well. However, the Chinese system is so opaque that it remains difficult to get a clear picture. Much of the talk and debate remains theoretical and hard to prove.
Even the slowdown in Chinese manufacturing and inbound FDI has largely been passed off as a result of the lingering effects of the global economic situation. Yet Shenzhen, a benchmark city in China and the central hub for much IT and hi-tech manufacturing, is experiencing its slowest growth rates since 1979.
This isn’t about any global slowdown. This is about high wages and infrastructure that is expensive to maintain. Paradoxically, the global GDP rate was above 2% last year at a time when GDP growth in China was slowing.
Higher costs are now coupled with a realization among many analysts that all may not be sustainable in China’s 20-year manufacturing boom. Their sentiments are beginning to have an impact.
This is not the first time that China has gone through such a crisis. Looking back may provide some clues as to the likely behavior should times get tough in China, as some people are suggesting.
Lessons from the past
We can go back in time relatively recently – although perhaps beyond the time of many foreign invested businesses – when China last defaulted on loans and had banking problems. For that, we need to turn the clock back to 1999 and 2000 to see what occurred then.
Thirteen years ago, China had been encouraging foreign investment in a number of government-backed and owned financial institutions, including what was, at the time, one of the country’s largest state-owned enterprises – the Guangdong International Trust & Investment Corporation (GITIC).
This SOE took in significant amounts of foreign capital in the form of bonds. It was to invest the proceeds on many of Guangdong Province’s infrastructure development plans, which made sense as the provincial growth rates were sky high and it was becoming China’s largest manufacturing hub.
But amidst a plethora of bad investments, multiple white elephants – Zhuhai’s ‘international’ airport among them) – and corruption, GITIC went bankrupt with liabilities of US$4.7 billion. It remains China’s largest corporate bankruptcy to date.
China was also experiencing credit problems at the time, and difficulties with its foreign currency reserves. It was not uncommon for fully legitimate profit transfers by foreign investors from RMB earnings into foreign currency to be delayed by the State Administration for Foreign Exchange (SAFE) for periods often in excess of six months.
Against that backdrop, the GITIC bankruptcy was too much for the Chinese government to take on – so they reneged on the SOE’s foreign debt. Chinese creditors in GITIC came first, and foreign holders of bonds went to the back of the queue.
The Chinese government hid behind a technicality. – a ruling that required all foreign investors to have lodged their investments with SAFE. There was much debate about what this actually meant at the time, and few, if any, seemed to have complied with the directive.
The general feeling was that China was not acting honorably, although admittedly, the majority of foreign investors in the form of financial institutions had failed to look closely enough at China’s bankruptcy laws and the problems within that.
Faced with large losses, international bankers began readjusting their financial lending policies. China found international banking credit lines drying up. Meanwhile, we at Dezan Shira & Associates found ourselves advising numerous clients who could not repay their original investment loans to head offices as expected because SAFE had run out of forex.
For all, with no exceptions, the Chinese RMB profits just sat in China. We advised on getting tax breaks and taking advantage of re-investment incentives for the China-generated profits that, quite patently, were not going to be leaving China any time soon.
But another deadline was approaching – China’s accession to the World Trade Organisation (WTO). That soon became a larger priority than worrying about liabilities in Chinese SOEs, and the incident, after a lot of moaning and groaning from the affected international lenders, died down in the euphoria of China becoming part of the global trade body.
And that, for the past 13 years, is where things have pretty much been left in the eyes of the average foreign investor.
To be fair, there have in fact been changes to China’s bankruptcy laws since the GITIC scandal. The China Enterprise Bankruptcy Law revised in 2007 (click here for a useful summary by Weil Gotschal & Manges) was designed to cater for most business liquidations and bankruptcies that foreign investors may face in China.
However it is yet to be significantly tested; the recent Suntech bankruptcy being the first major occasion in which its merits or otherwise will be examined.
Of perhaps greater concern is the fact that no effective bankruptcy mechanism still exists in China for dealing with its financial services and banking industries – the very institutions that are facing enormous stresses at this time. Such measures are only at the provisional drafting stage.
So what can be learned from the GITIC incident in light of contemporary concerns about China’s banking health? I’d suggest the following, should things start to become wobbly:
Now may be a good time to look at repatriating excess profits that are not actually needed in the country. Getting money into China will never be a problem. Getting money out could be.
Check if your company has any exposure to China’s wealth-management vehicles, many of which actually comprise distressed banking debt. Domestic staff have been targeted to invest foreign company money into such instruments, which does not require foreign signatories of foreign invested enterprises to invest in them. We have found cases where Chinese accountants have taken the initiative without the foreign principals’ knowledge.
Be prepared for situations where Chinese banks call in loans or even property mortgages as they face a credit squeeze or problems with liquidity. Foreign MNC investors with credit lines are more vulnerable than Chinese businesses or individuals, due to the political nuances. It may be prudent to assess the impact of any loans or credit lines being withdrawn and to prepare head offices for making alternative financing arrangements.
As I mentioned earlier, it is hard to know how things actually stand in China. But in over 20 years of advising clients throughout Asia, I have found that one thing always rings true – in times of uncertainty, financial prudence is the best route. I would advise foreign investors in China to be taking steps to lessen risk until the situation becomes clearer.
But all is not doom and gloom. For well-managed companies, later opportunities always present themselves after any downturn in China. In 2000, we began assisting clients on the first of what proved to be many acquisitions over the years involving bankrupt stock and assets. Many MNCs and entrepreneurs positioned themselves to take advantage of the carcasses left over from lesser well-run businesses.
Even Chinese bankruptcies can have their upside for foreign investors – the trick is to ensure that during such times, your business remains secure and watertight.
About the Author
Chris Devonshire-Ellis is the founding partner and principal of Dezan Shira & Associates, a specialist foreign direct investment practice that provides advisory services to multinationals investing in emerging Asia. This article was first published in China Briefing and was reedited for clarity and conciseness. For further details or to contact the firm, please visit www.dezshira.com.
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