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To: Humblefrank who wrote (27227)	12/30/1997 8:22:00 AM
From: CPAMarty	Respond to of 50808

For a good discussion on whether there is a banking crisis in China and whether their currency will be devalued, follow this link interactive.wsj.com type china bank and click on search subscription required if you don't have a subscription, the go to www.wsj.com and sign up for the free 2 wek subscription here is a sample China Can Dodge A Financial Crisis By CHI LO China today has many things in common with Thailand two years ago. At that time, there was talk in Bangkok about austerity and soft landing amid rising debt, falling inflation and worsening banking woes. This weekend China's Central Bank governor again acknowledged the growing problem of bad loans by Chinese banks. But despite the fact that some data show that China's financial woes could be worse than those in Korea and other regional economies, China can still avert a full-blown financial crisis. China's bad loans are concentrated in two areas: state- owned enterprises and the property sector. About 70% of the 7.2 trillion renminbi ($870 billion) total credit in the Chinese banking system is lent through the four major state banks. SOEs receive 90% (or $548 billion) of all state-bank lending. Money-losing SOEs account for about 40% of the loans made to the state sector. This is equal to $219 billion, or 25% of total loans. If these firms were liquidated, central bank officials estimate that banks might be able to recoup no more than 10% of their loans. Hence, SOEs' bad loans account for over 15% of total loans in the banking system. Chinese banks also massively financed the property bubble of the early 1990s, with real-estate loans accounting for 20-25% of total domestic credit. Property prices are now off by over 50% in some areas, and banks have recovered less than 15% of the property loans made in the bubble days. Bad loans from the SOEs and the property sector amount to at least 30% of total loans. The banking system's fragility is aggravated by a low capital adequacy ratio, which is estimated at less than 4% of total assets. This is far below the 8% comfort ratio recommended by the Bank for International Settlements. The enormity of the bad loan problem would lead one to expect a collapse in the banking sector and a currency crisis. But China has stood out like an island in the storm of the recent regional financial crisis, with the yuan experiencing persistent upward pressure. In fact, China may be able to muddle through the regional turmoil in the near term due to a combination of several factors. First, the government underwrites the banking system by providing an implicit guarantee to all state banks. This limits the risk of a collapse in public confidence. Second, the lack of capital account convertibility in China helps to shield the financial system and the yuan from foreign attacks. Third, there are no signs of significant internal macroeconomic instability, such as rising inflation, that would elevate the banking problems to a full-blown crisis. Foreign confidence is boosted by China's large foreign- exchange reserves and healthy debt indicators. The $118.6 billion foreign debt stock is only 15% of GDP, far below the ratios of other developing countries. Short-term debts account for only 12% of total foreign borrowing, well below Thailand's over-50% ratio. The total foreign debt stock amounts to about 77% of total exports, compared with the regional average of 99% and the average of 146% for low- and middle-income countries. All this suggests that the yuan does not have the rollover risk that the currencies of many debtor countries have suffered. During the renminbi crises in the 1980s, surging inflation and a deteriorating external account balance prompted domestic players to dump the yuan and hoard U.S. dollars and gold. This time, inflation has fallen sharply and is likely to remain low in the medium term due to the deflationary pressures unleashed by SOE and banking reforms. Strong capital inflows may not cause a market bubble that will destabilize the economy, thanks to the abundant supply in the property and the goods markets. Both domestic fixed-asset investment and private consumption will be moderated by corporate restructuring, rising prudence in bank lending, increasing competition, existing overcapacity and the transfer of welfare burdens from state enterprises to households. Thus, the dramatic economic swings seen in previous cycles are now unlikely. High savings and moderating domestic demand will prevent the development of a large and chronic current account deficit. But under the weight of a regional financial implosion and with stronger economies such as Hong Kong, Singapore and Taiwan also falling victim to the regional financial crisis, will China be spared for long? Right now the government is walking a tight rope between inflation and deflation in dealing with the sick banks. If Beijing runs out of noninflationary means, such as mobilizing existing public savings, to write off bad debts, it might be forced to bail out the system by printing money. This will reignite runaway inflation and trigger financial instability. Alternatively, serious effort to cut bad debts would involve closure of nonviable SOEs and liquidation of their assets. These are deflationary measures. Either scenario could trigger a financial crisis. Development of local capital markets will also become a threat to the banking sector. Under the old financial monopoly system, domestic savers had no option but to put all their savings in the state banks. But now household savings are leaking to the domestic stock and bond markets in search for higher returns. The loss of deposits has created a funding squeeze on the state banks who are still required to fulfill their policy loan obligations. This trend could force the banking sector to contract. Hence, the long-term stability of China's financial system and currency depends very much on balancing the pace of financial liberalization and that of banking reform. On one hand, the government is trying to improve financial supervision and commercialize the banking system to reduce credit risk. On the other hand, it will continue to go slowly in withdrawing its protection from the state banks. A sudden retreat of government support could crush the banks and cause massive financial dislocation. This means that the yuan's full convertibility, development of domestic capital markets and the opening up of the banking sector to foreign participation will only proceed slowly. More importantly, a failure by the government to balance the long-term benefits of liberalization with the medium-term cost of containing the financial woes could aggravate the existing problems. Prudent economic and financial policies are needed to prevent China from becoming another Thailand in a few years. ------------------------------------------------------------------------ Mr. Lo is an investment bank economist based in Singapore