Twofish's Blog

August 27, 2007

Comments on Revaluation and NPL’s

Filed under: china, finance — twofish @ 3:17 am

My disagreement with most international economists is that I think they vastly underestimate the shock to the system that a sudden shift in currency value will cause, and the risks in a one time revaluation outweigh the benefits. I have no objections to a gradual shift of 10-15% over two years.

As far as NPL’s, I think most commentators overestimate the dangers of NPL’s to the banking system. Most loans by the big four banks are as working capital to the large state-owned enterprises. These are flush with cash, and even though there *will* be a change in the business cycle, the SOE’s should have enough cash reserve in the good times to insure that they won’t default when times turn lean. The danger in real estate and bad loans are in the joint stock commercial banks, but those are mainly small enough so that if one fails, then it won’t wreck the entire system.

The original NPL problem in the big banks was *not* due to bad risk management, but rather to the fact that they were ordered to make social welfare payments to the SOE’s. That problem has been fixed.

This is not to say that I’m not completely worried about NPL’s in the big banks. It means that I think that there are other things have me a lot more worried. The big one is provisioning of rural credit to create economic growth in the rural areas. The rural credit cooperatives have bad loans that are much worse than anything the big banks have. The other thing that worries me is how the bubble in the stock market will get deflated. I’m worried that there are linkages between the stock market and the rest of the financial system that aren’t immediately obvious.

On the other hand, one thing that makes me less worried is that it seems that most of the investment in China comes from internal revenues of SOE’s. This may be why it seems that the central bank has limited control of the financial system because most Chinese companies are spending their money rather than the banks money. This may be a good thing in that it means that when the shock comes, you’ll see a lot of empty office buildings, but you don’t end up with much bad debt.

I think the real solution to the problem of excess liquidity lies in getting the government to get SOE’s to issue dividends to the government to reduce their cash reserves. By the way, this all makes wholesale privatization of SOE’s a bad idea, IMHO, since whatever increases in efficency are outweighed by the government totally losing control over macroeconomic policy.

Finally, there is the worry about the thing that you don’t know what to worry about. It’s likely that the next Chinese financial crisis will come from something that no one has thought of yet, because things that people think of, tend to get fixed. You can’t predict everything, and you shouldn’t try. What is possible is to increase “robustness” into the system.

I do agree that inverted balance sheets are very bad things, but I think the key disagreement involves to what extent and where the balance sheets are inverted, and I think that the amount of balance sheet inversion in the big banks or the SOE’s isn’t that huge. I’m a lot more worried about the joint-stock commercial banks. I’m alarmed at anything that is connected with the stock markets.


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