Chapter 1 – Looking Back at the Policy of Reform
- Initiatives of the Jiang/Zhu program: SOD and bank reform; stock markets; international IPOs; accession to the WTO
- FDI created an entirely new economy, the non-state sector; money raised on capital markets has gone to creating and strengthening companies inside the system
- Zhu/Zhou’s framework to pursue comprehensive reform of the financial markets since 1998: creation of bad banks; strengthening of good banks; a national social security fund; bond markets with a broader investor base; stock markets open to meaningful foreign participation; a start to currency reform. The drift ended in 2005
- The character of China’s style of capitalism is marked deeply by how by how the political elite have coalesced around certain institutions, corporations and economic sectors
Chapter 2 – China’s Fortress Banking System
- In the past decade, equity as a percentage of total capital raised has been in the single digits as compared with loans and debt
- A basic flaw in institutional design of the banks in early days: they were organized in line with the government administrative system
- The collapse of GITIC led to the closure of hundreds of trust companies across the country, and it initiated a serious effort to centralize control of the Big 4 banks in Beijing’s hands
- Improved NPL ratios over the past 10 years suggest a dramatic improvement in the willingness of SOE clients to meet their loan commitments, and the selection of investment projects that actually generate real cash flow
- The growth model of China banks requires them to come to the capital markets every few years
Chapter 3 – The Fragile Fortress
- With the “perpetual put” option available, bank management need care little about loan valuations, credit and risk controls. They can simply outsource lending mistakes to the AMCs, and the AMCs will be almost automatically funded by the PBOC
- “Great Leap Forward Lending” over 2009-11
- China’s massive foreign exchange reserves give a false appearance of wealth because Beijing’s ability to use its reserves internationally is limited
- In China, political imperatives make significant internationalization of the banks unlikely. The Big 4 banks form the very core of the Party’s political power
- If the Asian Financial Crisis in 1997 caused one set of Chinese leaders to see the need for true transformational reform of the financial system, the global crisis of 2008 has had the opposite effect on the current generation of leadership
Chapter 4 – China’s Capitive Bond Market
- What makes China’s bond markets primitive is their lack of risk and the market’s ability to measure and price different levels of it
- If China’s fixed income market is to develop, there must be an increase in bond trading. Trading remains very limited compared to the total stock of bonds
- The difficulties with over-reliance on the retail market: small issue sizes, high cost, shorter maturities, and the fact that there was no secondary market prevented the development of benchmark interest rates and meaningful yield curves
- China’s banks are fully exposed to both interest rate-related and credit-induced write-downs in the value of their fixed income securities portfolios
Chapter 5 – The Struggle over China’s Bond Markets
- With its rapid growth in early 2000s, CDB became the darling of those supporting a return to both a more state-planned economy domestically and a natural resource-based foreign policy internationally
- As a policy bank, the CDB funds itself through debt issuance in the markets, and China’s bond markets are fully reliant on the commercial banks and the PBOC for support
- In 2009 and 2010, conditions were perfect for local governments to do all in their power to raise funds, with little possibility of their being blamed for financial excess
- Local governments directly and through their agencies have borrowed the equivalent of 27 percent of the country’s GDP largely in just the two years of 2009 and 2010
- CIC is at best only a part-time sovereign wealth fund. Its most important role is to serve as the linchpin of China’s financial system
- Viewed from the outside, bank profits reassure retail depositors that their banks are sound and their deposits safe. International investors support bank shares since they are seen as proxies of a bank-driven GDP number. The banks use household deposits and new equity capital to fund new loans to drive GDP and to support the conceit that is China’s debt capital market, which sustains the appearance of overall convergence toward a Western-style market system
Chapter 6 – Western Finance, SOE Reform, and China’s Stock Markets
- The IPO of China Mobile demonstrated to Beijing how it could overcome the regional fragmentation of its industrial sector and, with huge amounts of cash raised internationally, create powerful companies with national markets
- This was not the IPO of an existing company with a proven management team in place with a strategic plan to expand operations. It would be much closer to the truth to say that this was an IPO of the Ministry of Post and Telecommunications itself
Chapter 7 – The National Team and China’s Government
- The architecture of the entire SASAC arrangement bears the hallmarks of the Soviet-style ministry system abolished by Zhu in 1998. In that system, SOEs reported directly to their respective ministries and were administratively managed by them
- IPO prices are set artificially low while demand is set high. This approach eliminates underwriting risk but also eliminates the need for investors to understand companies or the industries in which they operate to arrive at a judgment as to valuation
- The Chinese market simply doesn’t have natural stock investors; everybody is a speculator. The high trading volume in the market are its most misleading characteristic since they give outside observers the impression that it is a proper market. In fact, in China, all that the volume represents is excess liquidity
Chapter 8 – The Forbidden City
- In China, the different regulators have over the past few years created so-called independent kingdoms; effective coordination across these fiefdoms had been difficult in the apparent absence of strong political leadership
- The debt buildup is not just the result of a weak hand at the financial tiller. It may also be accurate to say that these increases are the result of the government deliberately leveraging China’s domestic balance sheet to achieve its policy goal of high GDP growth
- The offshore RMB market bears no relation to the broader onshore market or its economic conditions. Bonds are issued more cheaply offshore than they would be in China because of the huge demand for even the smallest yield enhancement on the growing pool of RMB deposits
- Given China’s geographical size and huge population, it is unlikely that its economy will grind to a halt in the way that Japan’s did after its magnificent run in the 1980s. China knows well that when Japan freed up the yen to appreciate and deregulated its financial markets, it was entering the last stage of its wild asset bubble
- What is the advantage of creating such a complex and difficult-to-manage financial system? 1) an important catalyst for corporate transformation; 2) a mechanism allowing money to flow among various groups; 3) a familiar surface for local business and politics that attracts foreign support and admiration
- The Chinese commonly explain the complexity of their system saying: “Our economy is different from the West, so our markets work differently from those in the West.” It turns out that this is a simple statement of the truth
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