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The Economist - byline Bejing, Hong Kong, Shanghai.
The quote: "No country can sustainably invest more than it saves ..."
As most of you know, I generally agree with that sentiment, though it is certainly possible for a country to invest more than it saves for some time, so long as it can borrow the needed savings from the rest of the world. But broadly speaking, outsourcing savings in a sustained way is a major risk. Ask Latin America. Or ask the US in ten years.
The problem: the Economist was talking about China, not the US! And China SAVES more than it invests.
Now I agree that China invests inefficiently, as the Economist argues. And it is true that "In the first quarter of 2005, fixed asset investment reached an incredible 54% of GDP, 10% points above the household savings rate." Actually I am not sure about a 44% of GDP household savings rate; it seems a bit high. See the IMF (via Cynic's Delight).
But the argument that "no country can sustainably investment more than it saves" simply does not follow from the fact that Chinese investment exceeds household savings. What matters is national savings - and business and government savings count as well. Lots of investment in China is financed out of retained earnings - i.e. business savings.
Basic balance of payments accounting says that a country that with a current account surplus saves more than in invests. And China certainly had a current account surplus - quite a large out actually - in the first half of the year. About 8% of China's GDP.
Sorry to be pedantic, but it is hard to square that fact with the argument that China doesn't save enough to finance its current level of investment ...
Fixed asset investment is not quite national investment in the formal sense (see the World Bank Quarterly), but in broad terms, if you take investment and add the current account surplus, you have a reasonable estimate for national savings. And with investment close to 50% of China's GDP, savings had to be close to 60% of China's GDP. Sounds crazy -- crazy enough to make me suspicious of the GDP number. But this is just accounting.
Rant over. My assessment of the Economist's article on China's banks was no doubt colored by that one statement - but all in all, I was left with more questions than answers.
Those questions include:
- Will the profits from the 03-04 "lending binge," intended to help the banks grow out of "their bad loan problem" be sufficient to finance the write down of past bad loans? 2004 bank profits were only $11 billion (0.7% of GDP, not a lot for banking system with assets of over 200% of GDP). But those profits may reflect much higher underlying earnings which were used to write off bad loans. So low profits may be a good sign - but I would have liked to see a bit more analysis.
- How has the PBoC financed the disposal of bad loans? Three sources of financing are clear. One, the government has allowed the banks (often state owned) to devote a portion of their ongoing profits to write down bad loans. Two, the PBoC has shifted $60 billion of its reserves to three banks - along with an implicit promise to protect the banks should a revaluation reduce the RMB value of their foreign currency denominated capital. And three, China shifted roughly $170 billion in bad loans from the four state commercial banks were shifted to four asset management companies (AMCs) a few years ago. The banks got a bond from the AMCs in return - a bond that the state will have to pay since the AMC's recovery on the bad loans has been small. However, the PBoC also may be buying some dud loans for cash (it can print RMBs ....). But then what does it do with the dud loans, particularly if it pays more for the loans than they are worth? I am all ears if anyone has more information.
- Is Indonesia the right model for the Chinese banking system? David Marshall of Fitch thinks so. The Indonesia model (post crisis) implies lots of capital (20% plus) and very large interest margins (5% plus) to assure a decent return on equity. That is rather different from the current Chinese model, which has relatively low levels of capital (for an emerging economy) and relatively low interest spreads, once the interest margin created by a cap on deposit interest rates and a floor on lending rates is adjusted to reflect high levels of NPLs.
- Is selling the banking system to foreigners the solution? The Economist says yes, but argues that it won't happen. They are right on "it won't happen." China is not the Czech Republic, Hungary or Bulgaria. China clearly now wants Chinese-owned international companies - and I suspect Chinese-owned international banks. And why sell off control of the big banks when foreign investors are willing to pay so much for minority stakes?
Do not get me wrong, I certainly think foreign investment in Chinese banks can be part of the solution - though I don't think it is a substitute for a larger tax payer financed bailout of the banks.
But I also think those saying foreign ownership is the entire solution should look not just at Eastern Europe but also at Argentina.
Foreign banks dominated the Argentine banking system before its crisis. Yes, there were some Argentine owned banks. But realistically, the Chinese state is going to keep a few banks in any scenario. No foreigner wants the Agricultural Bank of China, or is salivating to provide banking services to China's rural poor. But even taking into account the big state owned Argentina banks and the one privately-owned Argentine bank (Galicia), Argentina's banking system was dominated by foreign banks - mostly Spanish and American banks.
And the Argentines argued this guaranteed the stability of their banking system. They had outsourced banking regulation - and deposit insurance -- to Madrid and New York.
The result? Mixed I would say. The foreign banks took in dollar deposits, and they had to match their books with dollar loans. They were less willing to lend to the government than the remaining Argentine banks (or perhaps less subject to government pressure). Chalk that up in their favor. They did not particularly want to lend to the tradables sector of Argentina's economy either. Too risky. Remember, a strong peso was really hurting the goods producing sector of Argentina, particularly after the devaluation of the Brazilian real. Plus, exports were a small part of Argentina's GDP - so it was hard to match dollar loans to companies with dollar export revenues. So the banks lent heavily to the largely foreign-owned Argentine utilities, utilities that had the deals with the state that allowed them to index their prices to the dollar. The banks had a hedge - they lent in dollars to utilities that could themselves index their prices to the dollar.
At least in theory. In practice, it was pretty clear that when the peg broke, the Argentine government was not going to let the utilities jack up their peso prices to offset the peso's fall against the dollar. That would have hit Argentine consumers hard precisely they were hurting more generally -- all to assure large profits for foreign owed utilities and their bankers. Not good politics.
The underlying currency mismatch was there. And letting foreign banks manage the mismatch did not get rid of it. Once the peg broke someone was gonna take losses. Not surprisingly, the Argentines decided the losses would be born not by Argentine consumers, but by the foreign owned utilities and the foreign owned banks.
My points: foreign banks investing in emerging economies need to be political realists, and foreign banks do not solve all problems. The real problem in Argentina was a dollarized banking system and a small export sector. China's real problems? In my view, low consumption, too much investment (not a problem now, but a source of future problems) and an economy that is now too dependent on exports.
Foreign banks pushing credit cards can help with the first problem, but only if Chinese consumers pick up a few of America's bad habits and do not pay off their balances every month. Foreign banks that lend to consumers not companies may help lower future levels of investment, but that alone won't clear away the legacy of current over-investment (assuming that there is some over-investment). And finanlly, I don't see how foreign ownership of the banks helps reduce China's exposure to the global economic cycle ...
A final footnote: the fact that China has a positive balance on transfers ($12b) and income ($5b -- foreign direct investors in China must not be sending any profits back home; they seem to prefer to keep their profits in RMB ... and all those reserves earn interest) in the first half of the year makes me fairly confident that China 2005 current account surplus will be closer to $150 billion than $100 billion. That is not saying much 2*$67b gets out to $135 billion pretty easily.