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22 January 1999

An eldorado of two billion armpits

Bankrupt companies, insolvent banks, astronomical debts: China is in trouble and the west had better

By Jonathan Mirsky

A crisis in China would put Brazil in the shade. Foreign China watchers uncorrupted by financial interest have for years doubted or denied that China’s economic power would dominate the 21st century. Now perhaps the near-worship of Premier Zhu Rongji as Beijing’s economic “guru” by Tony Blair and Bill Clinton will become muted. As the recentralisation of the Chinese economy accelerates we may hear less about “opening up” and “market forces”. And the value will diminish of those British and American ex-prime ministers, secretaries of state and ambassadors to China, paid for making introductions in Beijing and Shanghai; these will now be seen as no more reliable than dating agencies.

What has happened is this. Guangdong International Trust and Investment Corp (GITIC), a government-owned company which collapsed in October, appeared last week to owe more than $4 billion, twice the earlier estimate. Foreign investors have already been warned they are unlikely to get anything back. A day later, another company, Guangdong Enterprises, turned out to have debts of $2.94 billion and one of its subsidiaries, Guangnan Holdings, the principal shipper of food to Hong Kong, admitted to debts of $391 million. The creditors of Guangzhou International Trust and Investment Corp (GZITIC) claim it owes and is unable to pay at least $40 million.

Last Friday 47 foreign banks met in Hong Kong to find a way to persuade China’s courts to give them preference in recovering their debts. They are facing the prospect that the “red chips”, Chinese companies listed on the Hong Kong stock market, might be in collective debt of over $12 billion.

Even Hong Kong’s most Motherland-loving investors are in a panic. “Investors no longer trust the so-called guaranteed earnings of China assets and just want to be free of them,” commented a securities house researcher in Hong Kong. Guangnan’s disaster was attributed by its chairman to investment by its parent company which took no account of risk, to imprudent lending, and to improper accounting – the basic components of much Chinese investing.

This is hardly news. Fifteen minutes per day over the past five years with the Herald Tribune, Wall Street Journal and Financial Times, together with glances at reports of academic conferences on the Chinese economy, would have told any investor that China, like Russia, is a casino. Last July, Nicholas Lardy of the Brookings Institution in Washington, a leading expert on Chinese financial affairs, wrote a sweeping warning, which included these words: “The most serious threat to macroeconomic stability in China is the possibility of a domestic banking crisis. The central precondition for a crisis, a largely insolvent banking system, already exists.”

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Lardy observed that outstanding loans increased almost 40 times between 1978 and 1997, that 25 per cent of bank loans now appear to be non-performing, and that the major banks, virtually bankrupt, use their credulous depositors’ money to make loans for which there is no collateral. If China now starts to print money or devalue its currency, inflation will rise and depositors will demand payment and riot if it is not forthcoming.

As it happens, Lardy specifically warned that GITIC “has extended guarantees equal to almost five times its own capital”. But greed, hope and political grovelling rule when it comes to investing in China. In the case of Guangdong Enterprises, whose stock value has fallen through the floor, a German bank manager in Hong Kong explained: “It appeared to have good cash flow so the general thinking was ‘OK, there’s money being spun around and they have a viable business’. “

There are additional problems: bankruptcy laws are shrouded in secrecy, and the state has a habit of sending lenders “comfort letters” indicating undefined “state support” for loans to GITIC-like companies, although the same state has now announced it has no such obligation.

So why have Hong Kong, German, Japanese, French, American and British investors queued up to shovel their money down this notorious rat-hole and paid those with “contacts” in China to help grease the rat-hole walls? In Russia, where such investors have taken monumental baths, the answer was pure greed. There was no economy to invest in, just gangsters with their hands out who promised huge paybacks. In China the answer to the scramble to invest is more sinister and the “expert advisers” have a lot to answer for. Those offering large sums to Chinese firms did so hoping for an eldorado later, the old vision of the two billion armpits needing to be deodorised, the one billion scalps with dandruff, the 19th-century hope of “adding an inch of British cotton to the shirt-tail of every Chinaman”. The ultimate hope, always, was actual banking inside China, underwriting stocks and bonds, and dealing in local currency, not dollars. There were always, too, those “comfort letters” which promised guarantees that anyone should have known would never come good in a crunch.

And all this in a climate of corruption so pervasive that both President Jiang and ex-Premier Li Peng have warned “it could bring us down”. The handbooks on doing business in China – which many foreigners have virtually memorised – stress guanxi, or personal relationships, and many firms, in order not to be accused of direct bribery, hire local Chinese as middlemen to offer bribes, whether in cash or kind, such as ” foreign study trips” for Chinese managers or tuition fees for their children at foreign universities. A western fixer told me five years ago in Hong Kong that getting a western tycoon into the office of the minister who had to approve certain deals cost $50,000 straight away to the minister’s appointments’ secretary.

Much of the optimism was generated by a certainty that China was privatising, that its notorious loss-making state industries would be dismantled and market forces would become the order of the day. But at the last party congress President Jiang and Premier Zhu made clear that the really big state industries, the “core 400”, would continue to be underwritten by the state. They realised that dismembering them would swiftly lead to proletarian unrest which, if combined with already endemic peasant disorder, could cause “chaos”, the prevention of which is Beijing’s main reason for crushing democratic movements.

But although China’s is not as black an economic picture as Russia’s, and its gangsterism has not yet extended to murderous attacks on western businessmen and honest officials like Galina Starovoitova, we should remember that Premier Zhu has said that he has 99 bullets for corrupt businessmen and a final one for himself if he fails.

For years, western apologists for China (echoing their Beijing and Hong Kong friends) have insisted that democracy would destabilise China and that human rights would emerge with a growing economy – forgetting the capitalist growth in fascist Germany and Japan in the thirties. But unlike human rights, about which men who open doors in China such as Henry Kissinger and Sir Percy Cradock appear to care little, losing big money cannot for ever be hushed up, explained or denied. Investors can be told to be patient only for so long.

At last we reach the bottom line. For the jailers of China’s political prisoners, foreign credit has been unlimited. No western government will threaten Beijing if it shoots, tortures and imprisons Chinese. But foreigners losing their shirts is quite another thing. Soon we may hear less about China’s market forces and stability and more about the need for a Mexican or Brazilian bailout. I can imagine it now: “Chinese banks must not be allowed to go under.”

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