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Vietnam's hard economic lesson for China
By Chan Akya
Over the past few weeks, the decline of Vietnam from its erstwhile status of an
Asian "tiger" economy to being one of the first victims of a new regional
crisis has been swift and perhaps, outside of the country, unlamented. At the
heart of the escalating problems in the country are government actions aimed at
preventing a loss of competitiveness on its exports, and therein hangs the tale
for the rest of Asia.
The following brief mention in a recent article (Cheap
talk, pricey banks, Asia Times Online, June 4, 2008) now appears to be
rapidly becoming the main story in the region: Vietnam represents a
cautionary example for all Asian governments. The country attempted to fight
market attempts to push the value of its currency, the dong, higher. This was
"achieved" by strong-arm
tactics including the arrest of some bankers and pushing through
drastic limitations on foreign investors. Stuck with a number of their
investments, foreign investors have pushed up Vietnam's credit costs in
external markets, by more than 100 basis points in the past two weeks alone,
essentially rendering any recourse to such financing untenable for the country.
Meanwhile, the loss of investor confidence has pushed stock markets into a
downward spiral, with the benchmark index falling every day in May (absolutely
unprecedented anywhere in the world).
This is the problem with traditional Asian responses to market forces, dictated
as they are by communist ideology rather than rational understanding. The
fallout from Vietnam though is quite negative for smaller Asian economies, such
as the Philippines, as it shows the limits to market patience with such
government shenanigans. A rising US dollar would make matters worse for Asia in
the short run, by creating greater inflation and sharper declines in household
wealth, even as the concurrent benefits on exports fail to materialize thanks
to a US recession. Since then, the problems with Vietnam have
only become worse, with the currency in free fall against the US dollar as
foreigners are trying to get their investments out as quickly as possible.
Averting this would require the authorities to increase interest rates sharply
in order to maintain the attraction of the dong, but doing so will only
increase bad debts at the local banks and in turn spark a surge in
non-performing loans at state-controlled banks.
Even with its stock of foreign exchange reserves, the government cannot abide
by the situation as the country desperately needs continued foreign investments
to complete the various factory investments and infrastructure projects that
lie at the heart of its rejuvenation. It is perhaps not too dramatic a
statement to point out that the Vietnamese government has inadvertently
launched itself into an economic death spiral.
In the inter-connected world economy of today though, the problems of Vietnam
are hardly ever going to stop in the country itself. There are countries that
will benefit from the situation, and others that will be hurt by it.
Unfortunately for readers of this publication, most Asian countries fall in the
second category namely the ones that will be hurt by the Vietnam situation.
Already, the cracks are visible in the case of the Philippines and Indonesia,
two other countries in Southeast Asia that share many of the characteristics of
Vietnam. Between rising imports of commodities and oil, as well as burgeoning
investment needs that demand to be addressed, these countries have been running
current account deficits. The funding for the deficit has come from foreign
investments and remittances from nationals working abroad. Given the obvious
parallels to the Vietnam story, it is highly possible that both countries will
face rising outflows from foreigners as well as slowing remittances from their
own nationals working abroad in the near future.
These problems though pale with those that are increasingly visible in the case
of Asia's growth engine, namely China. While the broad metrics of GDP size,
foreign exchange reserves and population all put China in a different league to
the Southeast Asian minnows above, there are also important similarities. In
any event, the experience of Japan in the early 1990s should put an end to any
notion that large Asian economies with trade surpluses cannot suffer from
financial crises.
Cracks in the Great Wall
To be sure, making any quick comparison between Vietnam and China would prove
perilous given that the latter runs a strong current account surplus besides
boasting large foreign direct investment inflows, both of which provide
adequate financing for its expanding economy.
Still, the similarities with Vietnam on another level are also astounding. Much
like its southern communist neighbor, China has been anxious to control any
rapid appreciation of its currency. Its attempts to sterilize the large inflows
of short-term foreign capital have only been partly successful even if one goes
by statistics released by the People's Bank of China (PBoC). Indeed, M2 growth
has been accelerating in recent times as the central bank finds it impossible
to sterilize the combination of trade and investment inflows and banks find new
ways of lending. (Note - the temptation to use graphs in this section was quite
high for me, but I forswore the use of graphics in my articles a long time ago.
Readers with more numerical minds can consult official statistics of China to
bear out everything written in this article).
Additionally for the authorities, their main tool for preventing monetary
expansion has been the use of suasion, that is telling banks not to lend to
certain sectors, such as property, that could in turn create inflationary
impacts elsewhere. Official statistics and anecdotal evidence both now show
that money is being made available to a number of sectors that central
authorities had forbidden a little while ago.
This is happening because banks are increasingly hamstrung in their efforts to
make money as they bear the brunt of reserve increases that are designed to
force them to buy more government originated bonds as against private
investments. However, the authorities clean forgot that state-owned enterprises
have almost unlimited authority to borrow from banks, and now appear to be
using their borrowings to lend to Chinese companies in need, including in some
of the forbidden sectors. As the state-owned companies are not controlled or
overseen by the PBoC, they are free to do whatever they please even if the
essential risk of their activities, that is bad loans, are still ultimately
borne by the big commercial banks.
Secondly, various other kinds of semi-legal loans seem to be increasing.
Temporary loans that are repaid before the end of every quarter are in
particular proving quite popular for companies with large investment needs. As
the PBoC only monitors loans "on" the balance sheet on quarter-end reporting
dates, this has created a free market for short-term loans.
True, it is difficult for any large construction project to be funded by such
loans, but the experience of Vietnam and previously the Asian financial crisis
in the late '90s shows that such methods can and do come about when policies
make profitable lending difficult. In the case of various companies engaged in
such projects, the changes are visible in their increased working capital
needs, with one component, namely inventories, feeding into the GDP statistics.
Lastly, interest rates in China are still too low relative to the amount of
inflation in the economy. This means that anyone who can borrow does so at
rates that are far too low - what are referred to as negative real rates; when
people pay costs lower than inflation. That is prime fodder for asset bubbles
and this is exactly what is happening in many parts of China, often visible as
joint projects between state-owned companies or local government bodies with
"local" property companies.
At the top level, the following are becoming more apparent:
More inflation in both producer and consumer products even if authorities
attempt to exercise price controls in the latter category.
Rising balance sheets of both banks and large state-owned companies as they
circumvent current lending restrictions.
An attendant rise in financial risks across the official banking system and
more severely in the unofficial banking system.
Falling construction standards as companies attempt to finish projects quickly
in order to repay banks before quarter-ends (Note - this was certainly one
factor seen in the latest earthquake casualties).
Poor corporate governance at many banks and state-owned companies, where
officials with access to loan facilitation may be misusing their privileges.
Continued financial speculation by Chinese investors in markets as diverse as
stocks, property and commodities.
No let-up in the accumulation of short money aimed at benefiting from a quick
change in the value of the Chinese currency.
For China, the dangers of avoiding a Vietnam situation would simply push it to
a Japan imbroglio. As such, there are only a few market-based measures that
work here: firstly to float the currency, secondly to boost interest rates in
order to combat inflation and thirdly to improve supervision of the financial
system.
Combined, all these suggest that existing policy efforts (which famously avoid
all of the above three suggestions) at taming the financial markets have been a
colossal failure in China. The situation described above is starkly similar to
the one witnessed by Japan in the 1980s that eventually culminated in the Plaza
accord, which in turn pushed the Bank of Japan to raise interest rates sharply
even as the economy started slowing down. The result was calamitous, as the
Japanese economy entered a permanent downward spiral.
While there are many, including me, who hope that such an eventuality doesn't
come to pass, China now risks being suspended in a policy vacuum that puts it
right between the experience of Japan and Vietnam. The nomenclature of the
Middle Kingdom could thus get an altogether new and ironic meaning if China
fails to undertake urgent policy responses.
(Copyright 2008 Asia Times Online (Holdings) Ltd. All rights reserved. Please
contact us about
sales, syndication and
republishing.)
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