SUN WUKONG China takes stock in crisis
By Wu Zhong, China Editor
HONG KONG - China's financial system, even after three decades of reforms,
remains pretty much closed by standards of a free economy. In consequence, it
has been less savaged than many other countries as the financial crisis has
rippled out from the United States to Europe and more or less the rest of the
That crisis lapping at its borders and the sight of the "systemic risk" in the
financial system in the free economic world, with the US in the van, will
inevitably encourage China to slow down on the reform path that was leading to
further deregulation and opening up its financial markets.
So far, the direct impact of the US financial tsunami on the Middle Kingdom has
remained limited, even though the Chinese government, its sovereign wealth fund
- the China Investment
Corporation - and state-controlled commercial banks have had to write off or
make provisions for their more than US$300-billion worth holdings of shares or
bonds of American companies, including troubled financial institutions such as
Lehman Brothers, American International Group (AIG), and the two major mortgage
finance firms, Fannie Mae and Freddie Mac.
The total amount, though large, is relatively insignificant in view of the
financial strengths of these Chinese investment entities.
Growth in China's exports to US in the first seven months of the year slowed to
9.9% from the same period in 2007, reaching $140.39 billion, 8.1 percentage
points slower than the rate of 12 months earlier, according to Chinese Customs.
It is the first time since 2002 that the growth rate in China's exports to the
US has dropped to single digits.
US consumption will definitely shrink dramatically next year and Chinese
exporters will suffer a "very cold winter", according to Jack Ma Yun, chairman
of Hong Kong-listed Alibaba Group, which runs Alibaba.com, a leading
China-based business to business marketplace Internet site.
Beijing, anticipating a slowdown in exports, has begun to ease its monetary
policy to boost domestic consumption. The country's financial system is,
however, relatively unexposed directly to the US financial crisis.
"Our financial industries are not so much internationalized and thus not
attacked severely," a commentary on the official website of the state-run
Xinhua News Agency said. "Although the nine listed banks ... hold some Lehman
Brothers-related assets, the amount is relatively small, which will not have a
big impact [on the financial industry]. 
"In the past, China has been blamed for the low-degree of internationalization
of its financial industries. Now it seems we are profiting from this 'fault',"
the commentary said.
Many Chinese economists share this view. "Our not-fully-open financial system
and not-fully-convertible currency saved China from being rattled during the
1997 Asian Financial Crisis. And now again this seems to be a strong dam to
protect us against the current financial tsunami," an economics researcher with
the Chinese Academy of Social Sciences (CASS) said.
What is happening in the free economic world is reinforcing Beijing's belief in
its gradualist approach toward liberalization of the Chinese currency and
opening up its financial markets.
"China doesn't have a timetable for yuan liberalization, though it has
progressed gradually toward this goal. But under the current circumstances, it
is inevitable for China to slow down the pace in this regard so as not to
import systemic risks into our financial industries," the CASS researcher said.
Before it gains a full understanding of such systemic risks in the US, the
Chinese government will have to slow down its market-oriented financial
"It is evident that the financial industries cannot become entirely market
oriented. The semi-market, semi-government-control system may prove a better
[system]. The problem in China is that the part of government control is too
big and thus reforms are needed to deregulate."
In early September, Steven N S Cheung, a Hong Kong-born Chinese-American
economist living in exile in China, being wanted by the US government for
alleged tax evasion, claimed that China "has formed the best system in the
history of human kind".
Beijing is expected now to shift its aim of financial reforms to seek a balance
between market and government control, rather than simply emphasizing
market-oriented reforms. As Hao Bin, director of the China Securities
Regulatory Commission's research center, wrote, "We must seriously study the
Wall Street crisis to draw a lesson. We must also be fully aware of our own
national circumstances ... and prudently make financial [changes] to strengthen
risk management. From an early stage, market development has been pushed
forward jointly by the government and market forces. There is no absolute
freedom and no absolute regulation; a balance between the two is needed for the
healthy development of financial market."
The current "national circumstances" seem to put China at the exact opposite of
the US. At the center of the current financial crisis in the US is a lack of
liquidity, while China suffers excess liquidity, or too much cash in
circulation. "The Americans like to borrow and spend, but Chinese prefer saving
to spending. It seems we both have our own problems," Premier Wen Jiabao said
during his visit to the United Nations last month.
Apparently in consideration of the current situation at home and abroad, China
has shelved several financial-reform plans. For instance, the government
announced at the start of this year that it would launch a Nasdaq-like board
and index futures this year. Now, in early October, no one talks about such
things any more.
In the absence of a fully convertible yuan, China has said it will expand the
qualified foreign institutional investor (QFII) scheme that allows overseas
investors to trade in A shares, and the qualified domestic institutional
investor (QDII) scheme, which allows Chinese investors to trade in overseas
Expansion of the two schemes could be seen as a speedometer of China's opening
up its financial markets, but a proposed expansion has apparently been held
Between 2002, when the QFII scheme started, and 2007, China granted 49 foreign
institutions QFII status, with a total investment quota of nearly $10 billion.
At the end of last year, China said it would expand the QFII investment quota
to $30 billion. This year QFII licenses have been granted to a further four
foreign institutions, including KBC Asset Management NV and Samsung Investment,
but so far only a small proportion of the new investment quota has been
On the other hand, in apparent concern over possible trouble arising from an
influx of international speculative "hot money", China has tightened checks on
the inflow of foreign funds.
When announcing the increase in the QFII investment quota, the State
Administration of Foreign Exchange (SAFE) said it would further raise the quota
for the QDII scheme.
By end of 2007, 23 domestic and foreign banks in China had been given a QDII
license, with 16 marketing 262 QDII products worth more than 40 billion yuan
(US$5.84 billion). By the end of last year, Chinese investors could trade in
securities in Hong Kong, the UK, Singapore and Japan, provided relevant QDII
products were available. As agreed during the Sino-US Strategic Economic
Dialogue, China in March announced it would extend the QDII scheme to the US
However, according to Shanghai Benefit Wealth Management Consultation, only 10
of the 231 operating QDII products issued by banks were profitable by September
4 this year. All the rest, 95.67% of all products, recorded losses of up to 50%
due to the sluggish overseas securities markets.
Chinese investors have developed a wary view of QDII products. Eighty-eight
percent of respondents to a recent survey said QDII products were hopeless in
the short term, and 71% said they would not consider buying QDII products,
regardless of their performance.
As a result, the number of QDII products marketed this year has dropped each
month, from 70 in January to 11 in June. There is no more talk about expanding
the QDII quota.
The QDII scheme was one of the measures Beijing introduced to combat excess
liquidity, caused largely by the sharp increase in the country's foreign
exchange reserves. Under Beijing's foreign exchange regime, the government has
to buy any foreign currency flowing into the country. With more and more
foreign money coming in, the government has to spend increasing amounts of yuan
to buy it, resulting in too much money supply.
Beijing has hoped that by encouraging outbound investment people would convert
their yuan into foreign currencies so as to reduce liquidity in the domestic
economy. The poor response to the QDII scheme (and the failure of other
outbound investment projects) has proven this is not a way out, at least not at
the present time when the overseas markets are in very bad shape.
Even so, some experts have urged China to take the current opportunity to make
outbound investments. In an international forum in Tianjin at the end of last
month, former Hong Kong financial secretary Antony Leung Kam Chung and present
chairman of Blackstone Group's Asian office in Hong Kong, said the US financial
crisis provides "an opportunity in a hundred years" for cash-rich China to take
over foreign businesses. China famously took a $3 billion stake in US
investment company Blackstone in May 2007, just after Leung was appointed
chairman in Asia. Shares in the company, which subsequently went public, have
declined from about $35 in July 2007 to below $14.
Institutions that have large amounts of foreign currency at their disposal are
also state-owned or state-controlled enterprises. "Top management of these
enterprises are government officials, who are not willing to take the political
risk in making outbound investment decisions, seeing the failure of many such
projects," the CASS economist said.
Hence the Chinese government will have to continue managing the country's $2
trillion and growing, foreign reserve. That means China will have to continue
buying US Treasury bonds.
According to the US Department of Treasury and Federal Reserve, China by the
end of July this year was the second-largest holder of US Treasuries, at $518.7
billion, next only to Japan's $593.4 billion. China accounted for 19.38 % of
the total $2.676 trillion foreign holding of US Treasuries.
The People's Bank of China (PBoC) welcomed the recent US Congress approval of a
$850 billion financial sector bailout package, saying: "China and the United
States have common interest in stabilizing financial markets."
The US is expected to issue more Treasuries to raise the funds, and China is
expected to be a big buyer. Hong Kong's Chinese-language Ming Pao Daily
reported at the weekend that the Chinese government plans to buy at least $200
billion worth of new US Treasuries. A PBoC spokesman declined to confirm this.
"We must help the US to help ourselves,'' a Chinese government official said.
"We do not want to see the collapse of the US financial system, which would be
disastrous for us too." Premier Wen, on the sideline of a visit to the United
Nations, has pledged all coordination and assistance to help the US out of its
Right now, buying government-backed treasury bonds may be the safest way for
China to make outbound investments. "We believe the United States is a country
with good credit," Wen said in an interview with CNN last month.
1. The listed banks referred to are Industrial and Commercial Bank of China,
Bank of China, China Construction Bank, Bank of Communications, China Merchants
Bank, Minsheng Bank, China Citic Bank, the Industrial Bank and Huaxia Bank.