In James McGregor’s 2005 book “One Billion Customers” eager investors were warned about the pitfalls of doing business in China. Many U.S. firms, mostly large and concentrated in the hotel, machinery, commodities, and higher-end consumer goods segments have overcome these challenges and done spectacularly well. Financial firms on the other hand have hit a policy wall and will continue to face difficulties for the foreseeable future.
The potential envisioned by foreign banks, including retail branches, ATMs on every corner and healthy loan yields on prime construction projects never materialized, even with China’s double digit growth rates. Bloomberg reported recently that foreign banks hold a paltry 2% of total assets in China, despite clear obligations to open the financial sector following a 2001 entry into the WTO. That unequivocal obligation read:
“Upon accession foreign financial institutions will be permitted to provide services without client restrictions for foreign currency business upon accession; local currency services to Chinese companies within two years [by December 2003]; and services to all Chinese clients within five years [by December 2006].” WTO press release, 2001
By 2004 problems were already surfacing yet an IMF working paper wrote them off to “primarily technical difficulties, and not a broad pattern of non-compliance.” While China has benefited greatly from its WTO membership, it still plays pauper when confronted with its own lack of opening. For foreign banks the dream of riches pales in comparison to the reality of making back only $10 billion on their $60 billion in investment.
One of the major impediments to greater opening involves the interdependence of state owned enterprises, state controlled banks and government growth policies. Essentially the current Chinese banking system acts as the financial proxy for Communist Party economic policies. To develop “national champions” in telecommunications or oil and gas that can compete internationally, for example, state-owned banks dutifully comply with low interest loans to state-owned enterprises. If those companies run into trouble the loans may be rolled over or written off entirely.
Small and medium sized enterprises, were they even to qualify for loans, do not enjoy the same luxury. When banks themselves ran into trouble they were bailed out by the government. Several years later they re-capitalized through IPOs.
Funding for these policy-based loans come primarily through deposits of the general public which has precious few choices for their hard earned yuan (real estate, under the mattress or the banks). At current rates they lose money every month that inflation tops savings rates.
Recent government policies to close the lending/savings rate gap will be a small boost to consumers. If real competition existed, and foreign banks operated on a level playing field, market-based rates would rise through competition. Further financial sector reform would be a key sign that policymakers are committed to transition from state-led growth to a consumer-driven economy.
In the near-term liberalization remains highly unlikely. Government planners remain convinced that economic levers like the banks should remain firmly in their hands. Foreign companies don’t appear eager to lobby their respective governments to initiate WTO cases fearing that might jeopardize current and future business, despite the constraints.
For now they’ll fare better with private wealth management services. That’s a booming industry with longer-term growth prospects.
Photo: Brian P. Klein – National People’s Congress, Beijing.