BANKING
Embassy Perspective: Financial Attache Sees Advances in Financial Institutions
April 30, 2007
Betty Penzner

"If someone had told me five years ago that three of China's four biggest banks were all going to have strategic foreign investors and they were going to list on Hong Kong's market, I don't know if I would have believed them." ARTICLE TOOLS Print Version Reprints RECENT ARTICLES Different cities, same customers China is the region's top stop for exporting Improving wire transfers Quantifying your banks' performance

ChinaForum spoke with Financial Attache David Loevinger of the U.S. Embassy in Beijing, who gave his views about the state of the Chinese economy and the advancement of financial institutions.

How do you see China accelerating the process of revaluation of the currency?
We've been very clear in our discussions with the Chinese government. And U.S. Treasury Secretary Paulson said recently in his testimony to the U.S. Senate that we think China needs a flexible exchange rate. Basically the problem we see is that China's rigid exchange rate makes it more difficult for them to achieve their goal of balancing the economy away from a dependence on investments and exports and towards greater reliance on consumption. It inhibits their central bank from adjusting interest rates and reduces the risk of a liquidity-driven investment boom. We're seeing that now in the stock market and the real estate market. We have also been very clear that a rigid exchange rate, rising foreign exchange reserves and a rising trade imbalance with the U.S. give the impression in the U.S. that trade opportunities are not balanced.

How are you guiding companies to prepare for a change?
 U.S. companies operate all over the world under all different kinds of exchange rate regimes, including lots of countries where the exchange rates are all over the place. I am confident that U.S. companies have been told to manage the exchange rate risk.

One reason why we have been pushing for greater volatility in the exchange rate is that it is an incentive to use the financial derivatives and exchange rate derivatives that are already out in the market. The problem is that the market hasn't really developed because the exchange rate has been so rigid.

Would you comment on the development of capital markets in China?
It's kind of like the exchange rate. They've made some progress, but there's much more that China can do. This is going to be a priority for the U.S. Treasury department and Secretary Paulson. The financial sector has been a weakness in what otherwise has been a pretty strong Chinese economy. The country has been growing 10% a year for a long time, which is great, but they've had to invest about 40% of GDP to achieve that -- much higher than the investment rate of other Asian tigers or Japan during their periods of high growth. It's really a sign of how inefficient investment is in China. If China had a more efficient financial sector and well-developed capital markets, it could achieve high growth with a lot less investment. That would be great for Chinese households, which would consume more, and it would also help reduce some of the imbalance.

China has now allowed companies to resume IPOs and the stock market is booming. There is some concern in China that it has moved too far, too fast. Our position is that if China had a more flexible exchange rate, the central bank would have greater scope to adjust interest rates. It could focus more on containing growth of the money supply, which is contributing to excessive liquidity, again maybe in the stock market, maybe the real estate market, maybe too much fixed asset investment.

I think the one area where reform has lagged a bit has been in the bond market, which is just as important as the stock market and the banking sector, if not more so. If Chinese companies were to get their financing through the bond market, that would allow banks to focus more on small and medium size enterprises, which still have a hard time getting financing.

The financial sector is still fairly imbalanced. I think about three quarters of China's savings are intermediated to banking systems compared to about half in other developing economies and about 20% in developed economies like the U.S. and Europe. We think the country would do much better if capital markets played a bigger role.

Secretary Paulson has also said that, just as foreign investment helped turn China into a world class manufacturer and exporter, foreign investment can help China achieve a world class financial sector and capital markets. But China still maintains barriers to foreign investment in the banking, securities and asset management sectors. One line that Secretary Paulson always uses in conversation with senior leaders is that he can't think of a single example of a country that has a really strong financial system and strong capital markets that hasn't opened itself up to foreign competition.

Corporate treasurers have told us that banking is slow, laborious and inconsistent among the regions. What's happening in the banking industry?
Some of China's biggest banks still account for the largest share of the banking sector. If someone had told me five years ago that three of China's four biggest banks were all going to have strategic foreign investors and they were going to list on Hong Kong's market, I don't know if I would have believed them, and in the process of having IPOs, that they would have international accounting firms come in subjecting them to Hong Kong's listing requirements. This has helped by turning these banks into commercially orientated firms and giving them a more modern structure of corporate governance.

But people have to be realistic about how long it is going to take to change the institutions. These are very big organizations with thousands of branches spread all over a big country, with hundreds of thousands of employees. It is a bit like turning an ocean liner, getting these hundreds of thousands of employees to think about making loans in a more commercially oriented manner. Assessing risk. Managing credit risk. It's going to take time. So I'm not surprised that treasurers still find a wide disparity of experiences, be it a bank branch in Beijing, or Shanghai or Guangzhou.

How are you advising U.S. companies on dealing with financial reporting and regulatory requirements of the Chinese government? Has that area improved?
Just this year, China adopted accounting standards which are a lot closer to internationally accepted accounting practices. As more Chinese companies list abroad, they are having to meet accounting disclosure and listing requirements. They are becoming much more transparent.

We spend a lot of time dealing with financial regulators, banking regulators, securities regulators. Last fall, we worked very closely with them in the promulgation of regulations governing the operations of foreign banks in China. If you look at it from the perspective of where China was five years ago, they've made progress. If you look at it from the perspective of U.S. or European regulatory practices, they've got a long way to go. But we were very pleasantly surprised that the banking regulators produced a draft of regulations and that they gave foreign banks an opportunity to comment. They gave U.S. regulators an opportunity to comment, too. And they actually took some of the comments. My understanding is that not all Chinese regulators are as open as banking regulators. Another area where we are going to encourage strategic dialogue is the whole area of regulatory interest.

How will the proposed Enterprise Income Tax Law that would end preferential tax rates for foreign companies in China impact doing business in China?
The tax unification law has been debated for a long time. I think U.S. companies and foreign companies have made their views clear. The Chinese government wants to be able to have sufficient transition periods to adjust to any new tax routine. I don't know how it's going to impact the operations of individual companies. My general impression both in China and more broadly around the world is that tax incentives don't play a major role in a company's investment decisions. Companies want good infrastructure, a well educated labor force. They want regulatory stability. China is far from a perfect investment climate, but it is certainly good enough to have attracted billions and billions of dollars in foreign investment. I don't think that provision is going to have a major impact on foreign investment.

Where can U.S. companies find qualified financial professionals both for start up recruiting and retention and secondly for advisors and consultants?
I'd point them in two directions. First, Barry Friedman has staff at the commercial section of the U.S. Foreign Service in Beijing, but also all over China. Their main focus is on less exports. There is also a huge staff back in Washington, D.C. at the Commerce Department helping companies do business in China. Second, there are lawyers and consulting firms in all the major cities, and many of them have headquarters in Hong Kong. They are doing very well advising foreign companies on how to structure transactions, showing them how to ensure getting paid. 

Copyright © ChinaForum 2007