Zhou Xiaochuan Outlines Plan To Reduce Non-Performing Loans

by Paul Denlinger

Posted Oct. 29, 2003

Zhou Xiaochuan, governor of the People's Bank of China, outlined plans to reduce the bad loans of China's state-owned banks. China's banks carry US$350-550 billion in non-performing loans (NPLs), and need to reduce them in order to compete effectively with non-Chinese banks when they enter the Chinese market in 2006.

In an interview carried on Xinhua News Agency, Zhou said that the government had decided to inject more capital into the banks so that they could increase capital adequacy and reduce non-performing assets. Interestingly, Zhou also mentioned that the measures would not only speed up commercial development of the banks, but would also motivate trade liberalization and promote the flow of capital in two directions. According to Zhou, it would also allow a shift to a more flexible exchange rate for the yuan.

This is the first time a senior Chinese official has publicly tied cleaning up the banks' loan portfolios with a more flexible yuan exchange rate. The eventual goal is to make the Chinese yuan a convertible currency. Officially, the yuan is not a convertible currency and cannot be taken out of the country. But in fact, Chinese tourists take the yuan outside of China to spend, and it is widely welcomed in Asia. Since the beginning of the year, China has come under intense pressure from the US, Japan and the EU to loosen the yuan peg to the US dollar, which is fixed at 8.28 to one US dollar.

Under the outline, a second tranche of non-performing loans (NPLs) would be transferred to asset management companies, while allowing the companies to raise sufficient new capital to bring their adequacy levels up to international standards.

Chinese economists and researchers have long recommended these changes be made, which have been widely accepted by the government. However, implementing the policies has been difficult because of opposition at the Communist Party level and the government's legislative body, the Peoples' Congress. The Peoples' Congress meets twice annually to debate new laws. The end result is that laws are only passed when all sides reach some kind of consensus.

Recently, the pressure from the US, Japan and the EU has become so great that it has forced the Chinese leadership to force an internal consensus, and implement the necessary changes. Pressure from the US's Bush administration has been particularly intense, which is almost in a panic mode. Faced with an unpopular war in Iraq, a jobless recovery and a presidential election in 2004, it has pulled all stops to cast China as the bogey for America's economic problems.

When China refused to immediately loosen the yuan peg, it dispatched Commerce Secretary Donald Evans as a "bad cop" to force more pressure for change. In a speech to the US Chamber of Commerce in Beijing, Evans broadened the war of words by accusing China of going back on its commitments to WTO to open up the Chinese domestic market to foreign competition. In fact, China's implementation calendar has been slowed down by the SARS crisis in the spring, and the new Chinese leadershp under Hu Jintao. Certain factions in the Chinese government have questioned the US's commitment to WTO, which was marked by the Bush administration's imposition of imported steel tariffs. These tariffs were later ruled to be in violation of WTO guidelines.

When China follows through on its plan to set up asset management companies to handle the NPLs, American investment banks will play a role. It is known that Morgan Stanley is interested in contributing to the management of the asset management companies.

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