At a time when the sovereign debt crisis places ‘the Eurozone’, the European monetary union project in jeopardy, China is being encouraged to lend a supporting hand of up to US$100 billion. However, confidence in Beijing’s ability to manage its own finances despite its huge wealth has been shaken by a series of bad news about the nation’s private enterprises and its labyrinthine underground banking system in recent months that could put any international faith in any Chinese led bailout in difficulty itself. To summarise a turbulent week from a Greek financial perspective, despite a previous agreement struck between global economic powers, a counter move was launched by the Greeks on 01 November 2011, to hold a referendum into the legality of adopting them. George Papandreou’s stunning announcement of non-interference has thrown the Eurozone back into turmoil may bring down his government and hasten the end of his political career. Global markets slid as a result of the announcement amid fears the Greek bailout deal would collapse, but the worst affected were the Asian markets especially due to the price of the Chinese currency, the Yuan, which had dramatically strengthened in the approach to a deal and fell as a result.
This incident shows the fickle nature of money markets based on projected values and made or broken by investor confidence, however, of greater importance perhaps to the future of a stable Chinese economy and a stable Eurozone should be how China deals with the banking system going ahead. Since early summer, thousands of once vibrant small and medium-sized enterprises (SMEs), which account for more than half of China’s GDP and which create 80% of its jobs, have gone under. In Wenzhou, Zhejiang Province, the world-famous quasi-capitalist showcase, dozens of “red bosses” simply vanished last month without paying either their creditors or their employees. Wenzhou officials have increased visits to factories that appear to be in trouble with a view to forestalling mass layoffs should these firms fail. In the first seven months of the year, Wenzhou enterprises recorded losses of 640 million Yuan (US$100 million), or 220 million Yuan (US$34.5 million) more than 2010. While China’s private bosses are known for being savvy and resilient, many have turned from manufacturing, where labour and material costs are rising dramatically, to the much more lucrative business of speculating in the real estate market. The downturn in property and related sectors however means some of the most successful SMEs have gone bust. The so-called Wenzhou phenomenon is being duplicated elsewhere, including several cities in prosperous Guangdong Province. The financial disruption hitting private firms is linked closely with the country’s gargantuan “underground banks.” These unlicensed lenders range from local-based businessmen’s cooperatives and brokers to credit and trust companies that are offshoots of official banks, insurance companies and other financial institutions. While illegal on paper, underground banks have been tolerated by the authorities for more than a decade. Even though China has given so-called “national treatment” to quite a number of foreign enterprises and joint-ventures, non-state firms routinely face discrimination from creditors. Most government-controlled banks, including the “Big Four”; Industrial and Commercial Bank of China, China Construction Bank, Bank of China and Agriculture Bank of China, all prefer to do business with large state-owned enterprises (SOEs). Non-state companies, particularly SMEs, have for the past decade or so been forced to borrow from underground financial institutions. This is despite the fact that interest rates have been between 30 -100% during the past year. Since Beijing tightened the official banks’ credit to the real estate sector early this year, underground banks have also become the prime financier to property developers. The shadow bankers have lent 208 billion Yuan (US$32.6 billion) to real estate companies so far this year, or nearly as much as the 211 billion Yuan (US$33.1 billion) worth of loans that official banks have extended to the sector. Estimates of the total size of China’s underground lending range from 4 trillion Yuan to 8 trillion Yuan ($627 billion to US$1.3 trillion, respectively), or respectively around 8 – 16% of the official credit market. It is obvious that a sudden downturn in the economy, such as a bursting of the housing bubble and domino-style defaults by borrowers—could wreak havoc on this shady banking industry in turn not only negatively affect the Chinese economy but the ability for Europe to prosper from the Chinese economic leverage in their own market.
What affect may a collapse in underground banking have on the Eurozone you ask? Well simply put Europe is China’s largest trading partner and China is Europe’s second largest trading partner. Their bilateral dealings were valued at €363 billion last year. Without a guaranteed bailout of substantial origin emanating from Beijing the Euro will struggle. In 2009, the onset of global recession cut China’s exports to the EU by 15.6%, resulting in a sizable surge in unemployment and factory closure in southern China. A deep financial crisis in the Eurozone and the resulting reduction in spending would be felt particularly strongly in export-oriented provinces in southern China. To the extent that a supporting hand from China can contribute to a creditable resolution of the sovereign debt crisis and limit its negative impact on economic growth in the Eurozone, there is little reason for China to stand on the sidelines. For Beijing, maintaining the euro as a reserve currency is massively in China’s interest as China currently lacks the necessary institutions that would permit the country to adopt a floating exchange rate regime with free capital flows. The People’s Bank of China, the country’s central bank, is not run as an independent monetary authority and even its monopoly control over monetary policies can sometimes seem questionable. Under the prevailing institutional environment, China’s only viable option is to maintain its currency peg, but add some upward flexibility on the exchange rate. A stable euro, underpinned by sound monetary policies of the European Central Bank, would offer China more options in managing its monetary policies. It would also give Chinese policymakers time to diversify its foreign exchange reserves and to correct the imbalance in its economic structure, while creating a relatively stable economic environment that is conducive to long-term economic development. From a wider international relations perspective a prosperous Europe also offers the best chance of creating a multipolar global economic system which is in the China’s favour, especially as the US enters another election year, it is likely that Beijing will be criticised by Republican candidates and the Democrat-controlled US Senate both clamouring to label China a currency manipulator, trade and investment frictions are bound to increase. China will need to rely on the independence and impartiality of the WTO in adjudicating any future trade disputes with the US, and only a multipolar global economic system can guarantee this.
Even as China agrees in principle that it will contribute to the European rescue plan, details of the support will now more than ever still need to be negotiated. For Chinese participation to receive broad political support both at home and in Europe, the rescue plan must provide sufficient safety margins for success. China cannot be expected to lose money in this venture, although it should not have the right to dictate economic policies in the Eurozone. China’s participation in any eventual deal could bring a sizable amount of capital to bear and should materially improve the chance of success. Looking ahead, Beijing could also contribute to the European Financial Stability Facility (EFSF) directly or by providing it with a back-stop on request. EFSF, which is owned by Eurozone governments, looks like a safe bet so long as measures can be taken to mitigate the exchange rate risks that China faces. For example, part of the contribution can be denominated in Chinese Yuan. China could also contribute to a European rescue fund within the IMF. In return China could ask for the EU to recognise its market economy status and thus creating the opportunity for Beijing to gain a symbolic victory, since the EU has acted largely responsibly over trade with China in the past. Moreover, China could use this opportunity to raise its share of voting rights in the IMF by taking over additional voting shares from European countries. This would increase China’s influence in this multilateral institution commensurate with its economic weight in the global economy. Essentially if it can agree to participate in the rescue plan, China is announcing to the world that it is a willing and responsible stakeholder. Also either way, both Europe and China gain from this agreement on the political scoreboard.
