Summit Notebook
Exclusive outtakes from industry leaders
OUTSIDE EXPERT – S&P
Repeat of ’97 Asian financial crisis unlikely – Standard & Poor’s looks at China
Standard & Poor’s Ratings Services believes that a crisis similar to the financial crisis in 1997 is unlikely to recur in Asia. Key factors enabling the 1997 crisis are no longer as prevalent now as they were in 1997. Ten years ago, high foreign currency indebtedness by companies and external liquidity vulnerability of sovereigns, in part due to current account deficits, provided the backdrop to the crisis. Today, companies have reduced their foreign currency debt exposure or adopted hedging policies against foreign exchange risk, while sovereigns have bolstered their external positions with stronger reserves. In addition, many banking systems have fully regained the economic role they played before the crisis. Nevertheless, the overall increase in the debt of sovereigns and, to a lesser extent, corporates remains a concern. Our study includes the financial systems in China. Growing Government Debt The credit profile of China is stronger in 2006 than it was in 1996. China’s economic growth has propelled its sovereign credit ratings higher, and lifted those on Hong Kong. Corporate Borrowing Climbs In China And India In addition to higher government borrowing, private sector indebtedness as measured against GDP is greater in China in 2006 than it was in 1996. Strong economic growth has fueled increased corporate borrowing in China and India, while growing debt in Singapore reflects its role as a key financial market center amid healthy growth in the region. Smaller Interest Rate Differentials With The U.S. Unlike the situation in 1996, interest rates in Asia are largely lower or similar to U.S. interest rates, thus lowering the attraction of foreign currency borrowings. Prior to the 1997 crisis, U.S. borrowing rates were more attractive to Asian borrowers because of the larger differential with local interest rates. This situation encouraged Asian corporates to increase their borrowings in foreign currencies, particularly the U.S. dollar. When the exchange rates of various countries in the region were pressured during the crisis, borrowers whose earnings were substantially in local currency were severely distressed and unable to repay their foreign currency borrowings. Better Quality Of Banking Systems Qualitatively, many banking sectors in Asia are less fragmented, while some boast foreign shareholder expertise. This has helped improve the depth of management and development of risk management systems. These observations recognize that there is a limited pool of capable senior bankers that any one banking sector may have, and the economies of scale needed for IT-based risk management systems. In addition, financial disclosure from the banking sector has generally improved. The intermediary function of the banking sector has also evolved, as the development of domestic capital markets picked up over the past five years. One positive implication is that banks have increased their focus on the consumer and small and midsize enterprise (SME) markets. This has led to an increased granularity of lending portfolios, as the corporate sector increasingly accessed the capital markets for funding. Nevertheless, there still exists the risk of concentration if banks were to focus excessively on a particular sub-segment of the consumer lending market. Some of the leading Asian banks that had their credit ratings lowered by Standard & Poor’s during the 1997 crisis have yet to recover their full credit strength. The leading banks in China and Hong Kong now have slightly higher ratings; Chinese banks have benefited from extensive government capital injections, while the latter reflects the innate strength of Hongkong and Shanghai Banking Corp. Ltd. Nine System Risk Factors For this study, Standard & Poor’s analyzed nine system risk factors in 1996 and 2005-2006. These are: – Banking system structures, – Financial disclosure by banking systems, – Corporate indebtedness, – Government indebtedness, – Foreign exchange rate mechanism, – Foreign currency indebtedness, – Current account balance, – International reserve positions, and – Interest rate differentials with the U.S. These factors were selected after taking into account the drivers for the 1997 crisis.
OUTSIDE EXPERT – Cooke
Lenovo is paying the price of admission to the global marketplace
By Terry Cooke Foreign Policy Research Institute Senior Fellow After the fanfare of Lenovo Group Ltd’s purchase of the IBM ThinkPad Division in 2005, today’s decidedly downbeat news from Lenovo’s Chairman may come as a surprise to some. As Chairman Yang Yuangqing reported today at the Reuters China Century Summit, Lenovo’s “margins are just 1 – 2 percent,” adding that “that’s definitely not a healthy business.” Moreover, Chairman Yang noted that it would take at least three years to return to strong profitability for the Lenovo Group. What happened? In short, Lenovo overpaid for the allure of a blue-chip name in a tightening global market and is now paying the price. More fundamentally, Lenovo’s balance sheet today shows the impact of local desire in China to forge global brand champions hitting two brickwall realities of the global IT marketplace: commoditization pressures on the technology and merciless competitive pressure on profitability. None of this necessarily calls into question Lenovo’s long-term prospects. For one thing, if Dell and HP have both stumbled at the head of the pack, it is not surprising that the third-place runner has also been thrown off stride. Long-term, Lenovo’s proximity to, and advantages in, the fast-growing mainland market will bring it real advantages in the global race. The question is how those advantages in the local market can be leveraged over time to counteract and outweigh substantial disadvantages which Lenovo faces today in the much larger global marketplace. The key to answering this question doesn’t lie in any particular quarter’s numbers. It lies in the history and culture of the Legend Group’s ‘long march’ to its current position of global prominence. That march began in 1984 when Legend was founded by 11 scientists from the Chinese Academy of Sciences. The three most notable features of Legend/Lenovo’s rise over the next 22 years have been: (a) the company’s lifeline dependence on the domestic Chinese market, (b) its demonstrated lack of technology innovation for the global market, and (c) the consistent pattern that its international partnerships have been aimed primarily at ‘China market access’ plays. From this perspective, the heart of Lenovo’s strategy with the ThinkPad acquisition was to transform itself overnight from a domestically-focused regional player to a truly international player. The bottom-line in today’s news is two-fold: they paid a steep price for their admission ticket into the global league and they are now finding the competitive stakes within this league tougher than anticipated.
– Terry Cooke is a Senior Fellow at the Foreign Policy Research Institute (www.fpri.org) in Philadelphia, PA as well as the Founder and Chairman of GC3 Strategy (www.gc3s.com), an international consultancy focused on emerging market opportunities in China and India.
OUTSIDE EXPERT – Friedland
Chinese Premiers remarks on monetary policy welcome
By Jerold Friedland, Professor of Law and Director of the Asian Legal Studies Program at DePaul University in Chicago.
The statement by Chinese Premier Wen Jiabao ruling out any “surprise” adjustment to the RMB exchange rate is predictable and welcome. Although some may argue that a faster revaluaton of the RMB is needed to reduce the US – China trade deficit, the disadvantages of such action outweighs the benefits. Let’s look at the pros and cons.
China’s longstanding policy of rigidly pegging its currency at about 8.28 RMB to the dollar was changed in July of 2005. At that time, the peg was removed and the RMB allowed to float, in a very managed way, against of basket of currencies including the dollar, euro, yen, and Korean won. China will manage the RMB to prevent a rise or fall more 0.3 percent against the dollar. The effect has been a small, but important, revaluation of the RMB, which now trades at a bit below 8 per dollar. This is still about 25 percent lower than the exchange rate expected if the RMB freely traded on international markets.
Critics of China’s low-value RMB policy maintain that is an unfair currency manipulation that subsidizes Chinese exports and foreign investments in China. The result, it is argued, has been a loss of US manufacturing infrastructure and jobs, slow sales of US goods in China, and a soaring trade deficit. A stronger RMB may also foster development of a Chinese middle class that will promote political reform as well as purchase more products and services from US companies.
Some advocate US legislation to impose duties or other trade sanctions that would offset the injury to US business and employment resulting from the subsidized imports. Legislation would be required because the major international trade organizations will not address this issue. The International Monetary Fund that oversees currency exchange rates has no effective dispute settlement mechanism and the World Trade Organization lacks authority over currency issues.
On the other hand, the economic consequences to the US of a rapid revaluation of the RMB could be severe. These consequences include: – Reduced Chinese purchases of US Treasury bonds, causing higher interest rates and lower bond prices that would retard US economic growth. – A related devaluation of the US dollar would increase the price of imported oil and other commodities, resulting in lower economic growth and unemployment. – US firms that use low cost Chinese components and products, including retailers and computer and aerospace manufacturers, would suffer from rising prices. The result would be higher inflation or lower employment or both (stagflation). – Revaluation would not substantially affect the US trade imbalance because the benefit to some US companies would be offset by the detriment to others. Increasing the price of low-tech Chinese goods would not mean lower imports because they will still be much cheaper than domestic manufactures. Also, sales that China loses in the US would be replaced by sales from other countries. – Many US companies will suffer reduced earnings if Chinese exports decline. Most Chinese exports to the US are generated by companies owned by US and other foreign firms. – Speculation about the RMB revaluation and associated higher Chinese interest rates and asset values would encourage large capital inflows to China. This could destabilize the economies of many other nations, as occurred during the Asian financial crisis of the late 90′s. – Failure of Chinese banks unprepared to deal with speculative currency issues could destabilize the international financial system. – Rapid revaluation will reduce China’s exports of manufactured goods and agricultural products, causing high unemployment in export industries and reduced income for hundreds of millions of farmers. The resulting domestic unrest would hamper future economic and political reforms and possible destabilize the country.
AUDIO – Bank of China
Bank of China sees vast changes in the mainland’s banking landscape
Zhu Min, the executive assistant president of Bank of China, the country’s second-largest lender, said at the Reuters Summit that there will be vast changes in the mainland’s banking competitive environment as the market is opened further to foreign competition at the end of the year. Regulators have already moved aggressively to reform large state-run banks such as Bank of China by removing billions of dollars of impaired loans from their books and allowing foreign investors to take strategic ownership stakes. Zhu welcomed the greater competition. “Before we competed with pistols, now we have AK-47s,” he said.
