China tries to limit the impact of global financial crisis

China tries to limit the impact of global financial crisis

"Our orders from European countries have fallen by 20 percent so far this month, and we've cut our profit margin by nearly 50 percent to maintain business growth," says Pan, a manager at Zhejiang Grand Import and Export Co, adding he never expected the financial turbulence on Wall Street to have such a major impact in such a short period of time.

"The US financial market is not just the US market itself, it is the world financial market. What is good for the US is also good for every country, including China," says Guo Shuqing, chairman of China Construction Bank.

As the world's second largest owner of US debt, Chinese decision-makers are quite clear about this point and promised to "join hands" with other nations to tackle the deepest financial crisis since the 1930s. But the question is what kind of rescuer could China be?

"The biggest contribution we can make to the world economy under the current circumstances is to maintain China's strong, stable and relatively fast growth, and avoid big fluctuations," Premier Wen Jiabao said at the recently concluded 2008 Summer Davos in Tianjin.

And many economists echo his viewpoint.

High growth

"The most helpful measure China can take now is to maintain its robust growth, thus it could be a buffer for the rest of the world," says Louis Kuijs, senior economist of the World Bank's Beijing office.

Peng Wensheng, head of China Research at Barclays, says a sound economy and a stable financial market are the prerequisites for China to make any other moves to help ease the global storm.

So far, China has been relatively unscathed by the crisis. The country remains a huge net exporter of savings, boasting the world's largest foreign reserves of $1.8 trillion; the financial system is awash with cash; and capital account controls shield it from volatile outflows. But that does not means China will be immune to an economic downturn.

With the US and the EU accounting for about 40 percent of China's total exports, the country's exports are sensitive to weaker demand in industrialized countries. And lackluster exports will likely translate into poor performance of corporate earnings and weak confidence, dampening the investment appetite in export-oriented industries.

Meanwhile, China's double-digit GDP growth is expected to drop to around 9 percent in 2009. The benchmark Shanghai Composite index has dropped nearly 60 percent so far this year, and inflation rates remain above policymakers' comfort zone.

To boost China's economy, and also as part of concerted efforts by global central banking authorities to respond to the global crisis, the People's Bank of China on Wednesday cut the interest rate by 0.27 percentage points and the reserve requirement ratio by 0.5 percentage points. In addition, in order to boost domestic demand, the State Council scrapped the 5 percent individual income tax on savings interest earnings on Thursday.

More rate cuts?

And to boost the economy, the government is very likely to bring about a further easing of monetary policy and a more simulative fiscal policy in the form of tax cuts and extra government spending, experts say.

"We are expecting the central bank to take another two rate cuts by 0.27 percentage points each in the following six months," says Peng Wensheng.

While striving to keep China's economy on the right track, the government may also continue to buy US treasuries.

Though the central bank has denied media reports that China will buy up to $200 billion worth of US treasuries to help Washington combat the deepening financial crisis, experts say US treasuries remain a comparatively safe investment for China.

"We can hardly see any signs that China will stop buying US assets because of the financial chaos," says Louis Kuijs.

But Chinese financial investors, who used to top the list of "saviors" of Western financial institutions hungry for cash to see them through the global credit crisis, have kept their hands conspicuously in their pockets.

"We will tighten the purse strings and spend every penny carefully," Jiang Jianqing, chairman of the Industrial & Commercial Bank of China Ltd, told the Tianjin Davos gathering.

Jiang's comments indicate the world's largest lender by assets is unlikely to take stakes in ailing US financial institutions just because their prices are low.

"As a commercial bank, we don't favor bargain hunting. We will still focus on strategic investment rather than financial investment," he says.

Earlier this month, insurance firm Ping An shelved its plan to purchase a 50 percent stake in Fortis' asset management company. In April , Ping An and Fortis signed an agreement to buy the Fortis' asset management company for 2.15 billion euros.

In September, the government also abandoned a $10 billion plan by China Development Bank to buy Germany's Dresdner Bank from insurer Allianz.

Chinese financial institutions have a sound reason for their caution now. Almost every high-profile Chinese purchase of an overseas financial institution made last year is now deeply in the red. That includes China Investment Corp's stake in US private equity firm Blackstone, which has lost near ly50 per cent of its paper value; CIC's investment in Morgan Stanley, which is down almost 20 per cent; and CDB's investment in Barclays Bank, which has dropped more than 50 per cent. Ping An's investment in Franco-Belgian insurer Fortis has also lost more than half its value since it took the stake last November.

Food for thought

Chinese financial institutions are learning the hard way in overseas acquisitions. And the ongoing financial crisis also offers more food for thought.

China's financial professionals used to be envious of their foreign counterparts who could easily roll out very sophisticated products. But this time, they shall partly contribute to the country's efforts to limit the impact of the crisis.

"We should take a new approach to product innovation in the financial sector. Appropriate innovation shall be encouraged, but excessive innovation should be strictly regulated," says Yang Mingsheng, vice-chairman of China Insurance Regulatory Commission.

According to Fan Wenzhong, the China Banking Regulatory Commission's deputy research chief, the government may thwart new financial products including derivatives in order to avoid the subprime crisis that's wreaked havoc on the US credit market.

The regulator will instead improve risk-management practices and force banks to put checks in place to prevent Asia's second-biggest capital market from being roiled, he told a conference in Beijing.

"The subprime crisis is far from over, so China's regulator should enhance risk awareness and protection, putting the emphasis on ensuring financial stability rather than innovation," Fan says, adding China's financial reform is "not about speed, it's about stability".

For Michael Pettis, a professor at Peking University's Guanghua School of Management, derivatives can improve the efficiency of markets, but they cannot create an efficient and stable market.

It is only the existence of a diverse investor base, with plenty of fundamental and relative value investors, as well as some speculators, that can create a market that allocates capital efficiently, he says.

"In order for China to have such an investor base it is far more important that investors have better financial and economic information and a mechanism to enforce discipline on managers than shiny but dangerous derivative toys, which can exacerbate self-reinforcing behavior," says Pettis.

The crisis, on the other hand, also underscores the need for regulatory reform.

"The current financial crisis that has pushed major Wall Street players into bankruptcy means that leaders from the business world have called upon all countries to help improve matters. No one is an island. What we need is international cooperation," says Liu Mingkang, chairman of the China Banking Regulatory Commission.

The coordinated rate cuts taken by six central banks on Wednesday, in fact, also show international regulators' determination to strengthen their cooperation.

But Charles Dallara, managing director of the Institute of International Finance (IIF), a global association of financial services firms with more than 390 member institutions, believes that effective multilateral cooperation requires the reform of current global institutional arrangements.

"A new global regulatory coordinating body should be established to monitor and coordinate financial regulation and supervision on an internationally consistent and convergent basis, for systemically important firms," he says.

According to World Bank President Robert Zoellick, the Group of Seven (G7) developed nations is no longer effective and should be replaced by a steering group that includes emerging economic powers like China, India and Brazil.