fima research center, university of hawai'i

FIMA Research Center, University of Hawai'i 1

China’s WTO Entry and Its Financial Sector Reforms

S. Ghon RheeS. Ghon RheeCollege of Business AdministrationCollege of Business Administration

University of Hawai’iUniversity of Hawai’i


Size of China’s Economy

2000 GDP ($billion)2000 GDP ($billion) Per Capita GDP ($)Per Capita GDP ($)

USA 9,873 $35,000Japan 4,750 37,000China 1,080 850Korea 457 10,940Taiwan 309 13,275Hong Kong 163 23,960Indonesia 135 640Thailand 116 2,010*Singapore 92 22,860Malaysia 90 3,850Philippines 66 845

* As of 1999


Asian Stock Market Performance

1995 – 19991995 – 1999 20002000 20012001 11 stst Quarter, 2002 Quarter, 2002

ChinaChina 16.10%16.10% 60.43% 60.43% -21.89%-21.89% -2.23%-2.23%

Hong KongHong Kong 11.8411.84 -14.39 -20.01-14.39 -20.01 -1.10-1.10

IndonesiaIndonesia 7.567.56 -38.50 -5.80-38.50 -5.80 22.8922.89

JapanJapan -0.81 -27.19 -23.52-0.81 -27.19 -23.52 4.574.57

KoreaKorea 0.010.01 -50.92-50.92 37.47 37.47 29.1029.10

MalaysiaMalaysia -3.51-3.51 -16.33 -16.33 2.42 2.42 8.62 8.62

PhilippinesPhilippines -5.11 -30.26 -21.84-5.11 -30.26 -21.84 20.1620.16

SingaporeSingapore 2.062.06 -22.29 -15.74-22.29 -15.74 11.0611.06

TaiwanTaiwan 3.473.47 -43.85 -43.85 17.0217.02 11.1011.10

Thailand Thailand -18.74 -44.14 -18.74 -44.14 12.8812.88 23.0723.07

USA USA 24.5624.56 -6.18 -7.10-6.18 -7.10 3.823.82


Expected Changes after WTO Entry 1.1. Banking SectorBanking Sector

a. Corporate Banking by foreign banks:a. Corporate Banking by foreign banks: 2 years2 years

b. Individual Banking by foreign banks:b. Individual Banking by foreign banks: 5 years5 years

2.2. Insurance SectorInsurance Sector a. Life Insurance: 50% foreign ownershipa. Life Insurance: 50% foreign ownershipb. Property & Casualty Insurance: Majority foreign b. Property & Casualty Insurance: Majority foreign

ownership ownership

3.3. Fund-Management Industry Fund-Management Industry a. Initially 33% foreign ownershipa. Initially 33% foreign ownershipb. 49% foreign ownership in 3 yearsb. 49% foreign ownership in 3 years

4.4. Subsidies and tax breaks for Subsidies and tax breaks for State-Owned State-Owned EnterprisesEnterprises (SOEs)(SOEs) must be phased out must be phased out


Unexpected Surprises after December 11 WTO Entry (1) 1.1. Banking SectorBanking Sector a.a. Foreign banks are allowed to open Foreign banks are allowed to open one branch per yearone branch per year..

Agricultural Bank of China:Agricultural Bank of China: 50,000 branches50,000 branches

Industrial and Commerce Bank of China:Industrial and Commerce Bank of China: 44,000 branches44,000 branches

Construction Bank:Construction Bank: 23,000 branches23,000 branches

Bank of China:Bank of China: 13,000 branches13,000 branches

b.b. Foreign bank branches’ loan guarantee income is shrinking Foreign bank branches’ loan guarantee income is shrinking fast because of local competition from Chinese banks fast because of local competition from Chinese banks

c.c. Return on Assets earned by foreign bank branches is only Return on Assets earned by foreign bank branches is only 0.03%.0.03%.

d.d. Still undefined, but equity capital requirement for foreign Still undefined, but equity capital requirement for foreign banks may be prohibitively high. banks may be prohibitively high.


Unexpected Surprises after December 11 WTO Entry (2) 2.2. Insurance SectorInsurance Sector a.a. New insurance licenses granted before December 11, 2001: New insurance licenses granted before December 11, 2001:

9 European insurers 9 European insurers

2 US insurers 2 US insurers

b.b. Government approval on each licensee’s insurance business Government approval on each licensee’s insurance business plan….plan….may take more than a year.may take more than a year.

c.c. The above insurance business plan needs local insurance The above insurance business plan needs local insurance company as a partner…..company as a partner…..Negotiations with potential local Negotiations with potential local partners may be lengthy and prolonged process.partners may be lengthy and prolonged process.

d.d. Purchase of a local partner’s equity share….Purchase of a local partner’s equity share….will be will be prohibitively expensive. prohibitively expensive.

e.e. Unresolved IssueUnresolved Issue: American International Group (AIG) has a : American International Group (AIG) has a wholly owned subsidiary in China. New licensees want an wholly owned subsidiary in China. New licensees want an “equal treatment”… “equal treatment”… WTO arbitration may take years.WTO arbitration may take years.


Unexpected Surprises after December 11 WTO Entry (3) 3.3. Fund-Management Industry Fund-Management Industry

Foreign fund management companies have Foreign fund management companies have two ways of two ways of establishing a joint venture:establishing a joint venture:

(i) (i) Buy a 33% stake in an existing domestic fund Buy a 33% stake in an existing domestic fund management company or management company or

(ii) (ii) create a joint venture with an existing domestic create a joint venture with an existing domestic securities company company.securities company company.

BUT, 15 domestic companies already have foreign partners.BUT, 15 domestic companies already have foreign partners.Government approval on the creation of a joint venture with Government approval on the creation of a joint venture with a local securities company may take years. a local securities company may take years.

This means that a 33% stake in a domestic fund management This means that a 33% stake in a domestic fund management company will carry a huge premium…..company will carry a huge premium…..too expensive to buy!too expensive to buy!

II


Weak Links in Chinese Economy

Chinese government has all the incentives Chinese government has all the incentives to create entry barriers for foreign firmsto create entry barriers for foreign firmsWhy?Why?Government officials are keenly aware of Government officials are keenly aware of weak linksweak links in its economy in its economy

1. Ailing State-Banking Sector 2. Struggling State-Owned Enterprises 3. Weaknesses in Capital Markets


Ailing State-Banking Sector (1) Current StatusCurrent Status

a. a. Big 4 state banks hold 75% of banking assets and 60% Big 4 state banks hold 75% of banking assets and 60% of bank depositsof bank deposits Agricultural Bank of ChinaAgricultural Bank of China Bank of ChinaBank of China Construction Bank of ChinaConstruction Bank of China Industrial and Commerce Bank of ChinaIndustrial and Commerce Bank of China

b.b. Non-Performing Loan Ratio Non-Performing Loan Ratio Official Statistics: Official Statistics: 25.37%25.37% Unofficial Estimates: Unofficial Estimates: 50% of total loans50% of total loans

Unofficial Estimate of NPLs: $350 billionUnofficial Estimate of NPLs: $350 billion($169 billion of NPLs transferred to four Asset ($169 billion of NPLs transferred to four Asset Management Companies in 1998)Management Companies in 1998)


Ailing State-Banking Sector (2) Current StatusCurrent Status

c.c. Poor Profitability: ROA=0.19% Poor Profitability: ROA=0.19% i.i. Interest receivable treated as income until loans areInterest receivable treated as income until loans are

declared default declared default ii.ii. Loan-loss provision is subject to 1% of outstandingLoan-loss provision is subject to 1% of outstanding

loan regardless of loan qualityloan regardless of loan quality

d.d. AMCs are a viable solution in China? AMCs are a viable solution in China? i.i.Virtually illiquid markets for real assetsVirtually illiquid markets for real assetsi.i. How can you sell SOEs?How can you sell SOEs?ii.ii. Approximately 60% of new loans (extended after Approximately 60% of new loans (extended after

NPLs were transferred to AMCs) still go to cash-NPLs were transferred to AMCs) still go to cash-strapped SOEs in the form of working capitalstrapped SOEs in the form of working capital

iii.iii. No legal framework is in place to facilitate sale of No legal framework is in place to facilitate sale of AMC assets to foreign investorsAMC assets to foreign investors


SOE Sector Problems (1)

Snap Shot of SOE SectorSnap Shot of SOE Sectora.a. 60% of industrial fixed assets 60% of industrial fixed assets

29% of industrial output29% of industrial outputb.b. Employs 55% of urban workersEmploys 55% of urban workersb.b. Average capacity utilization:Average capacity utilization:

Below 60% Below 60% TV: TV: 46.0%46.0% Telephone:Telephone: 51.4% 51.4%

VCR:VCR: 40.3%40.3% Air Con:Air Con: 33.5%33.5%


SOE Sector Problems (2)

c.c. Redundant Workers: 15 million Redundant Workers: 15 million or 10-15% of SOE work forceor 10-15% of SOE work force

d.d. Average debt ratio = 65 - 70%Average debt ratio = 65 - 70%

e.e. 1 out of 4 SOEs is money-losing1 out of 4 SOEs is money-losing

f.f. Plan to create 30-50 giant SOEs to Plan to create 30-50 giant SOEs to compete with foreign multinational compete with foreign multinational companies: companies:

Feasibility? Feasibility?

Another series of handouts to failing SOEs?Another series of handouts to failing SOEs?


Weaknesses in Capital Markets (1)a.a. Stock Market is Too SmallStock Market is Too Small

Total Market Capitalization:Total Market Capitalization: $550 billion$550 billion

Tradable Shares:Tradable Shares: $192 billion $192 billion Savings Deposits:Savings Deposits: $773 billion$773 billion

b.b. Investment Vehicles Are LimitedInvestment Vehicles Are LimitedNumber of Financial Products Owned by Number of Financial Products Owned by

Individual InvestorsIndividual Investors

Hong Kong:Hong Kong: 6.96.9

Korea:Korea: 5.25.2Taiwan:Taiwan: 4.44.4China:China: 3.73.7

Source: McKinsey & Co.Source: McKinsey & Co.


Weaknesses in Capital Markets (2)

c.c. Corporate Bond and Financial Derivatives Corporate Bond and Financial Derivatives Markets are UndevelopedMarkets are Undeveloped

1. 1. No corporate bond market No corporate bond market 2.2. Financial derivatives market for bond Financial derivatives market for bond

futures futures were banned due to excessive were banned due to excessive speculation speculation since 1995since 1995

3.3. Equity index futures and options are Equity index futures and options are needed needed for risk hedgingfor risk hedging

d.d. Improvement in Corporate Governance and Improvement in Corporate Governance and Financial Disclosure is desperately needed.Financial Disclosure is desperately needed.


To Sum Up

1. China will open the markets gradually at its own pace.

2. When the markets open, entry barriers will be high.

3. Financial sector will see the highest barriers.


Mahalo for You Attention!

fima research center, university of hawai'i

Economy & Finance