China Challenges directs us to an article in The Australian about the alarming amount of non—performing loans being carried on the books of Chinese financial firms. The amount is thought to exceed one trillion dollars, or a staggering 40% of GDP.

Politics and corruption are to blame. The Australian comments

The revelation shows that half—hearted reforms have addressed merely the symptoms of China's financial fragility. Poor business practices are blamed for NPLs but the real source is political. As long as the communist party relies on state—controlled banks to maintain an unreformed core of a command economy, Chinese banks will make more bad loans.

Systemic economic waste, bank lending practices, political patronage and the survival of a one—party state are inseparably intertwined in China. The party can no longer secure the loyalty of its 70 million members through ideological indoctrination; instead, it uses material perks and careers in government and state—owned enterprises (SOEs). That is why, after nearly 30 years of economic reform, the state still owns 56 per cent of the fixed capital stock. The unreformed core of the economy is the base of political patronage.

Government figures show that, in 2003, 5.3 million party officials held executive positions in SOEs. The party appoints about 80 per cent of the chief executives in SOEs and 56 per cent of all senior corporate executives. Recent corporate governance reforms, Western—style on paper but not in substance, have made no difference. At 70 per cent of the large and medium—sized SOEs ostensibly restructured into Western—style companies, members of party committees were appointed to the boards. Painful restructuring appears to have spared this elite. China has shed more than 30 million industrial jobs since the late 1990s but few party officials have become jobless.

Our contributor Rosslyn Smith adds:

That sounds akin to the way American managers of public companies in the 1990s used a ton of accounting tricks to prop up quarterly earnings in order to keep their stock market prices high.  As we know, they pulled off for a while, but eventually reality (i.e. cash flow) caught up.  The article does not speculate on what may happen when a similar reality catches up to China.   

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