The recent announcement by Liu Mingkang, president of the Bank of China, that nearly 30 percent of the BOC's loans are non-performing confirms what many experts have long believed: China's large state-owned banks are insolvent.
Two years ago the newly created asset management companies removed nearly 20 percent of "dead capital" from the balance sheets of the four large state-owned banks with the objective of putting those banks on a sound commercial basis. The problem is that those banks continue to lend primarily to lackluster state-owned enterprises (SOEs), and there is no incentive to let big banks fail or to allow privatization.
The Chinese Communist Party (CCP) is the de facto owner of the bulk of enterprise assets. As such, party officials have the opportunity to oversee all important financial transactions and to benefit from "state" ownership at the expense of taxpayers and the private sector. Rampant corruption is the result.
To end corruption, China needs to depoliticize capital markets by putting state assets up for sale, decontrolling interest rates, removing capital controls, and protecting private property rights. As long as the state dominates China's banking system and stock exchanges, domestic capital markets will fail to provide the liquidity needed for future growth and will continue to waste scarce capital.
Allowing the sale of shares in SOEs would work only if private owners could gain full control of enterprise assets. Half-way measures that leave the CCP as the chief stakeholder and boss won't solve the liquidity or insolvency problems. Individuals must be allowed to freely specialize in ownership and risk taking if capital is to be put to its highest-valued uses.
During the past decade or more, foreign-funded enterprises and private enterprises have been the driving force in China's economy. State enterprises as a whole continue to stagnate. So-called profits often disappear under close scrutiny, as happened last year when auditors found that many SOEs had falsified their books to meet official targets. China's accession to the World Trade Organization, expected later this year or early next year, will pave the way for financial market liberalization.
State-owned banks will be under increasing pressure to compete or fail. The only way they can compete is by "jumping into the sea of private enterprise." And that means allowing specialization and risk diversification according to market criteria and on the basis of private ownership.
According to Tao Liping, a senior economist with the Department of Economic Forecasting of the State Information Centre, "Twisted signals for capital demand and supply due to a fixed interest rate system set by the government have acted as a ball and chain on financial reform in China." Banks must be free to pay market rates on their deposits and charge market rates on their loans, if capital is to be efficiently allocated. The governor of China's central bank, Dai Xianlong, has promised to liberalize interest rates over the next three years -- step by step. How fast those steps will be taken will depend on internal and external pressures. The forward motion of globalization will inevitably clash with the inertia of the CCP. How far and fast the party bends under the momentum of the WTO will determine how soon economic liberalization will bring about political change.
Those who are looking for rapid financial liberalization in China should be patient: experience has taught that market institutions -- -the rule of law, private property, freedom of contract -- -emerge only gradually, especially when confronted with a political force as strong as the CCP. Yet the dismal condition of China's banks, enterprises, and pension funds make reform essential.
The problem is that real reform requires exactly what the party cannot sanction if it is to survive -- -namely, the full-fledged privatization of state assets, including the social security system. Privatization would mean the death of the last vestige of the centrally planned economy -- -investment planning. It would mean the end of party influence in all enterprises and the collapse of work units in urban areas. Without the pillar of state ownership, the party would have nothing left on which to rest its moral authority. It would no longer be the chief guardian of the "people's property." The people themselves would rule.
In his speech celebrating the 80th anniversary of the CCP, President Jiang Zemin hinted that he would welcome private entrepreneurs into the party. That is good news for freedom-loving people but bad news for the party. For if the party seeks "truth from facts," the fact is that private property and market liberalism, rather than state ownership and market socialism, are the surest means to promote lasting prosperity and peace -- in China and in the rest of the world.