GITIC’s empty coffers

FOR avowedly prudent western bankers it is an acute embarrassment; but for China's attempts to build a modern financial system, it marks a watershed. On January 11th the Guangdong International Trust & Investment Corporation (GITIC) was forced by the central government to file for bankruptcy. This is, by far, China's biggest-ever corporate failure—though there are worries that the record may soon be challenged by another, non-financial, company, Guangdong Enterprises (GDE), which is under the same provincial government.

Current guesses are that GITIC's liabilities outstrip its $2.6 billion in assets by more than half. It owes foreigners more than $1 billion. Western lenders now think they will be lucky to recover 60 cents in the dollar. The many banks that lent to GITIC without registering their loans with the central authorities may get no cents at all.

That the laws of prudent banking apply even in China has come as a shock to foreigners. They had been assured by central-bank officials last October, when GITIC was suddenly shut down, that registered lenders would be at the front of the creditors' queue and would get their money back. But it has turned out that all the loan registrations, state and provincial guarantees, and “comfort letters” with which foreign loans are trussed up count for little.

The foreigners are indignant. But by forcing GITIC into bankruptcy, the central government is recognising the alarming hazards of guaranteeing the obligations of murky state borrowers. One senior official admits that the GITIC case posed a dilemma. On the one hand, he says, China counts heavily on foreign finance. On the other, the easy availability of foreign credit, in particular to the largest of China's 240-odd trust and investment corporations (ITICs), has led to such wayward—and often corrupt—investments that the whole fabric of China's development is at risk. Political, as much as economic, control, had to be reasserted.

The government says it plans to cut drastically the number of ITICs. They were set up in the early days of reform as the foreign-investment windows of provinces and localities. But, as the senior official admits, with localities not allowed to run budget deficits, ITICs have become the “treasury arms of local government”. When the returns from pet projects (power stations, toll roads and the like) began to fall, they jumped into ever riskier businesses, gaily sprinkling loan guarantees of their own about, and plunging into share-trading and property development. GITIC, for instance, is the biggest property developer in southern China, with 200 projects and 10m square metres of space.

Nor are the problems confined to Guangdong. GITIC's problems are those of some other ITICs writ not that much larger. The one in the neighbouring province of Fujian is reckoned to be in nearly as much trouble as GITIC.

The mood has now turned brutally against most Chinese credits, including “red chips”, state-controlled entities registered and listed in Hong Kong: the index of their shares fell by more than 12% on January 13th alone. The GITIC collapse will cast its shadow for some time to come. Most foreign banks—not just the Japanese, Hong Kong and European ones that were GITIC's main casualties—are rethinking their China strategies. Worries will mount as GITIC's case drags through the courts. China's bankruptcy law, passed in 1986 but scarcely tested, seems to rank western banks' unsecured lending behind not only secured lenders, but also the claims of employees and tax authorities—another reason why western bankers may in future be quicker to pull the plug on troubled Chinese companies.

The government is betting that the crisis will not damage the standing of China's sovereign debts. It may even be a boost, since the government will no longer be seen to stand behind every indebted state company. But the authorities' main concern is not about foreign lenders so much as domestic depositors. Their flight would lay bare the emperor's clothes of China's insolvent banking system. Although the ITICs account for less than 5% of all China's deposits, and individuals are supposedly not allowed to put money in them, that did not stop several thousand individuals from depositing money with GITIC. The government intends to pay them all back.

Foreign lenders to Guangdong Enterprises are hoping they will be so lucky. GDE is also in big trouble. It has been asking foreign bankers to reschedule its nearly $3 billion of debts. Once again, this time with more grounds for optimism, the bankers are hoping that the central government will allow the province to come to the rescue. If not, say the more hysterical, foreign lending to China is well and truly finished. Or perhaps only the more foolhardy kind.