China's macro-economy might be on the mend - with growth and exports up, capital inflow reviving, and price deflation subsiding. But regulatory, sectoral and credit risks still abound, as recent developments show. Chinese authorities have recently been shoring up the exchange rate by tightening foreign exchange regulations.
As well as cracking down on smuggling, they have begun to review company compliance with rules on remitting export earnings. They will reward companies with good compliance records, including extension of the deadline on remitting export earnings from six months to one year, and by increasing the maximum amount of foreign exchange a company can keep from 15% to 30% of exports.
Conversely, companies with poor compliance records will have to pay higher interest rates on state bank credits, endure closer scrutiny of their records, and have to deposit into a special account funds equivalent to the tariff on imported inputs. The government examined 15,731 enterprises last year and rated 13% high-risk. Companies so rated run the risk of having their licence for foreign trade suspended.
These recent steps highlight the legal and regulatory risks of exporting to China, and emphasise the need to check the buyer carefully before entering a contract.
Another ITIC default: On 11 July, the Hainan International Trust and Investment Corporation (Hainan ITIC) defaulted on a seven-year Samurai bond. The announcement came just a fortnight after the Chinese government successfully launched its first Samurai bond since 1995, a Y430 billion (US$284 million) issue at 1.72%.
The problem at Hainan ITIC is likely to renew concerns about credit risk at ITICs, one of the weakest parts of China's financial system. Subjected to the stress of the Asian crisis, many ITICs were found to be mismanaged, and subsequently defaulted and declared bankruptcy. In the case of several, the central and provincial governments stepped in to honour all commitments to foreign creditors.
But with Guangdong ITIC, which closed in January 1999 owing US$4.7 billion (US$2 billion to foreigners), the authorities provided only roughly 40% compensation. This brought home to creditors prior warnings from Beijing that it was no longer providing a blanket sovereign guarantee to all state-owned entities, only to those it explicitly singled out.
The problems at China's ITICs matter to exporters as well as bondholders and financiers because ITICs in financial difficulty have been defaulting on obligations to suppliers as well as creditors. Creditors will now watch closely the words and deeds of central and provincial authorities concerning Hainan ITIC.
The default is unlikely to dent the borrowing capacity of the central government, but it will result in sub-national entities becoming subject to more searching scrutiny.