Wednesday, May 24, 2006

Erroneous report? Not so fast!

Yesterday, Financial Times columnist Victor Mallet made an interesting point about Western companies' cravenness when faced with Chinese censorship, and notes that it isn't limited to media and technology firms:
But what if Beijing’s interference were to extend to the suppression of the economic and financial information on which investors rely to make business decisions? Would executives in China feel as sanguine as they do today about curbs on free speech?
The publication and humiliating withdrawal of Ernst & Young's global report on non-performing loans this month serves as a warning that open discussion of the economy – especially politically sensitive matters such as the health of the big banks – is, in fact, already compromised.
In the China section of its report on May 3, E&Y estimated the total exposure of China's financial system to bad loans to be $911bn. That included $358bn – nearly three times the official figure – at the big four state banks. Nine days later, E&Y withdrew the whole report, saying the $358bn figure was "factually erroneous" and lamenting the absence of the "normal internal review and approval process" before publication.
E&Y's explanation is hard to swallow, if only because it suggests the organisation was unusually incompetent at its work as well as unusually lax with its controls. A more likely reason is that E&Y is trying to protect its China business and mollify the People's Bank of China, the central bank, which had publicly called the report "ridiculous and barely understandable" hours before E&Y backed down.
E&Y's report on China, however, was carefully worded. It noted the scarcity of accurate information in "a banking culture that resists openness" and referred to bad loans that could lurk in the category of "special mention" credits not included in official non-performing loan ratios.
It should not be forgotten that E&Y described its $911bn estimate as "conservative" or that its concerns (although not the exact numbers) are shared by PwC, McKinsey Global Institute and the International Monetary Fund.
At worst, E&Y put out a report that could be criticised and debated – not one that should have been dismissed out of hand.
That makes it all the sadder that E&Y backed down. Much more is at stake than the fate of the state banks, although it is easy to see signs of frenzied over-investment in property and infrastructure financed by the banks in China's big cities. The underlying problem is Beijing's determination to curb the free flow of awkward information. That will ultimately threaten China's economic modernisation as well as its political development.
Do read the whole thing. No doubt most people will remember E&Y's retraction and not the valid points it had made. Even so, sooner or later China's problems will come to light, and thankfully they do not bode well for the "It's the next superpower!" cheerleading squad.

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