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Hank Paulson says China risks ‘real damage’ to economy

The Honorable Henry M. Paulson, Jr.

(Financial Times) – The Chinese government risks “real damage” to the economy if it does not hasten reform of China’s state-owned enterprises and overhaul a debt-fuelled growth model, Hank Paulson has warned.

For more than two decades the former US Treasury secretary and Goldman Sachs chief has worked closely with pivotal Chinese political figures such as Wang Qishan, currently head of the Chinese Communist party’s anti-graft bureau, and visits Beijing frequently.

“Until the state-owned enterprises are put on a level and competitive playing field, it’s going to be difficult to have the marketplace work efficiently in some key sectors of the economy,” Mr Paulson told the Financial Times during a visit to the Chinese capital. “Reform of the SOEs has been moving too slowly.”

At a party conclave in 2013, President Xi Jinping pledged that market forces would play a “decisive role” in the Chinese economy, presaging what appeared to be a renewed drive to reform the state companies that still dominate critical sectors such as energy, finance and telecommunications.

But two years later there has been little progress on state-sector reform even as economic growth slows to its lowest level in a quarter-century and overall debt levels, now at 250 per cent of gross domestic product, continue to climb.

As a banker in the mid-1990s, Mr Paulson was involved in the initial public offerings of state giants such as China Mobile, now the world’s largest mobile network operator, on the Hong Kong stock exchange.

But the Chinese government typically retained more than three-quarters of their equity and is reluctant to allow private competition in so-called “strategic sectors”, let alone sell down its stakes in the companies that occupy the commanding heights of the economy

“[Jobs and growth] have to come from the private sector,” Mr Paulson said. “You have to free up sectors like finance and energy and telecommunications and really open up the services market. There will be real magic when they do that.”

In its effort to contain the country’s dangerous debt bubble, Beijing has recently authorised local governments to issue bonds for the first time in order to refinance an estimated Rmb22tn ($3.5tn) worth of off-balance sheet debts run up by local government finance vehicles. In the wake of the global financial crisis, the central government looked the other way as such vehicles borrowed heavily to invest in infrastructure and prop up overall economic growth.

“The leverage at municipal level is not sustainable,” Mr Paulson said. “There are obviously some real losses there. Today they are manageable, but the longer you prolong this there’s a much greater danger that this will spill over and do real damage to the economy.”

The former US Treasury secretary pointed to a Bilateral Investment Treaty currently being negotiated by Beijing and Washington as an important potential “lever” for further reform, similar to how then-Chinese premier Zhu Rongji used accession to the World Trade Organisation to force painful reforms on reluctant state firms and bureaucrats in the late 1990s.

According to people close to the BIT discussions, the two sides have recently exchanged “negative lists” that would clearly define which areas in each country are off-limits to foreign investment.

The US is pushing for “ambitious” or short negative lists that could rekindle enthusiasm among multinationals frustrated by Chinese market access restrictions and a much tougher regulatory environment.

“Because it’s become more challenging to do business in China, [US companies] are no longer such vocal advocates for the importance of the US-China economic relationship,” Mr Paulson said. “Congress is hearing about the problems rather than the opportunities.”


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