Dealing with Financial Distress The following is an archived interview by Caixinâ€™s chief editor with then-Guangdong official and now Politburo member Wang Qishan on the first bankruptcy of a Chinese financial institution (Guangzhou) -- News of that a state-owned company in Guangdong Province had collapsed sent shockwaves through the Chinese and international business communities in 1999. It was not the first time a company had had trouble repaying debt, but in previous cases the government had stepped in and assumed repayment responsibility. Guangdong International Trust and Investment Corp. (GITIC) was the first Chinese financial institution to go bankrupt. The firm once carried extra weight in China's commercial sector because it was one of the so-called "window companies," set up to raise funds from overseas investors. The companies enjoyed the government's loan guarantees when market reforms were initiated. But some failed because they borrowed recklessly after the guarantees were gone. Wang Qishan, current member of the Standing Committee of the Politburo of the CPC Central Committee, was the man who oversaw the winding down of GITIC at the turn of the century. As the then-executive vice governor of Guangdong Province in 1999, he said the firm's bankruptcy was a painful step that had to be taken to solve an imminent debt crisis. It entailed a heavy cost for both the provincial government and domestic and foreign investors, he said, but in the long run, the bankruptcy was a milestone towards building an economy in which the government would take a backseat to companies that are held accountable for their own losses and gains. Caixin: GITIC was a state-owned company. Why didn't the government bail it out and help it repay the debt? Wang Qishan: From the holistic view of China's reform and economic development, shutting down GITIC and allowing it to go bankrupt represented a controllable solution to the firm's debt crisis. It may have turned out be a good thing, because it shows that Chinese financial institutions can go bankrupt according to laws and market principles. This marks significant progress towards building a real market economy. It also reflects a historic change in the government's thinking. The first national Financial Work Conference, held in 1997, raised the idea that local governments must take responsibility for financial institutions within their own jurisdiction. Before this meeting, it was once the norm that the central government would bail out all troubled financial institutions and help repay their debts. Now it is clear that whoever borrowed money needs to make the repayment on their own. This principle helps local governments and enterprises build an accountability mechanism regarding loans. Going forward, the credibility of the state, local governments and enterprises will be assessed on this. Did the provincial government carefully consider the likely consequences? How does it plan to counter the impact? We're ready to pay the necessary price. The primary consequence is that we lose "credit" in the old sense, but the old credit was gained at the expense of violations of laws and regulations. It will take time to build new credibility. Guangdong has the courage to pay the cost. GITIC's bankruptcy was the beginning of a new stage. Such a radical change from the past inevitably comes at a high expense. It is impossible to avoid all costs as the economy becomes more market-oriented and ruled by law. But we need to use all possible means to minimize the costs. In this case, both the Guangdong government and the firm's creditors, including foreign investors, need to pay a price. As far as I know, a large portion of foreign banks that lend to GITIC and other Chinese companies had not performed due diligence or assessed the risk of projects when they made loans. They were counting on local governments' implicit guarantee to repay corporate loans, mistaking their empty promise for the nation's sovereign credit. And yet they demanded higher interest than on China's sovereign debts. But the so-called window companies including GITIC were seen as having semi-sovereign-debt ratings by overseas investors. What's your take on that and how might China's sovereign credit be affected? Window companies are a unique historical phenomenon. When China embarked on the reform journey as a centrally-planned economy, sovereign credit was the only credit we could use to borrow from overseas. Window companies were established against the backdrop. These were legally independent entities backed by the government. When they were created, it was still a theory in process about how they should operate. But one point is clear: These companies were meant to facilitate the development of corporate credit, rather than build an alternative sovereign credit. GITIC's borrowing costs were higher than sovereign debt. Companies of its kind were a transitional arrangement, and their credit worthiness was between those for the government and common enterprises. Relying on this type of credit, GITIC has contributed a great deal to Guangdong's social and economic development. But the utility of window companies changed over the years, as companies became more independent from local governments. By the late 1990s, although window companies were still associated with the government, Beijing has prohibited local governments from guaranteeing window companies' debts using their fiscal revenue. The so-called government guarantee became more and more of an empty promise. However, companies including GITIC continue to abuse the window company concept. Its debt issuance documents stated explicitly on the cover that the bonds were not guaranteed by the central or Guangdong government, but the contents inside were usually intentionally phrased to be misleading. The companies themselves were to blame for reckless operation and investment failures, but foreign investors and banks should take their share of blame as well because they went loose on examining the companies' financials based on false perceptions of window companies' credit. China's sovereign credit will emerge stronger after GITIC's default, because it will now be separated from those of companies whose debts were assumed to be the government's obligation. What can be learned from GITIC's failure? First, it is imperative to stop local governments from playing such a large role in financing and investment. Efforts had been underway for a long time before GITIC's failure to push for the separation between governments and enterprises. Companies should be given a leading role in a market economy. GITIC's collapse should serve as a constant reminder for the Guangdong government to not deviate from the principle. Institutions and the regulatory framework must also be changed to adapt to the new environment. It will be impossible to continue relying on the model of window companies to raise capital. We will step up efforts to build a new credit system, one that relies on companies themselves based on sound management and healthy financial returns. Guangdong has been a forerunner in this respect over the past 20 years, and we intend to keep up the momentum with more innovation. Dealing with Financial Distress - ************************************** A glimpse of the financial state of China?