As the cliché goes, 1997 was a year of two halves for Hong Kong. As it began, lingering concern about the handover by Britain to China had largely subsided. The two leading indicators of sentiment, the stock market and property market, were both bullish. The Hang Seng Index closed at 15,197 points on June 30, about 50% higher than a year earlier. In May, the IPO of Beijing Enterprises, controlled by the Beijing municipal government, was more than 1,000 times oversubscribed. The application form for retail subscription ran out and was said to be up for sale at HK$100 each.
But the mood was to change sharply, with euphoria giving way to a region-wide financial crisis. While China’s robust growth saw it spared the worst of what was to follow, it gave impetus to state leaders’ push for reform. Crisis comes at the most unexpected time, yet is often the catalyst for change. China reacted to the Asian financial crisis by implementing much needed financial structural reform, while remaining cautious on its capital account for the next decade.
I transferred to the Hong Kong office of the then SBC Warburg at the end of 1996 and completed my first Chinese IPO in the first half of 1997 for Beijing Yanhua, a subsidiary of state-owned oil and gas group Sinopec. I was closely involved in the IPO of a Swiss speciality chemical company in 1995 and thought my sector knowledge and IPO experience would be helpful. They were, but the differences were stark. I quickly learned that the IPO of a Chinese state-owned enterprise was a means rather than an end. It was a precipitator for change. The SOE would need significant restructuring to meet listing requirements, and would then operate under the discipline of external market forces. There would be many instances of breaches and failures post-IPO, but in my mind, there is no question that the transparency fostered by the IPO process, alongside the new capital raised, played a significant and overall positive role in SOE and financial sector reform in the last two decades.
The turning point
On 1 July 1997, amidst the pomp and circumstance of the handover ceremony, the sovereignty of Hong Kong reverted to China. The following day, Thailand succumbed to the inevitable and floated the baht, having resisted weeks of intense pressure. The toxic mix of a credit bubble fuelled by foreign currency denominated debt, weak financial institutions, current account deficits, and fixed exchange rates unravelled quickly. The crisis swept South Korea, Indonesia, Malaysia and the Philippines. For a short while, Hong Kong felt immune with its strong banking regulatory framework and large foreign reserves, but the HK$/US$ peg and the stock market soon came under attack. In October, the Hang Seng Index fell 10% on one day, and the Hong Kong inter-bank rate was pushed to 280%. It culminated in unprecedented intervention: the Hong Kong Monetary Authority bought a significant quantity of Hang Seng constituent stocks in the following year.
China, with its extensive trade and investment links to the rest of Asia, was expected to be the next domino to fall. The Chinese economy suffered many structural problems similar to those of its neighbours, including a fragile bank-dominated financial system with poor regulation and supervision and over-leveraged SOEs. At the end of 1997, Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of China and China Construction Bank, China’s “big four”, had a collective capital adequacy ratio of only around 3.5%, compared to the Basel requirement of 8%. In conjunction with the large build-up of non-performing loans, the Chinese banking sector was most likely insolvent.
Yet China stood firm. Its GDP continued to grow at around 8%, and it remained successful in attracting foreign direct investment. Most importantly, China maintained a stable renminbi exchange rate. The currency was a pillar of strength during the crisis and contributed to Asia's faster than expected recovery. The fact China’s capital flows were dominated by long-term foreign direct investment, and that it enjoyed current account surpluses contributed to the renminbi’s resilience, but most important of all, its closed capital account insulated it against sharp massive short term capital movement.
The issue of when and to what extent capital accounts should be opened must be carefully considered by all developing countries.
A deep impression
Despite coming through relatively unscathed, the crisis left a deep impression on top Chinese leaders. It coincided with a change of government, with Zhu Rongji taking over as premier. Zhu had grappled with economic reform as vice-premier since 1991, including controlling the money supply, restructuring SOEs and reforming the tax system. The crisis reinforced the need for China to reform, particularly in the financial sector.
On taking over as premier on March 22, 1998, Zhu described his programme of reforms as "one guarantee" and "three achievements". Zhu's guarantee aimed to protect China from the devastating effects of the Asian financial crisis, and called for continued 8% growth, with inflation held below 3% and no devaluation of the renminbi. The “three achievements” were objectives to be pursued. Among SOE and social reforms, Zhu first and foremost called for an overhaul of China’s banking and financial system. The aim was to strengthen the role of China’s central bank while allowing commercial banks to operate both independently and professionally. He set a tight, even unrealistic, deadline of three years for this to be achieved.
There were of course many factors at play, but the fear of havoc caused by the Asian financial crisis certainly drove reform of the Chinese financial sector. The pressure China is facing now could lead to further major changes in the financial sector and foreign exchange regime.
David Chin joined SG Warburg in London in 1994 and moved to Hong Kong in 1996. After various mergers he remained with UBS, he remained with the business, holding several senior roles and working on a string of high-profile deals before retiring as head of Asia investment banking in 2015.
