China's incursions into Ladakh and fragile Chinese financial system

• Daulat Beg Oldi (DBO) is a very strategic corner on the old road from Ladakh to Yarkant in Xinjiang and adjacent to the Chinese road leading to the Karakorum pass to NonPakisani-occupied Kashmir. The Indian air force landing base at DBO enables India to replenish troops at this site. Until now China felt it could seize it at any time. But with India fortifying its border and establishing tanks in high altitude mountain passes, Chinese supremacy was being threatened. Is that why China acted before the visit of the Chinese Premier to India? Did they want possession on the ground before any talks begin so that they can magnanimously offer to step back after getting India to stop its fortifications?

1. China's Demands

Our fears were realized this week. China's main demand is that India stop its military activity in the Depsang plateau of Ladakh. According to a Times of India article:

• A third flag meeting between Indian and Chinese troops failed to break the deadlock between the two sides, with the Chinese insisting that India take down security structures in Fukche and Chumar in Ladakh without offering reciprocal commitments.
• The Chinese demanded dismantling of the border structures that have recently come up, particularly in Fukche and Chumar. In addition, they asked the Indians to take down their tents facing the Chinese troops. Only after the Indians complied would the Chinese contemplate their next step, refusing to give any commitment on a withdrawal.
• According to ITBP sources, the border structures China wants India to pull down are not even permanent posts but only metal sheet shelters set up for troops who conduct frequent patrols in the desolate region prone to icy winds. Seeking their removal is a broad hint that India roll back its increased patrolling and presence in the area.

This makes it clear that China wants India to essentially leave its border in Ladakh defenseless. This is classic Chinese behavior. So far, the response has been met with purely Indian behavior. According to the Hindustan Times article Army takes a step back in Ladakh,

• The army has stopped patrolling the eastern Ladakh areas beyond the site where Chinese troops have taken up positions — 19km into Indian territory — to avoid escalating the stand-off.
• It is understood that the government may have advised the army not to comb the sector so that diplomatic efforts are not hampered. “As of now, there are no plans to launch patrols behind the Chinese positions. Patrolling right up to our perception of the line of actual control may be seen as provocative,” a source said.

So, in response to Chinese army's intrusion into Indian territory, the Indian army, rather than surround them, has withdrawn their presence from India's own territory? Why? To avoid giving provocation or to avoid escalation? Isn't this exactly the reaction of an Indian wife to being slapped by a Pathan husband? She is trained to remain quiet, walk around softly lest she anger the husband further. Now you understand why we used this Pathan husband - Indian wife analogy as the first of our two analogies last week. 

2. Chinese Doctrine  

Getting back to strategy, this is exactly how the Chinese behave strategically and militarily. We remind readers of our review of The Perils of Proximity, the authoritative book on China-Japan relationship. The last section of  that review article included the following comment about Chinese doctrine: 

• "Thomas Christensen finds that China has used force most frequently when it perceived an opening window of vulnerability or a closing of opportunity. When Beijing assesses a tactical military situation,it may choose to fight even if the adversary has the advantage if it is clear the advantage is only going to grow." (emphasis ours).
  

Frankly, both fit here: 

1. With India increasing its defense fortifications in the area, the Chinese were clearly concerned that their present advantage would close. 
   
2. Secondly, the Chinese are master tacticians. They probably saw an opening of vulnerability in today's Indian Government beset with protests, weakened by corruption scandals and preoccupied with 2014 elections. In addition, having met Chief Minister Narendra Modi in Beijing last year, the Chinese leadership might have perceived a window of opportunity with today's weakened Government. 
   

So the Chinese acted with deliberation, resolve, and in accordance with their doctrine, a doctrine that has been very successful against India since 1950.  The Chinese also know that Indian Government is usually desperate to show peaceful relations with China and they have created similar storms in the past before high level visits to gain maximum advantage. 

Given all the above, it boggles the mind that Indian Government & the Indian Army were so unprepared for some adventure from China. Had they been even slightly prepared, they would have had counter-measures ready to be implemented immediately. But neither planning nor resolve have been India's strength. 

Go back and look at the last 1,000 years. Indians are never prepared and are always stunned when an attack or intrusion takes place., regardless of whether it is Kargil in 1999 or Ghori in 1198 or any of the Pathan/Mughal/Iranian/British invaders in between.   

Frankly, it is not just the government. The fault lies with Indian society, with all the Indian people, whether they are British-obedient Indians or Pathan/Mughal colonized Indians or proud Indians. Today's Indian society is brainwashed with the belief that economy & technology are only what matter in today's world and wars belong to the past. So there is no vigilance in India's society, no monitoring of external danger by India's TV & Print media and utter negligence by Indian politicians whether within Government or outside Government. 

So India keeps getting slapped by Chinese leaders like the pathetic Makhichand slapped publicly by Chulbul Pande. 

3. Xi JinPing

We are stunned and deeply troubled by the pathetic coverage of Xi Jinping in Indian media. As in the 1950s,  Indian media has lapped up Xi's soothing words about a new 5-point China-India friendship plan. But then intelligence or ability are not traits of India's screamingly hysterical TV anchors or columnists. 

What is tragic is Indian Government's own supine negligence. Because it has been evident to any interested novice that Xi Jinping is deliberate in building a military powerbase for his presidency. His basic stance was evident in his comments during his tour of military forces in southern Guandong province in December:

• "We must ensure that our  troops are ready when called upon, that they are fully capable of fighting, and that they must win every war,"
  

This was December 2012 and yet the Indian Government was found unprepared when the Chinese Army intruded into Indian territory.  

4. Divine Matrix exercise of the Indian Army in 2009

Readers might recall that back on April 4, 2009 we wrote about a secret exercise of the Indian Army named "Divine Matrix". In that exercise, the Indian Army had visualized a war scenario with China by 2017:

•  “A misadventure by China is very much within the realm of possibility with Beijing trying to position itself as the only power in the region. There will be no nuclear warfare but a short, swift war that could have menacing consequences for India,”

So why was India prepared for a Chinese intrusion?

5. Sexist Analogy?

An Indian commentator termed our analogy of China-India as a Pathan husband slapping his Indian wife as sexist. That negative comment was very revealing to us. It showed that Indian commentators really don't understand much and react in a dumb platitudinous matter.  

When will India understand that Ghazni. Ghori, Khilji, Babur, Clive, Dalhousie, Elphinstone were alpha males, males who knew how to attack, pillage, humiliate and kill their opponents. If any of them had been called sexist, they would have taken it as a compliment. So would Xi Jinping and Vladimir Putin.

Indian society is the one with a female worshiping effeminate culture. Look who is India's unquestioned ruler today, an Italian immigrant woman named Sonia. The entire Indian government bows to her and worships her feet, both figuratively and sometimes physically. 

Unfortunately, the analogy between an alpha-male husband and a passive, suffer-in-silence wife fits the relationship between Chinese leaders and Indian leaders. Already, Prime Minister Manmohan Singh has already reacted like an obediently passive wife and made soothing noises about the Chinese intrusion being "a localized affair". 

By the way, who knows Indians better than the 19th century British, right? After all, a private British company came to trade without an army or money. Then this British company conquered the entire Indian subcontinent with hired Indian soldiers and borrowed financing from Indian Baniyas. And how did the British scholars of that period describe Indians? And aren't these British scholars studied with reverence in today's Indian schools?

• (scholar James) Mill had declared that "the Hindu, like the eunuch, excels in the qualities of a slave,"³⁷ - page xxiv
• popular historian Thomas Babington Macaulay had dwelt on the emasculation of Bengalis, who'd "found the little finger of the Company thicker than the loins" of the prince Siraj-ud-daula³⁷.- page xxiv
• (Rudyard Kipling) - It was the Bengali male's "extraordinary effeminacy", as evinced by his diminutive physique, his flowing clothes, and his worship of goddesses, that best illustrated why he, and by extension India, had to be guided by the firm, benevolent hand of a supremely masculine race."³⁷ - page xxiv
• "All those arts which are the natural defence of the weak are more familiar to this subtle race than to...the Jew of the dark ages," Macaulay had written of the Bengali, who compressed into his diminutive form every loathsome aspect of the Hindu.⁴¹ - page 235

So, dear English-educated Indian commentator, isn't the sexist "Pathan husband - Indian wife" analogy perfect for China-India? 

• While many in the West view China as a centralized one-party dictatorship, Dr. Walter says this is simplistic and wrong.  China’s consolidated power structure is made up of a complex web of interconnected entities, each with their own interest, and each with their own levers of power.  Dr. Walter compares the China of today to Europe.  Even though the nation is run by a central Party,much of the actual power is de-centralized across geographic and economic mini-centers.  

• And Power is what it is all about.  The challenge every political official faces is, How to stay in power?  The answer in every case is, Create economic growth and do it in a way that reinforces social stability.  The average Western observer may not appreciate how delicate China’s social fabric feels.  If the head that wears a crown lies uneasy, imagine being one of a small cluster of crowned heads – all with competing interests – with 1.3 billion potentially dissatisfied subjects.  Clearly, it’s not all dumplings and wine at Central Party HQ.

• The big banks are the pillar of China’s economic system, providing the funding that drives economic programs.  Individual Chinese do not deposit their money in small local banks, because they know local institutions are essentially powerless.  China’s five biggest banks hold over 60% of the nation’s deposits, with a more than equivalent share of influence.  

• Policy makers pushed for greater corporate capital raising in recent years, in their efforts to stimulate growth.  The banks dominated the marketplace, but without a developed capital market, “capital expansion” was really expansion further into the banks’ balance sheets.  New bank loans accounted for over 85% of capital raised in 2009 – the peak year for corporate capital expansion, with over 11 billion reminbi (RMB ) raised.  The balance was corporate bonds – zero equity capital was raised that year – and most of the bonds are, in turn, bought by the large banks.  Where does the money go?

• Seventy-five percent of corporate bonds are issued by State-Owned Enterprises (SOEs), while 20% go to the financial platforms of a host of joint ventures and other private financial vehicles, much of it in connection with local economic programs.  Financing from private deposits is already used up, and there is little or no equity financing, making China’s economy look like the serpent that swallows its own tail.   
  

• The drain on bank balance sheets is exacerbated by China’s rating agencies, which rate all corporate bond issues and corporate loans as investment grade.  These means the banks have to make only minimal loss provisions – or none at all – as they continue to expand outstanding credit to an ever-larger percentage of their asset base.

• There is no liquid trading market for corporate bonds, which means the prices don’t fluctuate.  “Marking to market” can only happen if the market actually exists.  With no trading in the bonds, the prices don’t change, so banks don’t have to reflect lower asset values on their balance sheets.

• The banks over-lent in the 1980s and were reined in during the 1990s, giving way to a brief inflationary period in the early 2000s, all while China’s central planners were trying to figure out how to best grow their economy to keep the largest numbers of citizens content.

• Now the banks are lending but not generating economic growth.  The central authorities recognize that banking may no longer be the economic solution for China and the discussion now is aboutchanging business models.

• Any business model requires fundamental underpinnings.  With the banks so dominant in China’s economy, Dr. Walter says corporate governance is a glaring weak point.

• Even though the major banks are listed on the Hong Kong exchange, and even though they are subject to public company audits, Dr. Walter says the real management of the banks is not their boards of directors, but the Party committee.  In fact, until recently it was not even Beijing, but regional party committees who directed bank operations, as so much lending was tied to regional projects.  

• In the past, local officials or Party cadres who wanted to advance their careers would lean on banks to over-lend locally to drive economic growth in their region.  In the 1980s, when the banks prepared to list on the Hong Kong exchange, control was centralized to Beijing.  In 2008, when the central Party announced their intention to lend in order to stimulate the economy, provincial party officials went into a feeding frenzy.  Local projects were proposed and approved left and right and, says Dr. Walter, “the banks lent like crazy.”  In this scenario, Beijing lost a significant amount of influence over the banking system even while nominally retaining control.

• China still has far to go before it develops credible capital markets.  Dr. Walter calls China’s stock market an economic “afterthought.”  The stock markets were primarily a policy tool to permit China’s SOEs to incorporate and establish a presence and a valuation for their securities.  Out of tens of millions of trading accounts on China’s exchanges, only about 7% actually execute transactions.  

• China’s big banks are the economy.  This goes beyond Too Big To Fail.  The Chinese will not allow their big banks to fail.  When Lehman was put into bankruptcy, says Dr. Walter, the Chinese were flabbergasted.  They simply could not understand how the US government could allow a “flagship name” institution to fail.  Could it be, they wondered, the US was actually too weak to rescue a major investment bank?  

• China will have a difficult time creating a financial marketplace.  Until it does, there will be no market discipline to accurately price its securities, bonds and loans, to attract serious inflows of foreign capital, or to drive growth.

• Government policy has distorted the pricing of bank portfolios.  Currently, there is a 3% differential in yields between corporate loans and bonds.  Since the same entities that issue bonds also take out bank loans, there is no incentive to create a bond trading market.  The banks continue to dominate – or to be stuck with – the lion’s share of Chinese debt.  Chinese households own less than 5% of the nation’s bonds, while foreigners own less than 2%.  Despite noises from such potential buyers as Australia, there is no significant outside market to create accurate pricing or provide liquidity for China’s banks.

• Without liquid markets, how do the banks stay afloat?  Remember that the bonds don’t trade – which means no liquidity for the banks (bad) – but it also means the price of the bonds in their portfolios never changes (good!)  Far better[easier] than issuing new bonds to pay off the old ones, China’s banks simply extend maturities – extend and pretend.

• This is simply [at worst] unsustainable [and at best economically unhealthy].  All the more so as Chinese local governments and the SOEs turn out to be bad credit risks.  In the 1990s, says Dr. Walter, banks loans rose as high as 75% of GDP – and up to 25% of loans went bad.  Now, the level of problem loans has declined slightly – around 20% in 2010 – but total loans have soared to over 130% of GDP.

• In the past decade, the more banks have loaned, the slower China’s economy has grown.  Lending has continued to flow to massive projects driven more by concerns over social stability than by economic justification.  Local debt continues to pile up – by some estimates it could be up to RMB 16 trillion today – a RMB 6 trillion increase over 2011 – on a current GDP of about RMB 45 trillion.  China has borrowed itself into a quagmire, by borrowing from itself for dubious projects.  It has perhaps not been more profligate in its misuse of debt than the West – indeed, Dr. Walter says a global economic recovery will [would] play a significant role in revitalizing China’s economy.  

• China’s Party officials remain deeply concerned over potential civil unrest and will continue to focus on local economic programs.  But the country is already significantly overbuilt.  At the same time, economic inequality continues to grow.

• Some 300 million people have been brought up out of poverty in China in the last 20 years – but that leaves one billion people who have not.  Central Party officials and their hangers-on will continue to grow richer, as will those living and working in the prosperous coastal regions.  Dr. Walter expects the rest of the society to decline economically, leading to ever-greater inequality.  China’s aging population does not have Medicare or 401(K) accounts – they have only their savings – and less of a younger generation to rely on, thanks to years of the one child per family policy.  

• The difficulty of establishing a consumer-based economy under these circumstances could pale next to a very real possibility of severe social problems, and possible social unrest, in the coming 3-5 years.  This has Party officials constantly looking over their shoulders.

• Dr. Walter says China’s banks are not headed for collapse.  There are plenty of assets available to fill the gap left by an unreliable financial system.  But China does not have a good record on financial reform.  Its most significant players – the SOEs, the banks, and the local party organizations – are opposed to it, as each sees the current dysfunction as working to their advantage.  It will take ingenuity and cooperation and the forceful exercise of political authority to bring meaningful change, and the key to how well and how quickly the Chinese ship can be righted lies with the personalities at the center.

• Walter says Xi Jinping, the new General Secretary, is an excellent man for the job: he is outgoing, relaxed and confident in public, and has the support of the military.  But one man is not sufficient to change the course of the gargantuan ship of the Chinese state.