- Joe Zhang met with visitors from GIC

Clients: As a former central banker and a former research analyst, how do you feel about the Chinese banks these days?

Joe: I always like the banks. I published at Economist, SCMP and Nekkei in the past five years to argue the points. I may sound ridiculous: they are well run. They are doing better each day thanks to the overbearing regulator and fierce competition. But the harsh reality is, four years into a recession, the banks are burdened with tons of NPLs - no less than in Italy or Spain. This is a systematic problem. The banks are a mirror to the economy and when the economy slows like this, even well-run banks cannot escape the hurt. We are approaching the bottom and the worst is not behind us. Many banks are probably running on empty, whatever their provisions for NPLs. Meanwhile, most non-bank financial institutions (trust companies, micro lenders, leasing companies, pawnshops, finance companies, P2P operators and factoring firms) are decimated. I have small personal stakes in five such firms and am nursing my wounds. The banks do relatively better thank NBFIs because of endless liquidity, much lower cost of funding and state backing.

But is a rotten banking sector scary? Are we headed to a train crash? Absolutely not! First, liquidity flows are strong at 11-12%, so the banks will take time to replenish their capital base, while still paying high dividends every year. Secondly, the banks are state-owned and the state does not hesitate to tell one good bank to take over a failing one, and if that is still not enough, the printing press is ready to flood the market with new equity. The Italian and Spanish officials wish they had that flexibility.

Finally, the absence of derivatives products can minimise contagion. After all, dealing with any bank is dealing with the government.

Clients: Are we going to see another bail-out and recapitalisation of the Chinese banking sector?

Joe: I do not think so. The exercise in 2000 proved to be a huge mistake and has caused a giant credit bubble ever since. In my view, there is no political will to repeat that exercise. It is unnecessary any way.

Clients: Surely this "Ponzi scheme" cannot go on forever?

Joe: Of course not. But in the past 39 years that is the path China has travelled down. We got huge inflation and its flip side: a currency devaluation. The crazy property price and the overvaluation of the domestic stock market are proof. Forget about the official CPI data. The true inflation in medical care, education, food, transportation and so on is scary if you look back five years, ten or twenty years. On the flip side, when I became a rooky central banker in 1983, one US dollar sold for two yuan. Today, 6.7 yuan. Shocking! This devaluation will go on and on. Because of fast rising M2.

Clients: Are we in for a drastic collapse of the yuan's value?

Joe: I do not think so. The state is still in good control of the economy. Secondly, China still records 50-60 billion dollars of trade surplus each month. Its factories are still fiercely competitive. A moderate but continued depreciation is what I expect.

Clients: What kind of Chinese stocks do you like?

Joe: I do not like anything. When you have the outlook of continued currency depreciation, the equity market is simply not very attractive. Any earnings growth is a wash against the currency devaluation. You can look elsewhere for China plays such as Glencore, Apple, etc. But anyone expecting a China credit crisis or a currency crisis is dead wrong.