KILL THE MESSENGER:

Don't Bank on China: A flawed audit, or all too accurate? (Gary Schmitt and Jared Feiger, 06/19/2006, Weekly Standard)

EARLY LAST MONTH, the accounting firm of Ernst and Young released a report concluding that the "nonperforming" loans of China's banks totaled $911 billion (40 percent of China's GDP)--a figure that far exceeds the Chinese government's own estimate of $164 billion. Beijing's response to the report was not subtle: "The report not only seriously distorts the actual assets quality of the Chinese banking sector," but "its conclusions are absurd and incomprehensible." Ernst and Young withdrew the report the next day, citing fundamental errors in the analysis.

But was the report really that flawed? Or was the firm's report more right than wrong, and retracted only because doing business in China these days requires pulling one's punches? [...]

In fact, the Ernst and Young report was not unique. Very few financial analysts believe China's "official" figure for NPLs. Most think the ratio of bad loans is considerably higher, maybe as high as 50 percent, according to Frank Song, director of Hong Kong University's China Financial Research Center. When suspected NPL figures are combined with prospective NPL estimates, the Ernst and Young report's figure of $900 billion is probably not wildly off the mark. In fact, previous estimates by Standard and Poor's and PricewaterhouseCoopers indicated that Chinese NPLs could very well top $800 billion; and Fitch Ratings has just put the number at close to $700 billion. Like any such assessment, it's possible that the Ernst and Young report was based on assumptions and analysis that could be called into question. But it's just as likely that the report's inconvenient timing was the reason it was retracted.