By Arthur Kroeber
Since 2006, financial reforms in China have been stuck in a rut. But for a number of reasons – most simply because Beijing now has little choice – we are now convinced that financial reform is going to be a far bigger part of the China story over the next three years.
The basic reason for this belief is not the intentions of regulators but brute economic reality.
Over the last 20 years, Chinese exports grew by 19 per cent a year in dollar terms, and average export growth was 27 per cent in 2002-08.
Those growth rates depended principally on debt-turbocharged consumption growth in the US, which will not return anytime soon. So over the next five years we are likely to see exports growing far more slowly than at any point in recent history — our guess is no more than 5 per cent on average in 2009-2012.
As a result, China will lose a substantial chunk of the productivity growth that has driven the economy over the past two decades.
In the short term, Beijing has substituted for this lost productivity growth by a vast monetary expansion. But to maintain GDP growth at the target rate of around 8 per cent beyond the end of next year, when the stimulus programme runs out, Beijing will need to undertake domestic market reforms that will generate a domestic source of productivity growth to replace what has been lost in exports.
In broad terms, two things can be done. One is to deregulate domestic service industries, many of which remain state-owned sinks of inefficiency. The other is to undertake large-scale financial sector reform, to improve capital allocation and thereby increase the amount of economic growth produced by each investment dollar.
Developments of recent months leave little doubt that China’s financial-sector supervisors, who are in the main a liberal bunch, have spotted this opportunity and are making a strong case for stepping up the pace of financial reform.
Especially interesting in this context were comments two weeks ago by Fang Xinghai, the Stanford-educated head of the Shanghai municipal government office charged with executing the April 14 State Council decree to turn Shanghai into an “international financial centre” by 2020.
There is absolutely no prospect of Shanghai overtaking Hong Kong as China’s chief international financial centre at any point in the next two or three decades. But Mr Fang made clear that the central purpose of the Shanghai IFC policy is domestic reform.
Shanghai’s internationalisation, he said, “can serve as a powerful lever to modernise China’s financial system”. And why is this necessary? “China’s financial system is good at financing the growth of SOEs and controlling systemic risk,” he said. “But it is not so good at allocating capital efficiently. This works fine so long as Chinese exports grow at 20 per cent a year. But this is gone forever.”
In other words, it seems clear that Mr Fang sees the Shanghai IFC policy as analogous to China’s entry into the World Trade Organisation eight years ago, which was used by reformers to engineer a host of domestic market reforms that would otherwise have been politically impossible.
Under the guise of creating a mainland financial centre to rival and eventually supplant Hong Kong, reformers will have an opportunity to create better functioning domestic capital markets and a far more diversified set of specialised financial institutions.
The expansion of China’s puny capital markets is already underway (see Dragonbeat’s previous blog post on this subject: “A moribund Chinese bond market springs to life”). Other imminent financial market reforms include:
* the establishment of dedicated small– and medium-sized enterprise (SME) lending units in major banks;
* the establishment of the long-awaited Growth Enterprise Board (GEB) on the Shenzhen Stock Exchange;
* the licencing of dedicated consumer finance companies, for which the China Banking Regulatory Commission has already issued draft rules;
* and experiments in the mortgaging of agricultural land – the first pilot programmes were launched in February. (Read our previous blog post on this subject: “China’s land-rights reform is vital but not enough”.)
There can be no doubt that the pace of financial sector reform is quickening, and will likely accelerate further in the coming year or two.