The slow path to financial reform

Talk of reform of China’s financial sector is in the air once again. Wen Jiabao says the monopoly of the four big state banks should end. Foreign banks and pension funds are to be allowed to invest more in the People’s Republic’s capital markets. The Prime Minister’s office is considering allowing citizens of the eastern manufacturing hub of Wenzhou to make direct investments abroad. Hardly a day seems to go by without a new comment in favour of internationalisation of the currency.

The big profits reported by the main state banks, which Wen said were earned “far too easily”, are prompting suggestions that they are strong enough to sustain the liberalization of interest rates and competition for depositors’ funds. Zhou Xiaochuan, Governor of the People’s Bank of China (PBoC) says conditions are ‘basically ripe’ for reform on the interest rate front. Li Daokui, who has just stepped down from the central bank’s monetary committee, described the state banks in March as ‘dinosaurs’ which can fend for themselves. ‘We don't need to worry about protecting them,’ he added.

Slowly does it. Senior figures at the People’s Bank are talking of the establishment of a deposit insurance system which would offer stability in the event of competition between banks in a liberalized regime. Higher payment for depositors would reverse the trend of negative interest rates and ‘financial repression’ of households which has marked China’s growth. As usual, their progress is likely to be slow, however. The powerful state enterprises will lobby against losing guaranteed access to cheap capital. A source told my colleague, Larry Brainard, that while a liberalization plan existed, including internationalization of the yuan, it would stretch over 15 years – and we are only in year one.

As for current monetary policy, having tamed inflation – at least for the time being – the central bank does not seem to see the need to swing towards major easing until it gets a better fix on the prospects for 2012 – the timing of Chinese New Year has distorted the data for the first two months.

PMI cheer. The PBoC was widely expected to move its foot from the brake pedal to the accelerator at the turn of the year as the rise in the CPI fell below 4 per cent. But easing, in the form of reductions in the reserve ratio requirement for banks, has been slow. The jump in the latest official purchasing managers’ index (PMI) to 53.1 from 51.0 in February will reinforce the belief that growth is doing all right without additional stimulus. However this index is weighted toward big state firms and the HSBC index which relies more on smaller companies remains below 50. In any case, data for the first two months of the year is upset by the timing of the Chinese New Year so any judgments should be deferred for at least a month.

No loan target was set for this year at the annual economic work conference in December and the new loan volume in the first two months of the year was less than anticipated. Meanwhile restrictions on the property market designed to curb speculation and bring down prices to make entry easier for first-time buyers remain in force – they are unlikely to be lifted until the second half of the year.

Lower target. This is all part and parcel of a macroeconomic policy which is ready to accept growth below the runaway levels of 2010-11. The central government’s annual target is now 7-8 per cent. That is certainly in line with the desire to move to a more sustainable expansion pattern that avoids the asset bubbles that characterized China’s boom years.

In its latest statement, the central bank highlighted the need to keep prices stable, saying it would pursue ‘prudent’ monetary policies while maintaining a ‘reasonable’ level of social financing – the measure designed to enable authorities to keep tabs on the credit flow by covering bank lending, loans from trust companies, corporate bond issuance and equity fundraising by non-financial companies. In February, it amounted to Rmb1.04 trillion (US$165 billion), up from Rmb955.9 in January and an increase of Rmb391.2 billion from a year earlier.

New model. The question is whether this approach can be maintained if Chinese exports are hit by sluggish demand from the West and companies come under growing cost pressure especially from the wage rises that are central to the government’s efforts to boost consumption. Companies want to defray labour costs by installing more productive machinery, but this takes capital. The pressure for easing will rise if the data turn bearish.

Wang Yang, Communist Party Secretary of Guangdong, China’s richest province, who is likely to be promoted to the Politburo Standing Committee at the Party Congress, has been talking about the need for a new economic model which is less fixated on crude GDP growth. But poorer inland regions are still bent on major expansion. The fall of Bo Xilai, the one-time shooting star of Chinese politics, is unlikely to slow down the growth of his former bastion of Chongqing – his political demise was the result of personal factors rather than a policy dispute. A dozen provinces have written growth of 12.5 per cent or higher into their five year plans. Weaning China off the high growth trajectory will take time, and test the determination of the new leadership moving in late this year.