Finance is the most underdeveloped and least reformed sector in China, and yet it is the very sector where large breakthroughs are needed.
Author: Mo Lin, Journalist of the Magazine Chinese Entrepreneur
The National School of Development at Peking University where Yang Yao is Dean, once proposed a controversial prediction: In the future, by roughly 2020, China will surpass the US as the world's largest economy. Although today China’s economy is cloaked in a shroud of numerous uncertainties, Yang Yao claims that he is still convinced of the above forecast.
But a growth in economic mass doesn’t solve the structural problems, and topics related to China’s economic structural reform are still quite worrying.
"We are all very focused on the launch of the new policies at the Third Plenary Session of the 18th Central Committee. Discussions on topics such as the household registration system, urbanization, FTZ, financial reform, etc, are very enthusiastic. In my opinion, with regards to China’s economic restructuring in the next decade, the biggest risk is in the financial sector. Finance is the most underdeveloped and least reformed sector in China, and yet it should be in this very sector where large breakthroughs lie." Yang Yao told the Chinese Entrepreneur.
In Yang Yao’s opinion, the concept of FTA has been passionately adored by the Chinese, so much so that the focus has detrimentally been only on opening up China to the international market, whereas the country's financial system has yet to establish an open domestic market or the qualification of private finance.
What is the economic situation in the United States and Europe?
Yang Yao: Up to this moment, the news claiming that manufacturing is returning to the US has merely been a case of hyped up reporting. The employment rate and other related data do not support this conclusion. Economic recovery in the US hasn't created enough jobs, so it is still too early to talk about a full recovery of the US economy. What we cannot deny is that because the US government had borne the burden of providing assistance to unemployed workers during the crisis, the profit reports of US companies in the past few years have been impressive. Coupled with the emergence of shale gas-related industries, the US which was enveloped in the debt crisis has already climbed back onto the road of slow recovery.
Europe is also on a path to slow recovery as the murky clouds of the European debt crisis are slowly dispersing. Germany is the main reason for Europe’s recovery. Angela Merkel who has just won re-election is a great statesman. Under her influence, European political forces adopted an approach similar to the “cliff policy”, allowing southern Europe to stay always near the brink of collapse and yet without collapsing, thus contributing to reform. Perhaps Merkel’s intent is to force the European people to be as industrious as the Germans, however the results may not be as she envisioned.
This year, the US and Europe showed very good signs of recovery, yet China’s economic downturn was worrisome. Does this mean that the golden decade of growth (1271.10, -2.40, -0.19%) in emerging economies has ended?
Yang Yao: the global economic pattern has undergone a subtle change during the five years since the financial crisis. First, Europe and the US were in crisis. This was then followed by the recession in emerging economies, during which transfer of power or election of senior government officials occurred in economic powers such as the US, China, major EU countries and Japan. These changes are a big part of the background to China’s current reform.
Some time ago, a friend asked me, “Li Ka-Shing divested himself of real estate in mainland China, so does it mean that the international market has not been optimistic about China’s economic growth?" I personally do not agree with this interpretation. Li Ka-Shing is a business man and has already earned a tremendous profit in China’s real estate market. It is a rational choice made by a mature businessman to look for new high-growth markets while return on investment is slowing down in the mainland.
I personally still have full confidence in China’s economic development because the economic recovery in developed countries means good news rather than competitive relationships for China. In fact, the so-called golden decade is also a decade where developed countries experienced rapid growth. The developed countries have created demands for China’s economy. Earlier, the National School of Development of Peking University predicted that by 2020, China’s economy would overtake the US as the world’s largest economy. Today I still adhere to this opinion. The reason behind it is very simple. If China’s economy can maintain an 8% growth rate it will surpass the US by 2020. Even if the annual growth rate of China’s economy falls to 7%, it will still surpass the US as the world’s largest economy by 2023.
Before the Third Plenary Session of the 18th Central Committee, scholars were calling for reform. What is the key point in the reform?
Yang Yao: According to past experience, the biggest bonus to reform and economic development in China is the accompanying institutional reform.
Today, the Chinese economy and even Chinese society have reached the point where urgent change is necessary. Over the past 20 years of practice, we find that economic success has been inseparable from the active guidance of the government, as a country is facing many institutional and economic bottlenecks in the early stages of economic development which market forces alone cannot overcome.
For now, the problem is that the boundary between the government and the market is blurred, that is, there is excessive government control of the economy and direct government involvement in the economy. Continuous technological progress must be driven by market players. The success of technological innovation is an uncertain event, and the market can guarantee a small number of successful cases by a wide range of experiments. On the contrary, if led by the government, there will only be a small number of experiments, which will reduce the chances of success. The reason why the US has been able to lead the world in technological progress long term is closely related to its comprehensive and flexible market system. The biggest problem with regards to transition in China for the future remains the government. The government must learn their place in the economy and society, and draw a clear line between themselves and the market for the next step of reform.
Is the key point in financial reform the marketization of interest rates?
Yang Yao: Indeed there are some ideas that financial reform should focus on the marketization of interest rates. Personally I’ve had some different views, because the so-called marketization of interest rates has basically been achieved by shadow banking. But shadow banking which plays an important role in economic operation is running at high risk. Although much shadow banking business lies outside of the scope of the regulatory authorities, it is closely related to formal finance. The important source of funds from shadow banking is a formal financial strength. In June of this year, the occurrence of the liquidity crisis already demonstrated some problems. If the central bank hadn't injected money quickly at that time, the rupture of the shadow banking funding channel would have quickly spread to formal financial sector. To solve the problem of shadow banking, it is imperative to give it legal status and integrate it into the regulated categories of banking. The regulatory authority also needs to deal with internet banking, which is now in full swing, to figure out where the money of these new financial powers originates from, where it goes, and the path it travels between these two points.
Deeper reforms will have to involve the boundary between the government and market and additionally an opening up of the financial sector to the domestic market. We’ve done a good job of opening up the financial sector to the outside world but it is still inadequate to domestic and private capital. Why is the practice of shadow banking still growing? Many people are reluctant to invest in the formal financial sector. Many small and medium size enterprises and companies that need money cannot obtain financing from the formal financial sector, so they get funds from shadow banking with a 10%-20% interest rate.
So what do you think is the core link in the reform in a financial system?
Yang Yao: One of the most important changes to make in financial reform is to shine light on shadow banking to make it more transparent and to also find an exit for capital funds to flow to private enterprises. This mode of opening up to the domestic market needs a new set of regulatory measures, such as new standards of capital adequacy ratio and lending of private banks so that some small loan companies can obtain qualifications to carry out banking businesses. In fact, under the current regulation, small loan companies are also absorbing deposits like banks in a variety of ways.
Another important change in financial reform is the control of loans to local governments. Earlier foreign research reports had called into question why there was such a high rate of bad debt in China and huge Chinese local government debts. The drivers of these two issues seem unrelated but both in fact stem from local governments, because local governments are the main loan customers of banks.
If the banks, especially the operation of city commercial banks, can be more market-oriented, and city commercial banks don’t play the role of “second financier” any longer, it is possible to curb the expansion of local government debts through market means. As for high-risk city investment bonds and municipal bonds, my own view is that the power to issue bonds should no longer be given to local governments. If local governments have the need to borrow money, the central government can help issue the bond and then return the money to the local government. This kind of mechanism, at least, creates a check and balance to the power of local governments.
