In the case of economic reform, Chinese leaders are crossing the river by feeling the stones, as the saying goes, but the river is proving to be much wider than anticipated.
As the Chinese economy confronts the new normal – a decline of the breakneck growth previously enjoyed – the need for financial reform has become even more urgent. Among the ailments plaguing the current system are capital misallocation, overcapacity in certain sectors, and credit risk assessments not grounded in financial realities. Here’s a brief look at some recent reform measures:
One significant and overarching “reform” has been the leadership’s public acceptance of slower growth figures. Last year’s National People’s Congress issued a work report that targeted 7.5 percent growth, in contrast to the long-standing focus on a minimum of 8% growth. Since then, there have been a number of encouraging steps in the direction of reform.
In May, the State Council discussed a list of structural reforms, including liberalizing capital flows and steadily liberalizing interest rates. As The Economist notes, a number of the reforms are currently underway, while others are just beginning. Andrew Batson of the research and advisory firm, GaveKal Dragonomics, commented that the proposed reform agenda “goes far beyond Wen-era platitudes in its boldness and specificity.”
In July, the State Council issued an economic reform plan encompassing 10 financial measures. The plan, called the “Jin Shi Tiao,” includes “making better use of the existing stock of money, promoting industrial upgrading, diversifying the capital market and deepening the participation of private investors in the financial sector,” according to Caixin. The plan focuses on making better use of money supply, and an important part of the policy says that “private capital can be allowed to set up private banks at their own risk on a trial basis,” which Caixin expects will “be a milestone toward engaging private investors in the financial industry.”
In mid-July, the People’s Bank of China announced that it was removing the floor on commercial lending interest rates, a move that The Financial Times called “the biggest change to the country’s interest rate regime since caps on lending rates were removed in 2004.” The central bank had hoped to liberalize the bank deposit rate ceilings at the same time, but China’s state-owned banks put up fierce resistance – much of their revenue comes from the difference between deposit rates and lending rates.
The measure remains significant symbolically, but as a practical matter, will have little impact on financial markets: FT notes that “only 11 percent of all loans in China were priced anywhere below the benchmark interest rate in the first quarter of this year and almost none of them was priced at a 30 percent discount.” Caixin commented that a positive reading of the removal of the lending rate floor would expect the change to “diversify the investment channels for private capital, invigorate the economy and force state-owned banks in particular to improve their pricing mechanism and services.” As The Financial Times noted, interest rate liberalization is crucial for convertibility of the RMB and for expanded cross-border capital flows.
As for the future, Reuters reports that the Chinese government plans on establishing a deposit insurance system later this year, which, by protecting the depositors at smaller banks, could smooth the way for interest rate liberalization. (Smaller banks would be protected from failure amidst increased interest rate competition in a free interest rate market).
The other needed reforms will be left to future discussion, but suffice it to say, they are numerous, complex, and interconnected – and very crucial to adapting to China’s “new normal.”
It’s difficult to know what reforms will make it past infancy in light of the significant headwinds that reforms face: challenges from entrenched state-run banks, the backlash from other factions within the government, and perhaps even from the public if and when economic growth falls to a sustainable level.
However, any progress is good progress, and Premier Li Keqiang has publicly voiced his support for economic reforms a number of times since his recent ascension to the top. In July, Li commented at a State Council forum: “We must adapt to the new situation, and give consideration to the promotion of steady growth, structural adjustment and reform, so as to develop a scientific macroeconomic policy framework.”
A lot of rhetoric, but it is still a strong endorsement to move forward with economic reforms.