Accelerating the reform of the economic system and solidifying the decisive role that the market should play in the allocation of resources is the core of the recently concluded Third Plenum of the 18th Central Committee of the Communist Party of China and its annual economic conference. The former’s focus is on long-term planning, while specific economic work in upcoming 2014 is what the latter is all about. What the two conferences require of the financial reform sends the message that financial sector reforms will take center stage in the economic reform. That is exactly where the breakthrough is expected to be made, which has a general bearing on the entire economic reform. The important aspects of financial reform in 2014 are as follows.
The first is how far the reforms will go in interest rate liberalization. In recent years the reform of interest rate liberalization has been advanced. In 2012, restrictions on the ceiling and floor for deposit and lending rates started to be eased. The lending rate floor for banks was removed in July of this year. In October and December, the mechanism was established for the Loan Prime Rate (LPR) centralized quote mechanism and launched the Interbank Negotiable Certificates of Deposits (IBNCD) in the money market. These are meant to push interest rates the market, liberating it from administrative control. However, now the roadmap for market-oriented interest rate reform shows the need to remove the lending rate floor first, and then the variety of trading commodities in the money market will be increased to adjust the supply and demand of currency in the market. On the basis of this, fixed deposits will be issued to individuals and enterprises to gradually lift the constraints on deposit rates, etc. It is still uncertain whether such thinking is fit for China. Such reform is meant to protect the banking system, which is dominated by State-owned banks, without giving any thought to the interest of individual depositors. It may be detrimental to market efficiency and the interest of individual depositors, but the financial markets will remain stable by doing so. The lifting of government control over the deposit rate for commercial banks is the most important key to the reform. It is still uncertain whether a breakthrough will be made in this direction in 2014.
Second, stock market reforms that have already been unveiled are also an essential part of the financial reform in 2014. The stagnancy of the stock market, and investors’ lack of confidence in it, lie in the government’s dominance over it and lack of responsibility for its performance. In addition, the government’s invisible guarantee of the stock market’s credit has resulted in rampant deception and speculation, which have seriously infringed upon the interest of small and medium investors. IPO is a typical case in point. China Securities Regulatory Commission’s issuing of the reform plan for the initial public offering system and a series of market-oriented regulations are meant to overhaul such situation and to establish the registration-based system. How far this restructuring can go depends on whether the new arrangement will be able to draw a clear line of demarcation between the right and responsibility of the regulator, on the effective regulation over the regulator and especially on whether the top supervising organ will be able to break from the obstruction of interest groups and be willing to do what it should. Only in this way will the new market rules be implemented to the letter for the smooth reform of the stock market. If the chairman of CSRC is forced to resign as his predecessor was, the stock market will face many uncertainties in 2014.
The third area is the market-oriented reform of the exchange rate regime. The People’s Bank of China is expediting such reform. For example, the central bank is increasing the flexibility of the exchange rate of the renminbi, has basically withdrawn from its intervening in usual foreign exchange market, is pushing for the capital account convertibility of the RMB, and changing the way cross-border capital flow is controlled. Yet, in the face of an international market where liquidity is overflowing, a lot of hot money will flow into China if the process of opening the country’s financial market to the outside world is accelerated. This is expressed not just in the rapid increase of foreign exchange reserve but also in the repeated record high RMB exchange rate. The rapid appreciation of the RMB has resulted in not only the entry of global over-liquidity into the Chinese market, but also in further price hikes of real estate and other assets. It will also possibly tempt some enterprises to bring in foreign exchange by presenting forged exports. Such cases, if taking place, will deal a heavy blow not only to the country’s financial market, but also to its real economy. And if such money suddenly flows out of the Chinese market in case of unexpected changes, the risk will be even higher for the country’s entire economy and financial market.
Fourth, financial reform will not only meet strong resistance from interest groups but also possibly bring about a series of financial risks as any change in the financial sector indicates a “revolution in the system”, which will result in the reallocation of social interest. So the financial reform in 2014 should overcome the barriers that are formed by different interest groups while efforts must be made to guard against risks. The government believes that the risks in the country’s financial system are controllable. Yet, both the risks that may arise from financial reform and the periodic crisis it may bring to the real economy are unpredictable from a dynamic perspective. If periodic adjustment appears, the bubbles in the real estate market that have been inflated by over expansion of credit in the past couple of years will result in serious conflict of interests. And it will also lay bare the huge risks hidden within China’s financial system.
How far will China’s reforms of the financial system go in 2014? This is a question that deserves a lot of attention.
Yi Xianrong is a Researcher at the Finance Institute of the Chinese Academy of Social Sciences.