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What Kind of Modern and Open Financial System Does China Need?

Jan 20 , 2016
  • Zhang Monan

    Senior Fellow, China Int'l Economic Exchanges Center

How to build a modern, highly efficient and open financial system is a key element in determining the success of China’s future economic reform and development during “the 13th Five-Year Plan” period.

China has a huge stock of financial assets. But in general, constrained by the weak financial base and affected by such factors as the unsound financial system, the unregulated capital market and the inefficient financial institutions, the internationalization and integration of China’s financial system will fall behind the reform of the entire market system within a short term. The commercial banks suffer low capital quality, the loss in capital utilization, and a high rate of bad debts, not only causing the distortion of financial resource allocation but also a large amount of idle and precipitated capital.

A remarkable phenomenon: the financial sector produces an obvious “crowding-out effect” on the real sector. Since 2011, the increasing total social financing and the big increase of both off-balance-sheet financing and bond financing have been a stark contrast to and substantially deviated from the continuous downward economic growth rate and the macro economy. But, the increased financing did not enter the real economy but circulate in the finance and the virtual economy instead, reflecting a still rather weak industrial production in the real economy, a weak manufacturing investment and a weak commercial circulation data.

On the other hand, the debt ratio went up and the risk of bank recessive bad assets rose sharply. According to the recent China Banking Regulatory Commission data, by the end of the third quarter of 2015, the non-performing loans of the commercial banks climbed to 1183.6 billion RMB with the non-performing rate reaching 1.59%. The non-performing loans of the fourth quarter are expected to grow to 1263.782 billion RMB at 1.67%. The non-performing rate in the fourth quarter of 2016 is predicted to be 1.94%.

Particularly over the past year, the money multiplier clearly deviated from the economic output. The money multiplier increased somewhat while the economic downward pressure was still great. Mainly because the government wanted to stabilize debts and the cost of capital, credit creation continuously extended inward, but the effective demand of the real economy was insufficient. The money supply picked up to alleviate the debt burden more than to flow to the real economy.

Therefore, how finance can really and effectively support the development of the real economy is still a critical challenge faced by China, at present and for a long time in the future. After the third plenary session of the 18th Central Committee of the CPC, the focus of deepening the financial reform is on developing a financial system that supports the real economy to prevent an over-expanded virtual economy and to avoid the deviation of the financial economy from the actual demand of the real economy, realizing the goal of turning from a fund-raising system to an optimizing-resource-allocation system in the financial construction. It is necessary to cautiously control the financial procyclicality and the credit expansion speed by means of macro regulations, avoiding an over-indebted economy.

Faced with these problems and challenges, China will push to construct a modern financial system and improve the efficiency of financial service to the real economy during the 13th Five-Year Plan period. Besides comprehensively deepening financial reform and perfecting the financial system, China should also focus on perfecting the sci-tech financial system, develop a green financial system and promote an inclusive financial strategy. The finance industry should emphasize the thought about actively “capitalizing” technological achievement and adapt to the development based on “mass innovation and entrepreneurship”. It is urgent now to establish a modern financial system that is different from the traditional one and is more open to economic update and industrial autonomous innovation. By means of government fiscal investment, corporate R&D, industrial investment, venture capital, bank credit investment, capital market financing, science funding and so forth, China should make a strategic investment in this type of financial system that can provide a full range of financial support to update its economy.

Meanwhile, China takes “two-way financial openness” as an important strategic task during the 13th Five-Year Plan period. This is the only way to construct a more open economic system and transform China from a financial giant to a financial power. In the next five years, both the international and domestic financial environments will become more complicated, and China will still face the challenges like low-efficiency financial asset allocation and the serious imbalance arising from the international division and distribution of benefits between the global financial centers and the global manufacturing centers.

In the full global market competition, the technological advancement and the human capital formed by the input of capital and labor elements will continuously increase the marginal income, promoting sustainable long-term growth of the open economy. To this end, the finance industry should play a role in optimizing resource allocation to improve the operating efficiency of the financial system. Therefore, China must carry out the development strategy of financial opening-up and financial internationalization in a cautious, orderly and gradual way. China must promote the cross-border flow and the market allocation of the financial or capital factor, eradicate institutional barriers to financial development and make substantive breakthroughs in major fields and key elements, speeding up the financial transformation of market allocation.

In 2014, China became a net capital exporter with the direct investment in foreign countries at $116 billion in 2014 compared with $69 billion in 2010.  Especially with the implementation of major strategies like “One Belt One Road” and international cooperation on production capacity, overseas direct investment by private investors will continue to outgrow foreign direct investment in the future. It thus decides that in macro economy, China must actively adjust the structure of reserve-asset allocation. As it grasps the opportunities of “One Belt One Road” and “Go Global” strategies, China should construct an efficiently operating system that covers the global investment transactions, payment and settlements and to construct a credit-rating system and financial security safeguarding system in order to comprehensively improve China’s financial competitiveness.

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