This time, it’s different. Or so many observers say. Now that Chinese President Xi Jinping and his team are in power, there is excitement about the dramatic change in the public face of the Chinese political leadership. Many are viewing Xi as a technocrat and moderate with a liberal background and expect him to implement economic reforms at a faster pace.
Fraser Howie, who delivered a lively presentation on reform expectations in the Chinese capital markets last week at the 66th CFA Institute Annual Conference in Singapore, is not as optimistic. A decade ago, when former President Hu Jintao and his team came on board, Howie said, the public generally had similar expectations, only to be disappointed. Howie, a former managing director in the derivatives unit at CLSA, is the co-author of two books on China, Red Capitalism and Privatizing China.
When it comes to current market conditions, Howie has his concerns. Although the country’s GDP growth has been maintained at around 8%, he said, China’s dependence on credit to fund growth is a major worry. Total social financing (TSF) — the official liquidity measure that reflects the magnitude of liquidity support from the entire financial system to the real economy — has been rising twice as fast as GDP in the past decade. It stood at RMB (renminbi) 16 trillion around the end of 2012. In the past four years, it has grown by around 125%.
Bank loans, which accounted for more than 90% of TSF a decade ago, now stands at 50%. They have been replaced by wealth management products and local government financing vehicles from the shadow banking sector. Partial interest-rate liberalization has effectively been taking place. Bank customers are sold wealth management products that carry much higher interest rates than bank deposits. These products are typically a pool of assets, including repackaged loans to local governments, real estate developers, and other borrowers. So far there are no rampant problems, but China’s legal system is not up to the task of handling defaults, according to Howie. He sees the potential for a systemic collapse.
No doubt, in the reform arena, there is a lot of work to be done. A recent Brookings Institution study (PDF) indicated that the commonly used Chinn-Ito index, which measures a country’s capital account openness, “has not registered any change in China’s de jure openness since 1993.” Against this backdrop, Howie is highly skeptical. He sees significant problems with a couple of key developments in China that are commonly cited as leading initiatives of financial sector reform:
- Offshore RMB. This is supposed to force greater liberalization onshore, but the offshore RMB market has developed at a slower pace than expected. After a surge from mid-2010 to late 2011, RMB bank deposit growth in Hong Kong has stalled and for several months was negative. Issuance of the RMB-denominated “dim sum” bonds has also slowed significantly from a 2011 peak. Howie cited a recent Brookings–Tsinghua Public Policy Center study (PDF), which reviewed in-depth RMB internationalization as a catalyst for financial sector reform and liberalization. The study’s conclusion is that loss of government control of the financial markets is likely to remain a key political concern and will result in slower financial sector reform and RMB internationalization.
- Qualified Foreign Institutional Investor (QFII) Program. After 10 years, the number of approved foreign institutional investors remains relatively low, at around 200, despite recent announcements to significantly open up the QFII program with the new RMB QFII program — a result that Howie compared unfavorably with India’s liberalization. Repatriation of invested funds and cross-border flows are still quite restrictive despite recent easing, he said.
Reform in China will continue to be slow and incremental, Howie predicted, with many of the key parts of the system remaining closed. Although preparatory work to open up cross-border distribution of investment funds in China and Hong Kong under a mutual recognition protocol is under way, there has been no concrete official announcements to date. Howie thinks that the financial sector landscape is best illustrated by Beijing’s Forbidden City: Just as Chinese officials keep most of the city off limits, when it comes to the financial sector, the leadership in China seem willing to open only small courtyards to foreign players.
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