As the 3rd Plenary of the 18th CPC Central Committee approaches, people have high expectations for financial system reform. With a priority placed on redressing imbalances in the financial structure, the focus will be enhancing the efficiency of resource allocation through finance, and supporting a real economy.
Zhang Monan
China has a huge inventory of financial assets. However, structural and directional misallocation has led not only to a distortion in the allocation of financial resources, but also large amounts of idle assets and sunk costs. How can these assets really play a role in promoting a real economy? How can the liquidity be guided to different financial layers, and into peripheral circulation in particular? How can the efficiency of the financial system be enhanced? These are the most important strategic questions for China now.
China has the world’s largest amounts of credit. With M2 twice that in the US, China is the world’s largest currency issuer. The ratio between M2 and GDP is 2, far bigger than 1 in Japan and 0.7 in the US. Total residents’ and corporate savings have exceeded 70 trillion RMB, which is very much in both vertical and horizontal comparisons. Still, sectors of the real economy feel that liquidity is tight. The mismatch lies with the structure of the financial system.
Further, the durational, structural and directional misallocation of the financial system has led not only to a distortion of the allocation of financial resources, but also to large amounts of non-performing assets, idle assets and sunk costs.
First, the bank credit financing system determines that manufacturing and infrastructure are more developed, whereas money supply for high-tech, services and SMEs lags behind. Credit allocation has structurally focused on government projects, SOEs, large enterprises and traditional sectors, with insufficient support for the private sector, SMEs or emerging industries. And there has been apparent preference given to real estate and local government projects. Now, loans to local government financing vehicles and real estate account for nearly 35% of the total loan balance.
Secondly, the financial sector has clearly crowded out the real sector. Since 2011, there has been a sharp contrast between the large-scale increase of total social financing, off-balance-sheet financing and bond financing, and the continued slowing down of economic growth and macroeconomic output. Money has not gone into the real economy; rather it has circulated within the virtual economy. As a result, data reflecting industrial production, manufacturing investment and commodities circulation remains weak, while the debt ratio and the risk of hidden non-performing assets in the banking system are on the rise. The circulation and expansion of liquidity into the hot financial sector rather than the cold real sector contains huge financial risks.
Thirdly, the efficiency of financial outputs has dropped drastically. Since the outbreak of the financial crisis, an excess currency issuance in China has become increasingly serious, which is directly linked to a large drop in the efficiency of the currency-economic output. The speed of currency circulation in the economic crisis has sharply reduced, from 0.63 in 2008 to 0.51 in 2012, a decrease of nearly 20%. A slower circulation of currency reflects a lower GDP achieved with a certain amount of money supplied. In other words, the effect and efficiency of monetary expansion in economic output has decreased.
Thus, after the 3rd Plenary of 18th CPC Central Committee, the focus of deepened financial reform will need to be developing a financial system that supports a real economy, preventing excessive expansion of the virtual economy, avoiding the deviation of the financial sector away from actual needs of the real economy, and transforming the financial system from a fund raiser to a resource allocator. On the one hand, the pro-cyclicality of the financial system and the expansion of credit should be controlled with macro-prudential regulation, so as to avoid being over-indebted. At the same time, reforms such as interest rate liberalization, asset securitization and direct financing should be sped up to facilitate the circulation of social funds within and without the financial system.
On the other hand, the structure of the financial system should be optimized to match and serve a transformed real economy. Firstly, there should be small and medium-sized banks to match the needs of SMEs and micro-enterprises. Many countries in the world have specialized financial institutions to provide credit support for SMEs. China should also make efforts to create a small and medium-sized banking system favorable to the development of SMEs. As small and medium-sized banks are local with more direct contacts with local SMEs, in particular, some small local banks own shares of some SMEs, they can better match these enterprises in terms of credit structure, asset structure, business structure, revenue structure, and profit structure.
Besides, a capitalization on science and technology should also be given priority consideration. Efforts should be made to establish a modern financial system that is more conducive to economic upgrading and industrial innovation, one quite different from the financial system in the traditional industrial economy age. Such a financial system should serve as the country’s strategic investment system, and provide systemic financial support to upgrading the Chinese economy by utilizing government fiscal input, corporate research and development investment, venture capital for startups, bank credits, financing on the capital market, and science and technology funds.
Zhang Monan is Research Associate at the China Center for International Economic Exchanges.
