Financial sector will play second fiddle to ‘real economy’

A mix of new and old will be the flavour of the financial sector in 2014. A calibrated structural slowdown within the ‘real economy’, and the rise of new products, experimental bonds, mature futures markets as the ‘topping’ will remain the hallmark of China’s ‘socialist market system’ in the new year.

At the core of China’s much trumpeted reforms of the financial sector, is the unwavering principle that the financial markets should ultimately serve brick and mortar businesses. Nevertheless, at this juncture, there is an overdrive to create a detailed legal framework for all the financial reforms being planned, as was evident at the annual Central Economic Work Conference that opened in Beijing this week.

New course

Talking of the new, measures will be taken to steadily expand the scale of the domestic bond market. The National Development and Reform Commission, China’s top planning body, is encouraging ‘catastrophe bonds’, apparently to leverage financial resources in response to climate change. Catastrophe bonds are risk-linked securities that transfer a specified set of risks from a sponsor to investors. Created and first used in the mid-1990s in the aftermath of natural disasters in the United States, catastrophe bonds have caught the fancy of policymakers who want to experiment with innovative financing methods to soften the impact of climate change. Also in the pipeline are insurance products for the agricultural and forestry.

More significantly, the ambitious reforms project includes revising securities laws and writing fresh legislation to enhance the futures market. A unified market access system will be adopted to encourage and guide the flow of private capital to financial services. The aim is to allow qualified private capital to set up small-and medium-sized financial institutions that will cater to regional, small-and micro-sized enterprises and ease their fund shortages. China’s state owned banks have failed to cater to small businesses, leaving them at the mercy of usurious money lenders.

The administration of stock exchange bourses in the Mainland will be up for continuous monitoring as efforts will be made to push for the construction of a multi-bourse equity market. Although it may take time, market watchers are excited at this prospect. Under this unified institutional framework, all provinces, municipalities and autonomous regions will be able to set up equity markets that are suitable for local economic conditions. Measures will be taken to direct private equity and venture capital investment into innovative enterprises. At the same time, differentiated institutional arrangements and a unified registration platform will be set up to push for the formation of an organic equity market system.

Financial opening up will continue with the cross-border use of RMB, as well as the establishment of an international financial centre to push for internationalising the currency. State-owned businesses are in for another shake-up; changes to the laws on mergers and acquisitions and corporate restructurings are also on the anvil, while the IPO process is well on the way to becoming more transparent.

Structural slowdown

Critics of China’s financial sector reforms are sarcastically referring to it as the ‘Beijing Consensus’ — maximum government control of the economy, with limited room for competition. The bottom line is, that a strong regulatory State will not only co-exist with an open, competitive market, but also make policies to ‘guide’ the market in an era of structural slowdown.

Truth is, the government is in no position to withdraw from industry and financial sectors overnight. There is need to slow down the growth process without causing large scale disruption and for this, the involvement of provincial governments is essential. Chinese think tanks have decreed that the rate of growth must decrease to less than 6 per cent in the next decade and half, for the economy to be sustainable.

To achieve this gigantic slowdown, local governments will no longer be measured by GDP growth; the thrust will be on efficiency, not bailouts.

In fact, Chinese officials have been asked to downplay their obsession with growth and focus more on people’s livelihoods and the environment. The central government used to traditionally assess the performance of local authorities through economic indices like gross regional product (GRP); but this only resulted in vast environmental damage and social disruption.

This out of control competition resulted in local governments running up billions of RMB in debt. Finally, all ‘vanity’ projects that were high investment and heavy pollution generating will come to an end and a more nuanced approach to the market will begin.

— The writer is a freelance journalist based in Beijing