China needs to be on the money with reform of its financial system


A POWERFUL theme emerging from the past few turbulent months in China’s political life has been the view that fundamental reform is necessary if the economy is to continue to expand.

Despite its image as a freewheeling capitalist paradise, the arteries of the Chinese financial system are furring up rapidly and investors here are frustrated at the lack of investment opportunities and the heavy hand of state interference in many areas.

For years, China has followed the policy of “touching stones to cross the river”, a slow but steady approach to economic progress championed by former supreme leader Deng Xiaoping, who is widely credited as kick-starting the economic reform process in China.

However, progress has been uneven. China’s foreign direct investment and international portfolio assets and liabilities are a tiny percentage – less than 3 per cent – of total global stocks. At the same time its foreign exchange reserves account for about 30 per cent of global stocks.

A new report by British think tank, Chatham House, Shifting Capital: The Rise of Financial Centres in Greater China, argues that China needs to deepen the financial sector to reflect the country’s financial strength, and it needs the renminbi currency to be convertible.

China needs to take steps to correct the fundamental problem affecting the international economic and monetary system – where the world’s second largest economy and largest exporter is managing its exchange rate, resulting in a whopping current account surplus and a large accumulation of foreign reserves.

And creating efficient financial systems in China and modern financial centres in Greater China will be “riddled with challenges and obstacles”.

“What China is doing is critically important. It is also historically unprecedented. China has no roadmap or past experience to rely on. Indeed it is the first emerging country to seek a comprehensive reform and expansion of its financial services sector and to establish a truly international currency,” said one of the report’s authors, Paola Subacchi.

The report sees the emergence of four major regional financial centres in Greater China. Hong Kong will retain its position as one of the world’s leading international financial centres, but by the beginning of the next decade Shanghai may have considerably narrowed the gap that now exists between them.

Shenzhen will step up its role as a domestic financial centre, focused on the needs of small and medium-sized enterprises (SMEs) and start-ups located in Guangdong that currently have difficulty in obtaining credit through the banking sector.

And the Taiwanese capital Taipei will leverage its experience with high-tech SMEs in the broader Asia region to target Chinese SMEs at a relatively advanced stage of growth and become a complementary regional financial centre.

In terms of policy recommendations, Chatham House believes the Chinese government needs to moderate government intervention in the financial services sector and provide greater operational independence to the financial institutions, including state-owned banks.

Beijing must accelerate banking reform, develop capital markets and reduce reliance on the banking sector for the financing requirements of the economy, and increase Hong Kong’s exposure to the financial systems of the BRICS and other emerging-market economies.