An economics professor from one of China’s leading universities says the country’s ongoing deleveraging push and regulatory crackdown will do little to remedy enduring defects within its financial system.
Zhang Jun, Professor of Economics and Director of the China Center for Economic Studies at Fudan University in Shanghai, writes in Project Syndicate that China’s ongoing slowdown is reflective of financial constraints on the real economy, which will be difficult to remedy in the short-term.
Zhang notes that these constraints have arisen and worsened despite the flourishing growth of China’s financial sector over the past decade, on the back of monetary expansion spurred by the central bank as a safeguard against broader economic risk.
“This trend can be traced back at least to 2004, when a fast-growing trade surplus and massive capital inflows, as well as relentless exchange-rate appreciation, forced the People’s Bank of China to resort to monetary expansion as a hedge against the resultant risks,” wrote Zhang.
“Since China’s unremitting investment in infrastructure and real estate has fuelled domestic demand, absorbing and reinforcing this credit growth. In 2009, China took things a step further with a massive three-year stimulus plan that expanded bank credit to more than 20 trillion yuan.”
While PBOC availed itself of monetary and credit expansion as a hedge against economic risk, the flourishing growth of the financial sector that this prompted has now itself become a core source of peril.
Zhang points to skyrocketing growth in China’s shadow banking system, which lies beyond the remit of conventional regulation, Data from Moody’s Investors Service indicates that the Chinese shadow banking system tripled during the five-year period from 2011 to 2016, while their share of total credit has surged from 10% to 2006 to 33% as of last year.
In Zhang’s estimation the rapid expansion of the financial sector has not done enough, however, to help channel much needed funds to productive enterprises in the real economy.
Chinese lenders have instead have instead chased risk-fraught higher yields, turning to interbank loans and non-standard assets to shift investment off balance sheet and dodge regulatory constraints, leaving money “spinning within the financial system…instead of being put to use in real economy.”
Zhang cites data from PBOC’s 2014 Financial Stability Report report which shows that from the start of 2009 to the end of 2013, Chinese banks saw their interbank assets surge from 6.21 trillion yuan to 21.47 trillion yuan, for 246% growth rate that was 1.8 times that of total assets and 1.7 times that of total loans.
“All of this fuelled rising risk across China’s financial sector, while intensifying pressure on the real economy.”
Instead of flowing into the real economy, much lending by banks, whether conventional or shadow, has instead been used for speculative investment in financial instruments and real estate, driving the growth of asset bubbles and exacerbating market volatility.
The authorities are keenly aware of the risks and inadequacies of existing financial arrangements, with the China Banking Regulatory Commission launch a concerted crackdown on lenders since chairman Guo Shuqing took office in February this year.
While their efforts have disrupted markets with surging interest rates and ailing stock prices, Zhang expects Chinese regulators to be tenacious in their pursuit of financial reform, because “they know all too well that a bank-dominated financial system cannot weather a new and chaotic crisis.”
The Fudan professor does not expect the regulatory crackdown to prove effective in curing the long-term defects of China’s financial system or its “monetary conundrum.”
“For that, China will need to identify and encourage those financial innovations that can support real economic activity,” writes Zhang. “Unfortunately, on that front, not nearly enough progress has been made.”