One of China’s senior-most economic policymakers says that the country’s financial system suffers from severe distortions due to the emergence of a “bewildering” range of derivatives products and financial innovations.
According to Lou Jiwei (楼继伟), the current chair of China’s National Council for Social Security Fund, the Chinese economy is currently suffering from “efficiency losses created by distortions in mechanisms and systems,” that he believes should be the focal point of future reform efforts.
Lou, who was formerly the Minister of Finance and chair and CEO of sovereign wealth fund China Investment Corporation, made the remarks during a speech he delivered at the 16th High-level Enterprise Development Forum held in Beijing on 28 January.
“At present, China’s M2-GDP ratio is in excess of 200%, or roughly the same as Japan’s levels, and over twice the figure of 91% for the US.
“In terms of interest rate levels however, China’s 1-month SHIBOR average was 4.09% in 2017, while in Japan the comparable interest rate was -0.01% across the same period and 1.1% in United States.
“China’s monetary environment has become looser, yet the cost of funds has become higher, indicating that there are severe distortions in the financial system.”
According to Lou the unchecked proliferation of financial innovations and new derivatives products is a key culprit behind these distortions.
“Excessive mingling of sectors (we refer to this as “comprehensive operation) has created a series of financial incidents, with a bewildering range of uniquely Chinese derivatives products…the result is a continuous increase in the cost of funds that exacerbates the difficulties of the real economy.
“At the same time, channels for risk transmission are extremely opaque. Looking at the financial market of the United States ten years ago, the risk and yield features of various derivatives products were all defined, such as MBS, CDS and CDO, and were also all registered.
“China, on the other hand, is far more chaotic…[we] must penetrate to the bottom of products, in order to be able to identify their actual risk and revenue features.
“In addition to conventional banks, securities companies, insurance companies and funds, China is also host to a bewildering range of innovations in terms of uniquely Chinese financial institutions and regional transaction markets, all of which are too numerous to count.
“As a result, the likelihood of China’s suffering from systemic financial risk is quite large. For this reason,the urgent task at present is to effectively prosecute the war for the prevention of financial risk.”
Lou highlighted a total of five key areas for addressing distortions and improving China’s resource allocation efficiency, including the free movement of factors of production, simpler governance and tax reductions, the expansion of protections for private investment, continued expansion of China’s openness to the outside, and the prevention and dissolution of financial risk.