The head of one of China’s top economic think tanks has outlined the six major “directions” for the country’s financial supply-side structural reforms.
Li Yang (李扬), director of the National Institution for Finance and Development (国家金融与发展实验室) and a member of the Chinese Academy of Social Sciences (CASS), said to Economic Information Daily that China’s supply-side structural reforms can be broadly summarised as “one foundation and six major directions” (一个基础、六大方向).
The “one foundation” is emphasising the key status of finance with regard to the national economy, while the “six directions” refers to key areas for future financial reform, and include:
- Servicing the real economy;
- Optimising the financial structure;
- Managing financial risk;
- Abiding by the laws of economics;
- Developing fintech;
- Expanding external opening.
Servicing the real economy
Li Yang said that the central government’s thinking with regard to the relationship between finance and the real economy is “extremely clear,” with finance occupying a subordinate position.
“[Finance] has never been capable of existing independently of the real economy, and its problems cannot possibly be explained without making reference to the foundation of the real economy.”
A study session held by the Chinese politburo on 22 February announced that “when finance is active, the economy is active; when finance is stable the economy is stable….when the economy rises, finance rises, when the economy is strong, finance is strong.
“The economy is the body and finance is the arteries – the two arise and flourish together.”
Optimising the financial structure
The 22 February politburo study session also stressed optimisation of the financial structure on the grounds that the current financial structure is “distorted and suffers from the problem of misallocation.”
Li Yang said that optimisation of the financial structure will involve correcting the three “distortions” of misallocation of term structures, misallocation of rights and interests and misallocation of service target preferences.
“The financial system currently suffers from severe ‘short-term borrowing and long-term usage.’
“Based on China’s existing financial structure, we are capable of amassing together funds with comparatively short maturities. However, China’s current development phase and the mission it currently faces requires comparatively longer-term funds.
“China is still a developing country, and we are currently in the process of driving industrialisation and urbanisation. During this period of development, our need for long-term funds is greater than that of any other country, yet based on the existing financial structure, our fund resource terms are comparatively short.
“Overcoming maturity misallocation has become an immense, long-term mission.”
With regard to misallocation of service target preferences, Li said that China’s financial system had primarily sought to service large-scale enterprises and wealthy demographics.
This has led to a “severe inadequacy” in financial services for the huge mass of middle-income and lower-income citizens; small, medium and micro-enterprises and private companies, all of which are in more urgent need of funds.
In order to cure these misallocations and distortions, Li advocates:
- “Establish a mutually complementary financial structure with a rational division of labour between commercial finance, developmental finance, policy finance and cooperative finance…create a multi-tier, differentiated banking system with broad coverage.”
- “Establish a standardised, transparent, open, vital and resilient capital market, improve the foundational systems for capital markets, effectively manage the two key passes of market entry and market exit, and strengthen the full process monitoring and regulation of transactions.”
- “With regard to adjustments to product structure, emphasis guidance by market demand, actively develop personalised, differentiated and customised financial products.”
Managing financial risk
Li Yang said that the prevention and resolution of financial risk should focus on the three principles that:
- “The healthy development of the real economy is the foundation for the prevention and dissolution of financial risk.”
- “Focus on risk-prevention on a foundation of stable growth.”
- “Uphold risk prevention and dissolution while driving high-quality growth.”
Li also highlighted five directions for financial risk prevention:
- Accelerate the establishment of financial market infrastructure, gradually drive the domestic production of key information infrastructure for the financial sector.
- Properly create comprehensive statistics for the financial sector, improve information systems that promptly reflect risk fluctuations, improve administrative regulations for information dissemination, improve credit penalty mechanisms.
- Firmly establish systems firewalls.
- Make use of modern technological means and payments and settlement mechanisms; engage in the dynamic monitoring of online and offline, international and domestic capital flows, and ensure that all fund flows are situated within the monitoring purview of financial regulatory institutions.
- Deleverage – the fountain head of financial risk is high leverage, and for this reason deleveraging is a long-term mission.
Abiding by the laws of economics
Li calls for a focus on three areas of progress:
- Improve market-based mechanisms for the formation of renminbi exchange rates, accelerate the marketisation of interest rates, and improve yield curves for government bonds that reflect market supply and demand relationships.
- Abide by the principle of competitive neutrality, and provide high-efficiency services equally to enterprises in all ownership categories. Chinese central bank governor Yi Gang first made reference to “abiding by the principle of competitive neutrality” last year, while the central economic work conference at the end of 2018 also made reference to the “foundational position of competition,” and Premier Li Keqiang spoke of implementing the principle of competitive neutrality in the 2019 “Government Work Report” as well as at the Bo’ao Forum. According to Li Yang if competitive neutrality can be achieved, this would solve many of the financing challenges experienced by small, medium and micro-enterprises as well as private enterprises.
- Strengthen the establishment of financial infrastructure, including a complete set of registration, entrustment, transaction, clearance and settlement systems, as well as laws and regulations that standardise and protect these systems. “This will ensure the fundamental conditions for regular operation of the market,” said Li
Li Yang believes that the growth of fintech will greatly optimise the factors of production foundation and structure for China’s economic and financial development, and improve the quality of economic growth.
According to Li the growth of fintech will have a “revolutionary impact” upon financial development in five key areas:
- It will help to resolve the information asymmetries that have been a perennial problem for financial development.
- It will provide a more reliable credit foundation, and drive the regular operation of the financial system.
- It will permit the accurate monitoring of the flows of various factors, and make it easier for finance to service the real economy.
- It will enable various sectors and entities to display their own preferences, providing more effective parameters for resource allocation.
- It will reduce financial services costs, and more effectively connect with the general public and small and micro-enterprises.
Li points out that fintech “isn’t technology, but is fundamentally finance,” and that fintech enterprises should observe the above five points in order to prevent bubble formation.
Expanding external opening
According to Li the expansion of the external opening of the Chinese financial sector must be performed on the basis of changes to international economic and financial circumstances as well as the strategic needs of China’s own development.
On the foundation of this principle Li advocates the “three increases” when it comes to external opening of the Chinese financial sector.
- Increase the international competitiveness of the financial sector, and expand high-level bilateral openness of finance. “Financial supply-side structural reforms must be placed at the centre of China’s grand strategy for integration into the globalised financial system…the goal of opening of the financial sector is to increase the competitiveness of Chinese finance in a global context.”
- Increase economic and financial regulatory capability and risk prevention and control capability amidst conditions of opening. According to Li external opening of Chian’s financial sector involves a huge volume of uncertainty, which makes effective regulation and risk prevention more important than ever before.
- Increase China’s ability to participate in international financial regulation. Li says it is both possible and necessary for China to “express its opinions, make its voice heard, clarify its position and maintain its interests” during participation in global financial regulation.