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Don't hold your breath for big bang China financial reform
There are entrenched groups that are against further interest rate liberalisation; and the bond market has a few hurdles to scale
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There's been a lot of talk over the past week about how China's incoming generation of leaders are planning a massive liberalisation of the country's financial sector.
Don't hold your breath.
Outgoing president Hu Jintao turned the spotlight on financial reform last Wednesday in his address to the Communist Party's national congress.
"We should develop a multi-level capital market, take steady steps to make interest rates and the renminbi exchange rate more market-based and promote the renminbi's convertibility," he told the delegates assembled in the Great Hall of the People.
A day earlier, researchers at HSBC had published a weighty report suggesting how those objectives might be achieved.
In it, chief China economist Qu Hongbin and his colleagues set out a series of "big bang" reforms. At the heart of their programme is interest rate liberalisation, coupled with a shift away from the reliance on bank loans for corporate and local government financing, and towards greater dependence on the bond market.
Together these two reforms would markedly improve the efficiency of China's capital allocation, in turn allowing the yuan to be made fully and freely convertible "within five years".
Even more encouraging, there are signs the reform effort is already under weigh. Since the beginning of June, the authorities have cut the benchmark lending rate by more than half a percentage point to 6 per cent. But given more freedom to price their loans, banks have reduced their actual lending rates by less. As a result, in September the weighted average interest rate for general loans was 7.18 per cent, more than a full percentage point above the official rate.
Meanwhile corporate bond issuance has increased markedly. As the first chart illustrates, data released yesterday shows that local currency bank lending in October was just 505 billion yuan (HK$622 billion), down from 587 billion last year. At the same time, corporate bond issuance shot up to 299 billion yuan from 164 billion.
These are promising developments. But any excitement is premature. Senior officials have been pledging to develop China's bond market, liberalise its interest rate regime, and make the currency convertible "within five years" for the last decade.
Yet although the reform momentum has picked up recently, even the optimists at HSBC admit there remain daunting obstacles on the path to financial reform.
First, some of China's most powerful entrenched interest groups are firmly opposed to further interest rate liberalisation.
Among them are China's big state banks, which have long relied on the generous three percentage point spread between regulated deposit and loan rates (see the second chart) to generate their vast profits.
China's legion of state-owned enterprises are also dead against the idea. For years they have enjoyed a powerful competitive advantage over potential private sector rivals because of their preferential access to low cost bank loans.
A 2009 study by the Hong Kong Institute of Monetary Research even concluded that if state companies were forced to pay the same interest rates as private enterprises, their profits would be eliminated entirely, with the state sector making heavy losses.
Meanwhile, regulatory turf wars, the woeful standard of China's domestic credit rating agencies, and government fears of a wave of defaults by state-backed issuers have blocked the development of China's corporate bond market for 10 years now.
Despite the recent increase in activity, corporate bonds still make up less than 10 per cent of the debt market, with almost all the outstanding securities issued by privileged state-owned companies.
In short, the problems impeding rapid financial reform remain as intractable as ever. Expect a slow and painful crawl towards liberalisation, not a big bang.