Phasing out safe economic bets is no easy task for Beijing
It is hard to imagine Beijing leaving businesses to sink or swim on their merits any time soon, no matter how risky and poorly managed. While the expectation remains that the government will keep its unspoken promise of bailouts of failing ventures, ending it abruptly would involve too big a gamble with social and financial stability. But Beijing has served notice on investors, depositors and local governments that it wants to phase out the implicit guarantee.
In a major step towards financial sector reforms needed to support sustainable economic growth, the People's Bank of China has published a draft of a deposit insurance scheme to be arranged by domestic banks that would cover up to 500,000 yuan (about HK$632,000) per account. A consultation document says this would protect up to 99.63 per cent of mainland depositors, or nearly 50 trillion yuan.
An explicit, capped guarantee would be aimed at phasing out a safe bet: the pursuit of high returns while the state shoulders the risk. The draft deposit insurance plan follows a year in which many companies have struggled to repay loans and investors. Unwinding the implicit guarantee will therefore not be easy, particularly since beneficiaries include people with Communist Party connections.
With the property sector still facing a major correction, some analysts and economists see the plan as posing a major risk in itself. If it is implemented in current conditions and a financial institution collapses there is little doubt the implicit guarantee would be invoked, making it difficult to convince investors anything has changed. Indeed, although the central government has been sending mixed signals, it has used the implicit guarantee to head off looming defaults.
However, the plan is seen as a strong signal that Beijing is preparing to liberalise deposit interest rates, a key element of reforms aimed at weaning the mainland off unsustainable investment-driven growth, which also include increasing the role of market forces in the financial sector, so that lenders are allowed to fail if not well run or too exposed to risk.
Meanwhile, Beijing has shown it is still sensitive to corporate health with a surprise interest-rate cut last month after cash injections to banks over September and October.
The mainland may wind up with a dual system of explicit and implicit guarantees - until the latter does not come to the rescue in a major default. Then people will be reluctant to rely on it any longer.