As mainland companies face growing difficulty getting credit from domestic banks or raising capital on the stock market, they are left to securing funds through large, long-term bond issues, says a top banker.
Under such circumstances, the central government should focus more on reform and development of the domestic bond market that cash-hungry Chinese companies could turn to for raising more capital, said economist turned banker Frank Gong.
In an exclusive interview with the South China Morning Post, Gong said: "Unlike the United States economy, which offers a number of direct investment channels, China's next phase of economic growth will depend on its ability to ramp up its domestic corporate bond markets - an important financing source in developing markets."
Gong, a vice-chairman of China investment banking at JP Morgan, made his reputation partly thanks to successfully predicting Beijing's landmark yuan revaluation in 2005.
He was considered one of the most influential economists on mainland issues before he became a top dealmaker for the Wall Street firm in China.
Gong said he believed that mainland companies relied too much on bank loans and stock issues, which could exacerbate risks to the financial system.
His comments came as a number of the largest state-owned enterprises, including China National Petroleum Corp, raised huge sums of capital with offshore bond issues that attracted a warm welcome from investors on the back of a virtually dead initial public offering market at home.
"The necessity of developing a corporate bond market is probably the best response to the calls for deregulation of the country's financial services sector," Gong said.
"A classic example would be the development of the subway system in Hong Kong, for which the government selected the best contenders through an open bidding process.
"Hong Kong's government and private sector collaboration offers economic incentives and a viable solution for [the country's] massive urbanisation plan."
Following Hong Kong's runaway success in subway development, a lot of mainland cities have mimicked its urban development model since it represented a clear economic benefit for a country trying to maintain growth in its annual economic output of 7.5 per cent.
Currently, the bond market represents about 30 per cent of overall borrowing on the mainland, compared with 70 per cent in the US. This demonstrates that most borrowers rely on the traditional banking system, in spite of huge demand for capital to finance investment projects.
The mainland's bond market is now the fourth-largest globally, with the total notional amount of outstanding bonds at about 26 trillion yuan (HK$32.6 trillion) at the end of last year, but it lags far behind the US and European countries that have used debt financing as their primary sources of funding.
Gong said reform of overly-burdensome regulations at home was needed to reduce operating costs and boost market efficiency.
Meanwhile, he said, regulators for the nation's banking and securities industries should focus on "risk management", such as setting up a legal and regulatory framework for market participants to compete in a market-driven situation.
"After setting up clear rules of the game in capital markets, enterprises would act rationally in their own best interests, offering compelling products and services to cater for market-driven demand," Gong said.
He said the expansion of corporate bond issues would help ease the risks associated with shadow banking or off-balance sheet financing in the financial system, alleviating growing concerns about the health of mainland lenders and creating a new balance between market-orientated insurers and stability of lenders' asset quality.