Three pieces of financial news over the past week were worthy of note. One, China's interbank lending crunch has been roiling the markets; two, US Federal Reserve chief Ben Bernanke again indicated that an imminent reduction in stimulus was not far off; three, the State Council met to discuss how the financial industry could support China's economic restructuring.
These were related events.
China's economy today is generally stable, but faces many challenges, not least the risks of slowing growth, a squeeze on government revenue and substantial government debt. Add a credit crunch, and the pressure on policymakers to reach for a quick fix has been immense.
The central government was right to pledge last Wednesday that it would maintain a prudent monetary policy and keep money supply at a reasonable level, because such measures will benefit China's long-term development.
As a result, the central bank sat tight last week. But with the markets still in flux, it sought on Tuesday to reassure investors by announcing selective support for bank liquidity. It made clear, however, that its help would be conditional; commercial banks were warned they had to keep risks in check.
Monetary prudence is the right policy choice given the global financial outlook. Market expectations that the Fed will soon end its programme of bond buying are rising, after Bernanke - in an announcement made just hours after the State Council meeting ended - suggested that the stimulus could end in the middle of next year, when the unemployment rate is forecast to fall back to 7 per cent. The bond buying could be scaled back later this year as soon as the jobless rate starts to come down.
Once that happens, we'll see a shake-up in global financial markets. In the short term, the dollar will strengthen, relative to the newly rising currencies, and we'll see heightened risks of money outflows.
Given the speed of change in the market, China would be unwise to adopt a loose monetary policy now. Besides, such tinkering is proving ineffective; the next driver of Chinese growth should come from structural reforms.
But analysis shows there is no shortage of money supply. In May, the broad M2 money supply rose 15.8 per cent from a year earlier, already higher than the 13 per cent projected at the end of last year. As the State Council made clear last week, the credit crunch is temporary and the result of structural problems. Thus, banks must adapt by changing their lending behaviour.
The central bank is right to insist on a prudent monetary policy, and to have refused to be held hostage by interest groups. For the good of the nation, it must look to the long term.
At the same time, the government must push for reforms. As the State Council pointed out last week, not only must monetary policy support economic restructuring, the financial sector must be made more efficient to spur growth in the real economy.
This implies work is needed to strengthen an open market economy, and diversify the country's monetary policy tools.
To that end, Premier Li Keqiang has set out a strategic plan that moves away from using investment as a stimulus, towards the development of a healthy market. It names eight policy areas for attention, including goals to target overproduction and structural deficiencies; support for rural development and small and medium-sized private enterprises; promotion of domestic consumption; gradually allowing the market to set interest rates; diversity in the capital market; and promoting the growth of private capital.
These are sound policy ideas.
In particular, the proposals for financial reform require attention. For instance, the costs of borrowing remain a problem for many businesses, so the move to allow the market to determine rates will be closely watched. In recent years, the upper limits have been eased, but not the lower limits, apart from the interest rates for mortgages.
Furthermore, the proposal to facilitate individual investments overseas will depend on the progress of currency exchange reforms.
Li's proposal merely set out the directions for change. Clearly, it will need to be fleshed out, and the devil is in the detail. To spark real change, policymakers must design a comprehensive, unambiguous plan of action, in a way that does not encourage speculation about policy intent.
This is particularly important in the work of encouraging the growth of private capital, and the restructuring of the financial industry itself. Measures to achieve these goals must no longer be delayed.
Half-hearted attempts at reform will only lead to repeated failures, causing the motivation for change to flag. China's leaders urgently need to deliver a plan that goes beyond slogans and bring about a breakthrough in reform. The window of opportunity for action is closing. China must act while its will to stand firm on a tight monetary policy remains strong.
This article is provided by Caixin Media, and the Chinese version of it was first published in Century Weekly magazine. www.caing.com