Policymakers are expected to focus more on containing financial risk than vowing to make breakthroughs in financial reforms as deputies gather this week for China’s top annual legislative meeting.
While the world’s second-largest economy last year allowed banks to set their own lending rates and established a free-trade zone in Shanghai to pioneer financial reforms, observers widely anticipate no substantial steps this year in liberalising deposit rates and exchange rates or opening up capital accounts, the key areas where reforms are long-delayed and much needed.
“I see no substantial moves in financial reforms this year,” said Mao Zhenhua, Chairman of China Chengxin Credit Management. “Instead, Chinese policymakers will pay more attention to avert the escalating financial risk.”
Mao, founder of the mainland’s first credit ratings agency, said the company had been shunning local governments with poor creditability who asked for a good credit rating for bond issuances.
“We’ve turned down many clients, most of them being county or lower-level governments, to rate their bonds since last year,” Mao said. “We’d rather lose market share than hurt our reputation to whitewash the bond issuers with poor solvency.”
Mainland local government debt had swollen to 17.9 trillion yuan (HK$22.7 trillion) by the middle of last year, according to the National Audit Office. The figure, nearly 70 per cent more than the 10.7 trillion yuan by the end of 2010, is seen as a further sign of the risks building inside China’s financial system.
China’s local governments and state-owned enterprises received the bulk of funding in the economic stimulus following the 2008-09 global financial meltdown. White elephants and excessive industrial capacity were built and inefficient projects led to mounting bad debts in the financial system. To avoid a bad debt crisis, China has asked banks to roll over the loans and encouraged local governments to sell debts.
“Tackling the local government debt problem could be top of the government’s work agenda this year,” said Lu Ting, an economist at Bank of America Merrill Lynch.
Lu expects that the National People’s Congress (NPC) will approve laws permitting local governments to run fiscal deficits to finance public projects and will be officially given the access to banks and capital markets instead of through the current arrangements involving local government financing vehicles.
The mainland will also likely include local government debt in the budget-making process, to tighten local government bond issuance procedures, and make provincial governments responsible for the debts of lower-level local governments, he said.
Risk is also building in the shadow banking system as problematic borrowers including local government financing vehicles and property developers obtain funds through trust firms, microcredit companies and peer-to-peer (P2P) lending platforms where risk control is believed to be weaker than banks.
May Yan, an analyst at Barclays Capital said:”We will hear more discussion of regulations for shadow banking, especially those governing trust default risk, during the meetings of NPC and the Chinese People’s Political Consultative Conference (CPPCC).”
In January, the default of a 3 billion yuan trust product linked to an indebted coal miner is raising the spectre of a wave of defaults of similar high-yielding products with billions more yuan of investments at risk.
The product of China Credit Trust was distributed by the Industrial and Commercial Bank of China. Although the bank said it was not responsible for a bailout, dozens of investors protested at the lender’s Shanghai branch and asked for repayment. The controversy ended when undisclosed companies were arranged to take over the debt and repaid principal, with part of the interest left unpaid, according to the scheme’s investors.
China’s central bank is co-ordinating financial regulators to establish comprehensive regulations for shadow banking, with detailed rules expected to be issued after the NPC.
“We expect regulators could allow default and losses in trust products, as well as some other selected financial products, to reduce the implicit guarantee in the financial system and instil risk-pricing this year,Yan said.
Although rules and regulations will be introduced to improve supervision of shadow banking sector, policymakers are not intended to depress its development or choke it to death, observers say.
Sushil Saluja, a managing director of Accenture’s Asia-Pacific financial services said the biggest challenge for China’s financial reform “will be how to balance market liberalisation and financial services growth with market stability”.
Online lending risk escalated last year after 74 of China’s 800 or so P2P firms reported “operational difficulties, cash squeezes and even owners running away”, resulting in the loss of 1.2 billion yuan of investors’ funds, according to Shanghai-based Wang Dai Zhi Jia, a P2P industry information provider. P2P companies match lending supply and demand online.
As their activities have supported the small private firms that are the victims of the mainland’s unbalanced financial system, regulators had been supportive until recently, when defaults surged and sparked fears of social unrest.
Tang Ning, CEO and founder of CreditEase, a Beijing-based financial consulting company, said policymakers would “continue to encourage innovation and the development of internet finance, because it complements traditional financial services”.
The central bank has tolerated the rapid development of internet financial services, a similar approach it had to wealth management products. This reflects the regulator’s positive attitude towards such financial innovation, particularly because both have served to accelerate interest rate liberalisation, force banking-sector reform, and offer households higher returns to their savings, Barclays analysts said in a research note.
Although no bold steps are expected in financial reform this year, China will continue its reforms including setting up a deposit insurance system, allowing banks to collapse and permitting more private companies to set up banks, observers say.
“China is on the way to opening up its banking sector,”said Mark Boleat, chairman of the policy and resources committee at the City of London Corporation. “Moves such as recent permission for more private lenders would create more competition for existing big state-owned lenders. This is just one example of China’s interests in opening its financial markets further, which is supported by the City of London.
“Of course, development of the markets is a continuous process for all countries and China will need to find the way that is best for it to do so safely and effectively.”