Reform challenges remain but a fully convertible yuan is possible by 2020
Andrew Leung is encouraged by signs of China's resolve to fix its financial system and state sector
China's sudden credit crunch last month was anything but sudden. This was a desperate attempt to rein in an imploding financial crisis fuelled by indiscriminate bank lending linked to off-balance-sheet local government financing vehicles, a ballooning property bubble and massive Ponzi-like wealth management products. It was a tug of war between government regulators and the antics of "shadow banking".
Unlike state-owned enterprises, China's small and medium-sized enterprises have only limited access to bank loans, even though they register higher productivity. Thus, many have turned to shadow banking for funds.
Meanwhile, a system of "financial repression" caps the deposit interest rates on offer, which are no match for the lure of much higher returns promised by wealth management products. Due to the immaturity of China's investment market, a huge pool of hard-earned savings thus either runs the risk of investing in dubious products or is parked in savings accounts paying extremely low interest.
As many lower-income families rely on interest income to supplement their earnings, this repression dampens consumer demand. Moreover, the mispricing of such a large pool of funds makes for inefficient use and misallocation of capital on a grand scale.
Nevertheless, signs of a major shift of banking direction are emerging. According to a McKinsey Quarterly report, the share of bank loans by small and medium-sized enterprises has risen rapidly compared with loans for large corporations. In fact, total lending to small and medium-sized enterprises already exceeded that to large state-owned enterprises in 2011.
By 2021, according to McKinsey, small and midsize corporations are expected to account for 35 per cent and 18 per cent of bank lending respectively.
The new banking direction is gaining impetus with the internationalisation of the renminbi. The fact that China sits at the centre of a globalised production, supply and container cargo network helps consolidate the status of the currency. According to Arvind Subramanian of the Peterson Institute for International Economics, there are now more currencies that move in tune with the renminbi, eclipsing the US dollar as the world's ipso facto reference currency.