Tag Archives: Economic Reform

(Revised) Interest rate liberalization in China

China’s top officials made New Year resolution to bring about economic overhaul. At the Boao Davos Forum, Premier Li Keqiang emphasized that the government won’t panic in the face of slowing growth. Some analyst says that the slowing growth means that difficult reforms will be put off indefinitely. But easier one such as the interest rate reform is unwinding. The People’s Bank of China is in its final stages of winning approval for a bank deposit insurance system.

Interest rate liberalization in China is long overdue. But once it is implemented successfully, it will put money in the pockets of ordinary Chinese savers, make the banks evaluate risks more carefully, and direct lending to privately owned firms that complain of China’s largest banks ignoring them.

Yet steering the banking system of the second large economy in the world to a new direction is not an easy task. Currently, the PBOC targets a measure of bank credit called M2 and instructs China’s giant state-owned banks about their lending practices. For instance, the PBOC has told banks to halt loans to troubled real-estate developers and industries marked by overcapacity.  By contrast, other central banks take a less direct role by setting benchmark rates that offer a guidepost to banks as they lend.

 PBOC is hiring new brains to deepen their understanding of how to transform to a central bank more like other central banks. Ma Jun, until recently Deutsche Bank ‘s top China economist, was hired as the Chinese central bank’s new chief economist. He proposed a plan to liberalize the country’s financial system in steps within three years. First it needs to establish a central bank-blessed interest rate (China’s interbank rate) that would set a benchmark for lenders. That would give China the equivalent of the U.S. federal funds rate. During a first stage of reform, the PBOC should keep its intentions about the interbank market quiet and target a broader measure of money supply, known as M3. If the interbank lending system stabilized, China could shift fully to a monetary policy where the PBOC would set the interbank market rate, and banks would be free to charge what they like for deposits and loans.

But for such a plan to carry out, there are several caveats that must be factored in.

First of all, will PBOC be willing to give up control of lending by state-owned banks? Ma Jun must bear in mind the fact that it is much more easy for PBOC officials to send directives than to maneuver in a much more complicated market like Federal Funds Market.

Secondly, the biggest obstacle lies ahead for interest rate liberalization is what is known as the local government debt issue. Lots of local governments of China have been facing the risk of default on the colossal debts borrowed from state-owned banks. These debts were used to fund local governments unplanned and outrageous investment in infrastructure in order to boost local GDP growth, which is closely tied to the evaluation of local governors performance.

If the interest rate freed up too quickly, there is fear that the interest rate will be too high and local government will have to borrow more new debts to payback old debts. The huge default risk will put China’s economy in a perilous situation.The growing inability of local government to finance their debt is considered one of China’s biggest financial weaknesses. Unless there is a safer way to settle down local debt problem, I am afraid the interest rate liberalization agenda will be postponed.

China’s dilemma: reform or stimulate

Getting rid of one’s old and harmful behavior pattern is not an easy task, let alone changing the economic stimulus pattern of a whole nation.

Earlier this year, China’s top officials declared new resolution to  bring about economic overhaul and to stop such myopic and harmful stimulus measures as state initiate spending.

At the Boao Davos Forum,  Premier Li Keqiang emphasized that the government won’t panic in the face of slowing growth. “We won’t resort to strong short-term stimulus policies just because of temporary economic fluctuations.” Yet this does not mean they give up growth rate on the list of economic performance measures. They told business leaders that they would use monetary policy or “slightly bigger adjustment” measures if growth slips below acceptable levels. I guess that’s why there are so many room for public debates on what official statements mean.

But apparently, China’s slowdown in growth will likely put pressure on Beijing to pick up old stimulus measures and postpone structural reforms. What are the signs for this trend?

For example. Beijing has announced plans to build more railways and cut some taxes. Stimulus measures in coming weeks will likely involve stepped-up investments in transportation, urban renewal and alternate energy projects. The government is also planning to spur growth with a more accommodative monetary policy. Many analysts expect there will be a reserve-requirement reduction to give banks more money to lend. But it will more likely continue its long-standing reliance on investment even as spending becomes less effective.

Apart from Fiscal and Monetary policies, slower growth may also make PBOC continue depreciating yuan that has been downward trending for the past two months.  Although it is stated by PBOC officials that their currency moves were aim to reduce Yuan speculation, not to improve competitiveness of domestic product on foreign market. Actually, even if yuan were depreciating, China’s export barely increase. According to export companies, what they needed the most to improve competitiveness is more innovated product and better service quality.  But according to RBS economist Louis Kuijs, “the longer China needs to wait for convincing export growth, the more likely it is that keeping the currency down is a tempting policy measure to try to instill some life in exports and manufacturing.”

UBS analyst Tao Wang says that the slowing growth means that difficult reforms will be put off indefinitely. First up, said Ms. Wang: cutting red tape, opening the service sector to private investment and development of new financial products. For instance, the People’s Bank of China is in its final stages of winning approval for a bank deposit insurance system. Ms. Wang said more difficult efforts, including restructuring state-owned enterprises, land reform and establishing a nationwide property tax “will progress more slowly.”

 

Trade figures for March and China’ s Growth Prospect

If plunging of Chinese export is not surprising, then the double decline of both export and import is truly stunning. According to WSJ, China posted a 6.6% drop in exports in March, a drop compared with last March confounded economists, many of whom had expected growth of more than 4%. Imports also fell 11.3% year-on-year.

It is widely known that export reflect the foreign demand on domestic goods and services, and import reflect the domestic demand on foreign goods and services. Does these figures suggesting that China growth perspective becomes even more gloomy?

There are two reasons to believe the real picture may not be as bleak as the numbers suggest. One is that the “over-invoicing” artificially boosted trade figures of March 2013, making the latest data look poor by comparison.Over-invoicing is a phenomenon where companies use fake export invoices to dodge China’s capital controls and get money into the country, often for investment. Beijing cracked down on the practice last spring, but over-invoicing was still prevalent in March 2013. Another reason is that  China’s trade statistics in the first quarter are often skewed by the Lunar New Year holidays, which will make March figure relatively ugly.

But this two reason only explain for the drop of export, what is dragging down the import?

“I’m not that worried about exports,” Shuang Ding, an economist at Citigroup in Hong Kong said. “Imports are more worrisome. Tightening credit conditions are continuing to affect domestic demand, especially investment.” China’s policy makers have been walking a tightrope, trying to constrain the rapid growth of lending without stifling the economy. Even the modest tightening under way seems to have had a pronounced effect on demand, Mr. Ding said.

China is the major importer of raw materials, commodities, machinery and transportation goods. If import of China declined, this would have a huge impact on the global recovery pace.

Never the less, Premier Li Keqiang, when making a speech at the Boao Davos Forum,  emphasized that the government won’t panic in the face of slowing growth. “The downward pressure on economic growth remains,” Mr. Li said in a speech just as the trade data were being published. “We can’t underestimate these difficulties. We won’t resort to strong short-term stimulus policies just because of temporary economic fluctuations.”

I am glad to see that our government is determined to carry out economic reform that well bring China with a more sustainable growth prospect. Our economy has already paying a huge price on the rapid industrialization, which result in heavy pollution, unhealthy financial system, and a looming housing bubble. Nevertheless, the government’s tolerance for a slowdown has limits. Stability is always the number one priority for any politician.  Unemployment, although lack of a official and credible statistics in China, is posing more pressure on the government and central banks policy making decision. “The real space to watch in determining whether or not the leadership is stimulating the economy will be the pace of credit growth,” said Andrew Polk, an economist at The Conference Board, in a research report this week. March’s lending data is expected in the next few days.

 

 

 

 

Interest rate liberalization in China

Interest rate liberalization in China is long overdue, but steering the banking system of the second large economy in the world to a new direction is not a easy task. That’s why PBOC is hiring new brains to deepen their understanding of how to transform to a central bank more like other central banks, for instance, the Federal Reserve Bank of United States.

Ma Jun, until recently Deutsche Bank ‘s top China economist, was hired as the Chinese central bank’s new chief economist.   At a economic-policy session held by the PBOC and the IMF on March 27 in Beijing, he was proposing a plan to liberalize the country’s financial system within three years,  which he claimed will help the the country‘s economy reformation and sustain economic growth.

Currently, the PBOC targets a measure of bank credit called M2 and instructs China’s giant state-owned banks about their lending practices. For instance, the PBOC has told banks to halt loans to troubled real-estate developers and industries marked by overcapacity. By contrast, other central banks take a less direct role by setting benchmark rates that offer a guidepost to banks as they lend.

Mr. Ma said China should liberalize in steps in approximately three years. First it needs to establish a central bank-blessed interest rate(China’s interbank rate) that would set a benchmark for lenders. That would give China the equivalent of the U.S. federal funds rate. During a first stage of reform, the PBOC should keep its intentions about the interbank market quiet and target a broader measure of money supply, known as M3. If the interbank lending system stabilized, China could shift fully to a monetary policy where the PBOC would set the interbank market rate, and banks would be free to charge what they like for deposits and loans.But for such a plan to carry out, there are several caveats that must be factored in.

First of all, will PBOC be willing to give up control of lending by state-owned banks? Ma Jun must bear in mind the fact that it is much more easy for PBOC officials to send directives than to maneuver in a much more complicated market like Federal Funds Market.

Secondly, the biggest obstacle lies ahead for interest rate liberalization is what is known as the local government debt issue. lots of local governments of China have been facing the risk of default on the colossal debts borrowed from state-owned banks. These debts were used to fund local governments unplanned and outrageous investment in infrastructure in order to boost local GDP growth, which is closely tied to the evaluation of local governors performance.

If the interest rate freed up too quickly, there is fear that the interest rate will be too high and local government will have to borrow more new debts to payback old debts. The huge default risk will put China’s economy in a perilous situation.

Mr. Ma, taking into account the local debt issue, urged China’s local governments to boost the transparency of their operations and make bonds – not borrowing from banks and shadow-banking institutions—their main financial channel. “The advantages of doing so are to boost transparency of local government debt, to let the interest rates better reflect default risks, to solve duration mismatch and to diversify risks over-concentrated in the banking system,” he wrote.

The growing inability of local government to finance their debt is considered one of China’s biggest financial weaknesses. Unless there is a safer way to settle down local debt problem, I am afraid the interest rate liberalization agenda will be postponed.

 

China’s Two Major Financial Concerns

China released a 20-page blueprint for economic reform last Friday. Basically, market forces were set to play a more critical role in economic activities going forward as the Chinese government pledged to open closed fields to the private-sector and foreign competition.

Although the newly-established administration has indicated that they are willing to tolerate a slower growth pace in exchange for more sustainable expansion down the line, implantation of such a shift might be difficult due to the country’s immerse bureaucracy. As Stephen Green, a Standard Chartered economist, said: “Choose your sector. In every area, reformers have clear ideas, but it’s hard to push them past interest groups.”

On top of the bureaucracy, China has to face the following two major financial concerns, which could threaten its goal of “sustainable growth”.

The first one is inflation. Apparently, it is not a problem for the country, given that the Federal Reserve has started to scale back its massive bond purchase program, leading to significant capital outflows from emerging markets. But as Professor Kimball said in today’s class, there is not a definite link between inflationary pressure and the amount of money supply. Instead, inflation has a lot more to do with the level of economic activities. Despite a slowdown in terms of absolute growth rate, China’s economy is gaining momentum as the middle class is growing and the country is making a shift from overly dependent on exports and infrastructure investment to rely more on domestic consumption, pushing up inflationary pressure naturally. At present, the concern is eased as China’s consumer-price index rose 2.5% in January from a year earlier mainly due to muted food prices. According to estimates by J.P. Morgan, Consumer inflation could pick up somewhat later this year, averaging 3% in 2014. Still, that would be easily within the government’s stated tolerance of 3.5%. However, the figure implies another worry for growth, which is weaker domestic consumption. So the government has to face a trade-off between inflation and domestic consumption as the planned reform progresses.

The second one is the increase in bad loans.  According to the China Banking Regulatory Commission, Chinese banks’ nonperforming loan ratio rose to 1% at the end of the latest quarter from 0.97% at the end of September, which is the highest since the end of 2011. It is a dangerous sign of increasing risk in the banking sector because many loans were made on the expectation of faster economic growth. Moreover, a significant portion of lending were associated with the so-called “wealth management products”, a new financing channel for government-led investment projects. The mismatch of long-term investment return and short-term maturity could lead to potential default and even systematic risk in the overall economy.

Therefore, the “big picture”, especially the two concerns above, should be taken into consideration when implanting the country’s financial reform, otherwise the risk of higher leverage might damp economic stability in the long run.