Adventures in oriental finance

The economist has an excellent article this week that touches on the myriad problems in the Chinese financial sector:

Hank Paulson, America’s treasury secretary, was not just talking America’s book when he said that opening the Chinese financial system is “absolutely necessary” for China’s own long-term economic success. It would not only provide greater equilibrium to global capital flows, but would also bring more efficiency to China’s industry. Already, manufacturing firms in southern China are struggling to cope with the rising yuan, because there is no currency-futures market for hedging.

Similarly, Chinese firms are forced into inefficient financing arrangements. They can borrow from state-controlled banks at rising rates that may have little to do with their own creditworthiness, let alone what they plan to do with the money. Alternatively, they can join a long, bureaucratic queue to issue shares. Even the largest ones still rely on the state for permission to raise capital: Ping An, the second-largest insurer, recently pulled a vast secondary share offering after what was believed to be a quiet word from the authorities.

A state-driven financial market means state firms tend to do best. Financing for start-ups remains largely informal—loans from friends outside the financial (and tax) system—which stifles entrepreneurship. Worst of all, today’s system provides a truly rotten deal for Chinese citizens trying to put away money for retirement, for their children’s education or other personal needs. They are given a bleak choice of subsidising the financial system through deposits yielding less than inflation or speculating on highly volatile shares.

The only major disagreement I have with the article is its backing of Paulson’s stance on the currency. Paulson puts the opening of the capital account fairly high up on the “to do list” of Chinese financial reforms, whereas it seems to me that that jolts linked with moving to a freely convertible currency would wreak havoc on what is already a weak financial system.

While I’m personally very concerned that the current muck will slow reforms to a standstill, assuming things pick up again I still am guessing 10-15 years before there is direct trading of the RMB. The government would have to have a little more of a stomach for risk, which I think would require a turn around in demographics (less excess labor, which is happening right now), full-to-majority privatization of major banks (particularly ICBC and CCB, I’m not at all optimistic about ABC), and the full development of the capital markets (short selling needs to be introduced as soon as possible).

None of those things will happen any time soon.

Bradley Gardner