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Paulson Urges China to Open Financial Markets

China should open its financial sector further to foreign competition to help it become more than an exporter of low-cost manufactured goods, U.S. Treasury Secretary Henry Paulson said on Thursday.

"The risks for China are greater in moving too slowly than in moving too quickly towards transparent, liquid, stable capital markets," Paulson said in an address to the Shanghai Futures Exchange, a highlight of a four-day Asian tour.

While China already has the world's fourth largest economy, it is still in transition from a planned economy to one that is market-driven, and this transition will take years, Paulson said.

China therefore needs to step up the pace of reform for the sake of stability, both at home and globally, he argued.

He warned that China's growth was becoming "increasingly imbalanced" because it was overly dependent on exports and so carried the seeds of future problems if reforms lagged. "Financial sector development is the key to China's transition into an economy that is less reliant on industrial activity, produces more high-value-added products and reduces the intensity of natural resources consumption," Paulson said.

Paulson was winding up a visit that took him to Japan and South Korea before a brief stop on Wednesday in Beijing. As he did in Tokyo and Seoul, Paulson reiterated that he considered the
global economy "as strong as any I have seen during my business lifetime", and said it was characterized by vigorous growth, muted inflation and ample liquidity.

Not Linked To Turmoil

U.S. Treasury officials, anxious to dispel any notion that Paulson's China visit was related to turmoil in financial markets that began last week with a sharp drop in Chinese stock prices, said he had worked on his Shanghai address for weeks.

Paulson said "deep, liquid capital markets" were necessary to enable an economy to keep prospering. This meant, among other things, strong property rights and a robust regulatory regime as well as transparent financial information and independent credit rating agencies.

China's law on property rights will bolster protection of private assets, according to a draft given to the national parliament on Thursday, as the government seeks to balance private investment and state control.

China "is clearly on the right track" in efforts to modernize its economy, but needs to do more, Paulson said. "As I have said many times, our policy disagreements are not about the direction of change, but about the pace of change," said Paulson, a former chief executive of Wall Street giant Goldman Sachs who has long ties to China.

He said China needed a bigger and more accessible government bond market and a more liquid corporate bond market, and had to develop markets so that mutual funds and asset managers could bring more discipline to equity investing.

"The development of a broad-based institutional investing market is being inhibited by a number of policies, including the fact that some important institutional investors, such as insurance companies, are highly restricted in the types of investment they can own."

Currency An Issue

Paulson did not directly criticize China's reluctance to let its yuan currency, also called the renminbi or RMB, rise in value more rapidly. But he did note that "the combination of a rigid RMB exchange rate regime and large external surpluses mean there is a flood of liquidity into the banking system."

China's efforts to absorb the liquidity are increasingly strained, and it would be better able to reform its banking sector if its monetary policy were "less absorbed by managing the exchange rate," Paulson suggested.

He also said that if authorities allowed Chinese banks to sell controlling stakes to foreign investors, instead of limiting them to 25% ownership, it would help small- and medium-sized banks that would be takeover targets to improve their risk management.

Paulson said China's "tight caps" on foreign ownership in its capital markets should be eased, as they have been eased in other emerging-market countries including Brazil, India and Russia. That would foster the development in China of world-class investment bankers, he added.

Time is of the essence for Beijing to act, Paulson suggested, because reform would sustain China's growth and aid global economic stability. "It is better to implement reforms during periods of economic strength," Paulson said.

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