Hopes for Fresh Chinese Reforms Dashed

Signs that China is losing its appetite for key financial reforms are fuelling concerns that the country will remain on a path of unbalanced growth, increasing the chances of a future economic crisis.

Security personel pass by the Tiananmen Gate in Beijing, China. The Chinese People's Political Consultative Conference began on March 3 in Beijing.
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Security personel pass by the Tiananmen Gate in Beijing, China. The Chinese People's Political Consultative Conference began on March 3 in Beijing.

China’s economy has been driven by heavy investment and exports, but those two motors are beginning to sputter. Analysts say that financial reforms are critical to giving households a bigger share of the nation’s wealth and so unlocking consumption-led growth.

Meanwhile, the costs of an unreformed financial sector are rising, as shown by the huge debts incurred during its 2009-10 stimulus, which are now starting to come due.

However, the latest Chinese financial work conference — a meeting of regulators and policymakers held every five years which has previously laid the groundwork for major reforms – has disappointed analysts by failing to produce any significant new measures. The conference, which concluded over the weekend, was instead largely a restatement of old pledges that offered little new.

Partly, that is a reflection of where China is in its political cycle, with an emphasis on stability in the midst of a major leadership transition.

But more worryingly, observers say the conference’s failure to produce more substantial results is an indication that China’s reform drive has shifted down a gear. Instead, Beijing appears keen to avoid decisions that, while tough in the short term, are necessary to shore up the economy’s long-run success.

“Any kind of deregulation potentially has risks. The problem is that by not doing these things, you paint yourselves into a tighter and tighter corner as the years go by,” said Patrick Chovanec, a professor at Tsinghua University.

Analysts had been looking for Beijing to move forward on three specific long-mooted reforms: interest rate liberalisation, greater currency flexibility and bond market development.

There was a tentative nod in the direction of the latter, with leaders agreeing to promote “a more standardised and unified bond market”. Currently, the bond market is fragmented between five separate regulatory agencies, stunting its growth.

But the other issues rated as major disappointments. The post-conference communiqué recycled well-worn language, promising that China would “steadily push forward” exchange rate and interest rate reform.

It was a far cry from China’s inaugural financial work conference in 1997, which launched the clean-up of the then insolvent banking system and established securities and insurance regulatory agencies.

The second conference in 2002 laid the groundwork for the initial public offerings of the country’s top banks and for the establishment of the banking regulator. The third conference in 2007 led to the creation of China Investment Corporation, the country’s sovereign wealth fund.

By contrast, this year’s conference “lacked big-bang measures”, Zhu Haibin, an economist with JPMorgan, wrote in a note. “This was somewhat disappointing but might be a reflection that ‘stable’ is the policy priority in 2012, therefore major breakthroughs or big changes in strategies of financial sector reform are unlikely to occur,” he said.

It can be dangerous to read too much into the wooden language of the communiqués issued after the conferences, but investors in China were still poring over the wording to glean clues about the direction of future reforms.

One thing stood out. Whereas the 2007 communiqué mentioned “risks” three times, they came up ten times in the latest communiqué — an indication of a much more defensive tone.

The petering out of China’s reform momentum does not mean the end of reform. Cautious experiments with bond issuance by local governments, the shorting of stocks and making the renminbi more widely used globally are, among others, expected to continue.

“You will see nibbling around the edges. There will be a desire to show at least some progress,” Mr Chovanec said.

Before the financial work conference, Wei Yao, an economist with Société Générale, gave a punchy summary of why more sweeping changes were needed: “All in all, we think to reform is risky but not to reform is deadly”.