Few things are as important to the world over the next few decades as China’s smooth integration into the global economy. China’s growing share of world trade, the size of its economy and its role as the world’s largest creditor mean that what happens within China is directly relevant to the rest of the world.
The restructuring and opening up of China’s financial markets have been at the heart of China’s reform agenda for the last two decades. The process has, however, largely stalled in recent years.
A recent report, jointly published by the World Bank and the Development Research Council of China’s State Council, warns of the risks associated with postponing major economic reforms.
The report, China 2030, urges China to revamp its financial system in a comprehensive and coordinated matter in order to counter the risks facing the nation over the next 20 years. Central to the report’s findings is the need for China to modernise its domestic financial markets and to move to a more balanced financial system where the power of state-owned enterprises is scaled back and private enterprise encouraged.
It calls on Beijing to complete the transition to a market economy by following a properly sequenced roadmap, gradually removing interest rate controls, deepening capital markets (including bond markets), commercialising the banking system and further developing strong independent regulatory bodies to support the integration of China’s financial sector with the global financial system.
The case for reform is compelling. China is reaching a turning point in its economic development path. While external risks from an economic turndown remain a concern, bigger risks are likely to arise from China’s ability to manage its transition to a very different form of economic growth.
With a once-in-a-decade leadership transition looming and the political heir apparent, Xi Jinping, offering few clues about the economic policies he will pursue, the question remains whether the reforms proposed by the World Bank and the IMF will be adopted and implemented.
There appears to be a deep consensus within the Chinese community that reform is necessary, but the many vested and entrenched interests make change difficult. The power of the state-owned banks and the fact that China’s old growth model based on export and investment-led growth has been so successful means that few government leaders have been willing to make radical changes for fear that they may undermine near-term growth.
Within the Chinese business and financial community, the desire for reform is palpable, with reformers pushing for faster change ahead of the leadership transition. The fact that the World Bank report was co-published with one of China’s leading think-tanks is encouraging and comes at time when the voices of reform are becoming louder:
- The Chairman of China’s top securities regulator has publically floated ideas about the importance of making the domestic bond and equity markets more efficient. He has also called for new policies to provide capital for small, entrepreneurial companies that have long struggled to raise loans from the major banks. That cry has seemingly been heard, with the State Council recently announcing a pilot program allowing private lenders in Wenzhou to operate as regulated investment companies for cash-strapped businesses.
- China’s central bank, the People’s Bank of China, weighed in on the foreign exchange debate with a recent highly publicised article by one of its senior officers which laid out a staged plan for dismantling the capital account restrictions that prevent the free flow of currency across China’s borders. Most commentators agree that the internationalisation of the renminbi (RMB) is inevitable. What is less clear is the timing for full convertibility. The country’s capital controls have served it well to date but there are now difficulties arising from the maintenance of such rigidity. This is a thorny issue for China’s policymakers, but the reformers’ push is gaining momentum.
- Last week, Chinese banks were given some welcome flexibility in the setting of interest rates for deposits - an important step on the way to interest rate liberalisation.
China is known for its long-term planning and comprehensive reform process. We are now at an important juncture in China’s development cycle. The need for further change is clear, but for this to occur, China needs vision and commitment from the very top.
Reform implications for Australia
Just as China’s integration into the global economy is a critical policy goal for that country, so too is Australia’s ability to integrate into the regional economy and develop deep partnerships critical to its longer-term prosperity.
Australia’s financial services sector is one of the most efficient and sophisticated in the word. It is well-regulated and its financial institutions well-capitalised and profitable. There are linkages to the region through trade flows, in-bound investment into the booming resources sector, outbound superannuation funds and the activities of foreign (including Chinese) banks in Australia. Despite all this, however, it remains largely a domestic industry. All the major Australian banks have both a regional and a China strategy, but with one exception, direct investment in the region has been modest.
In our submission to the Australian Government’s White Paper on Australia in the Asian Century, we commented on the imperative for corporate Australia to become more deeply connected to the markets on our doorstep: “Financial integration is a tool [that can be used] to deepen regional financial markets, strengthen regional sources of funding and improve access by consumers and investors to financial services”.
This theme was echoed by the Australian Stock Exchange which observed in its submission to the Government’s White Paper that Australia’s financial services sector faces three choices for the next 10 to 20 years. We can either:
- continue to see Asia as a customer, offering two–way trade and investment flows and foreign exchange service, as well as some relatively narrow service offerings such as managed investments;
- engage more deeply with Asia, allowing us to export our expertise in financial services and benefit from local growth as a service provider to local companies and consumers; or
- integrate with the region, forging deep partnerships that make Australia’s financial services industry a truly regional industry with a strong Australian base, providing services seamlessly across the region.
While the first two options may be the right choice for individual institutions, for the nation, the third option - integration into the region and the forging of deeper partnerships - is compelling and demands the attention of business and policy makers.
The strategies that can be adopted by organisations will vary, but there are several aspects of China’s reform process that suggest significant long-term opportunities:
- Wealth management: The policy move away from reliance on bank deposits and lending will allow Chinese investors access to more sophisticated, higher-yielding and longer-term investment and insurance instruments. Years of experience gained in managing Australia’s burgeoning superannuation funds, our renowned expertise in product development and our skills in critical areas such as fee income generation, credit risk assessment and cross selling of products and asset management position Australian wealth and funds managers well to take advantage of these opportunities.
- Renminbi internationalisation: While the timing for the breakdown of the capital account barrier is not yet clear, the trend towards the increased use of the RMB in cross-border trade and market transactions is certain. Australian banks are actively seeking to set up RMB businesses and the recent $30 billion currency swap agreement signed by the central banks of China and Australia now provides Australian banks with greater liquidly comfort.
- Opening up of the bond market: This is the last and most critical of the steps in China’s sequential reform process. With little experience by Chinese firms in the operation of a domestic corporate bond market, Australian institutions are well-positioned to combine their experience in the origination of fixed income products and services with Chinese banks’ local knowledge, relationships and distribution capabilities.
- Alternative financial funding solutions: Policy reform is encouraging the development of “innovative” financing techniques. A long-anticipated pilot program for asset securitisation has just been launched. Australian expertise in this area is renowned and offers opportunities to work with local partners in order to ensure that this segment of the market develops in accordance with global best practice.
- The “going-out” of Chinese banks: Chinese banks are expanding internationally as they seek to support Chinese enterprises abroad. Australia has been an important testing ground for investments, helping Chinese banks to acquire experience, skills and capabilities. Partnerships with Chinese banks have the potential to provide further banking services in Australia and to unlock opportunities within China itself.
More generally, Australian financial institutions, legal advisers and other experts can play an important role in working with Chinese institutions to improve their systems of corporate governance, risk management, internal control and to adopt best practices, all of which are essential building blocks for a strong, integrated regional financial system.
How individual institutions take advantage of these opportunities will depend on the strategy of each institution, its market and product alignment, its risk appetite and the amount of capital an institution is willing to deploy.
What is clear, however, is that to be successful, Australian business and policymakers have to develop a longer-term (10 to 20 year) game plan and work closely to deliver it. Our policy horizons and national policies need to reflect those of our key regional partners, China being the most important.
Now, more than at any time in the past, success will be linked to the creation of partnerships, collaborations and strategic alliances.
China’s reform processes are underway. They will bring with them a massive rebalancing of the world’s financial markets. The ride will not be smooth, but for those prepared, the opportunities will be significant.
This article is an updated version of an article that appeared in Australia China Business Insight journal, Issue 1 2012, published by the China- Australia Chamber of Commerce, Beijing.