The report on China’s economy prepared by the IMF as part of its annual bilateral discussions with Beijing highlights the importance of advancing financial reform in the cause of rebalancing the economy.
Financial reform holds significant promise in contributing to the needed transformation of the Chinese economy. Over the horizon of the 12th Five-Year Plan, reforms should seek to secure a more modern framework for monetary management, improve supervision and regulation, deepen the channels for financial intermediation, transition to market-determined deposit and loan rates, and open the capital account. In all of this, a stronger renminbi will be an important complement.
Financial reform alone isn’t sufficient for rebalancing the economy in the IMF’s view. There will also need to be a stronger social safety net, higher household incomes and increases in the costs of various factors of production–i.e. an unwinding of price-distorting subsidies to things like energy. But the need for financial liberalization is pressing.
[The] potential combination—of rising inflationary pressures, already-high prices in the property market, and a weakening of direct monetary control—poses significant risks to financial and macroeconomic stability. In addition, the current system for financial intermediation continues to hold back rebalancing and the development of the service sector, generating industrial overcapacity that could present negative implications for long-run growth prospects.
China’s economy has become complex. Further financial liberalization will have to advance on a wide front: appreciating the currency, absorbing liquidity and strengthening monetary management, improving regulation and supervision, developing financial markets and products, particularly in fixed-income to help develop institutional investors, liberalizing interest rates and, once more market-based macroeconomic policymaking is in place, easing controls on capital flows.
The new five-year plan is broadly aligned with these needs. The question will be how far and how fast the reformers can push. Policymaking on this, and most other fronts, is now in stasis because of the leadership transition. There will always be economically delicate and politically difficult trade-offs between growth, inflation, financial stability and structural liberalization of the economy. Tackling inflation is the short-term political priority for economic policymakers, and absent a property or bank-credit crisis, there won’t be much political appetite for tackling financial reform until the factional jockeying for position within the Party’s new leadership calms down. That won’t happen for at least a couple of years, by which time the five-year plan will be deep into its second half, and the financial sector, we suspect, not look a lot different from what it is today.