The Chinese National Financial Work Conference this year took place on the 14th and 15th July and was led by the President, Xi Jinping. President Xi stated during the conference that the priority function of the financial sector was" to serve the real economy while guarding against systemic risks" (quoted from People's Daily). From the President's statement, the reforms involve two parts: to serve the real economy, and to reduce systemic risks in the financial market. More reform policies and regulations will be made based on the statemen and some reforms have been announced. For example, it has been announced that China will accelerate developing laws and regulations governing the financial sector and set up a committee to oversee financial stability and development, and the central bank will play a stronger role in the macro-economic management. I want to first discuss the announced reform plan of a larger role of the central bank, as the other plans are less specific and we still and then discuss how the Chinese financial market may be influenced and reformed in the coming years.
A more powerful central bank:
The function of a central bank in any country is undoubtedly important in terms of determining the economic performance as well as the financial market stability. However, the tool for any central bank to influence the economy as well as the financial market is its monetary policy. Nowadays, the most common monetary policies are changing base rates and asset purchasing programmes. If the central bank is limited to only using these two tools, it is almost impossible for the central bank to become more powerful. Therefore, to enlarge the influence of the central bank, it is necessary for the Chinese central bank to have more tools to make impacts on the economy and the financial markets. However, when a central bank uses too many tools to control over the supply of the money, other unwanted effects could be caused. For example, the use of the RMB in foreign countries could be affected when the Chinese central bank and the government seem to have too much control over the RMB. There is a theory called “impossible trinity” in the monetary policy that a monetary system cannot have all the three policy positions at the same time and the three positions are free capital flow, fixed exchange and sovereign monetary policy. This suggests that given the Chinese government and the central bank must maintain the current sovereign monetary policy, they have to find a balance between free capital flow and fixed exchange rate. When they weight more on fixed exchange rate, the capital flow could be affected and vice versa. Therefore, in the short term, it does not seem very easy for the Chinese central bank to further expand its influence over the economy and the financial market.
How the Chinese financial market may be reformed in the future:
Firstly, I expect more regulations and restrictions on the Chinese equity market. The equity market is a market that is considered to be more risky, especially given the Chinese equity market was unusually volatile last summer in 2016. To the very extreme, I think a restriction on the qualification of entering the equity market could be made. There are still many small share traders in China. The average return for these share traders are negative, and some of them are not fully aware the risk they are taking and more importantly they have not been educated about how the financial market is functioning. Therefore, the existence of these small traders could add more systemic risk, their reactions to the market are more easily manipulated by some ill-motivated large traders. Though the total number of small active trading accounts has been decreasing over time, it is still possible for the government to limit the access of some poorly educated traders to the financial market in order to reduce the systemic risk as well as eliminating the risk for those who do not understand the risk. On the other hand, I expect some regulations will aim to eliminate the profitability of purchasing newly listed companies or going for public listing. The profitability in the financial market should be independent of the act of purchasing or going for public listing and become dependent of the individual competitiveness of the company. This could encourage the companies to increase their individual competitiveness rather than seeking some shortcuts by getting their companies publicly listed. This could be beneficial for the real economy as companies are possible to become more competitive; meanwhile, it can lower the systemic risk, as the possibility of mispricing which is a source of risk could be lower when the profits gained from the financial market become more dependent of companies’ individual performances. In addition, the financial instruments will be limited, as when he various financial instruments could increase the complexity of the financial market, when people do not fully understand the instruments, the systemic risk is enormous, the 2007-08 financial market could be seen a crisis that was caused by people creating financial products they did not understand.
Secondly, I expect the bond market will be expanding. As stated in the Chinese official newspaper that “developing direct financing will be prioritized”, it implies that companies may be more able to finance themselves directly from the financial market. Due to the volatile nature of the Chinese stock market, loosening regulations on the stock market seems undesirable; therefore, to make companies easier directly finance themselves, instead of allowing more activities in the stock market, companies may be encouraged to issue more bonds and commercial papers directly to the financial market. When more bonds and commercial papers are issued, the bond market will become more active and be expanding. Moreover, due to the natures of bonds, the bond market is unlikely to be more volatile than the stock market, and bonds are normally ‘safer’ than stocks; therefore, expanding the bond market is less risky than expanding the stock market, and it can help companies to gain more direct finance as well.
Thirdly, the pace of the reforms and deleveraging could vary across different sectors. Leveraging and taking risk should not be seen as totally bad ideas in my opinion that leveraging and taking higher risk are the effect of individuals seeking for higher profits. People should be free to choose how much risk they want to take as long as the risk does not affect others. However, nowadays we are all connected with each other and we are all sharing our risk to different degrees; therefore, the regulations aim to balance the social benefit against the social risk, when the social benefit is high, it is reasonable to take some more risk and vice versa. The government has its views on which industries need more development and which industries should start to give some resources to other industries. Therefore, the pace of the reforms and deleveraging will dependent of how much the government supports the sector. In the industries which the government is willing to give more support, the companies are easier to get financed directly and indirectly from the financial market and the pace of deleveraging could be slower, even it is possible for some companies to be leveraging up their assets to gain more development. And in the industries which do not gain support from the government, companies may face more regulations when accessing to the financial market, the pace of deleveraging will be faster.
Conclusion:
I expect that in the future the Chinese bond market will have a faster growth rate than the stock market, as more regulations will be placed on the stock market as it has higher systemic risk to the economy. Moreover, the restrictions of regulations and laws will depend on the support from the central government. Finally, the financial sector is not seen as an individual industry by the Chinese government, it is seen as a tool for generating economic growth in the real economy; therefore, the profits of the financial sector could be sacrificed for the real economy.
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