China Urges Financial Industries to Serve Real Economy

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Jan. 13 – The two-day financial planning meeting held over the past weekend in Beijing has provided direction for China’s financial sector during the next five years. As part of the plan, financial industries will be used to serve the real economy, offering more credits to productive businesses that actually create most of the country’s new jobs and wealth. Financing channels will be further diversified, with the potential launch of new financial products.

For the future, China must improve the real economy’s access to finance and prevent over-speculation as well as virtual bubbles from inflating the economy, Chinese Premier Wen Jiabao said at the meeting.

Increased lending will be channeled to micro and small-sized enterprises (MSEs) and other essential projects, such as key infrastructure projects under construction and affordable housing projects.

The financial sector will also offer more support to China’s economic restructuring, indigenous innovation and environmental protection, noted Wen.

China has been implementing a tight monetary policy since late 2010 due to high inflationary pressure. Bank lending curbs, together with the weakened external demand caused by the recent debt crisis in Europe, have parched many small businesses’ cash flows and even led to their bankruptcy. The significant increase in laid-off workers has also heightened social tensions, bringing the government larger challenges.

The financial sector’s new focus on MSEs will likely bring about a series of changes, said Cao Yuanzheng, chief economist at Bank of China. New lending technologies may emerge, small and medium-sized financial institutions with more flexibility may increase, private financing may find more exposure to lenders, and market-oriented interest rate reform may come closer.

However, for the time being, China’s central bank – the People’s Bank of China (PBC) – still seems to be taking a prudent attitude towards the market-oriented interest rate reform, which is regarded by economists as a necessary solution to high-cost financing.

“…It still is not a good time to promote ‘interest rate marketization,’” said PBC Governor Zhou Xiaochuan, pointing out that there is still uncertainty in the global economy and other central banks are currently holding down their interest rates.

While the mention of market-oriented interest rates has attracted a massive amount of attention, the Chinese policymakers’ plan to boost direct financing has become another major topic at the two-day meeting.

The total assets of China’s securities industry – which amounted to RMB4.7 trillion by the end of 2011 – account for only 3.9 percent of the total assets of the country’s financial industry. The small presence of direct financing could cause a systemic risk in the banking sector and limit access to funding for small businesses.

“Some of the firms may be more suitable for stock or bond financing, but they can’t get sufficient financial support because direct financing remains small-scale,” said Guo Shuqing, chairman of the China Securities Regulatory Commission (CSRC). “This structural problem can damage the economy seriously.”

Guo added that regulators are planning to launch several new financing products, including high-yield corporate, municipal and government agency bonds. They are also aiming to reduce administrative procedures for bond issuance.

China already initiated a trial program last year that would allow four select local governments to issue bonds directly, due to the increasing capital raising pressures in local governments and concern over their defaulting on debt by the year-end of 2011.

In addition to instilling more vitality into the bond market, the Chinese policymakers are also working on further opening the securities market to foreign investors. China Daily reported that the CSRC may boost the current investment quota for Qualified Foreign Institutional Investors (QFIIs) in the A-share market by US$50 billion, and another RMB50 billion for QFIIs investing with overseas RMB deposits.

China has also recently approved the U.S. bank Citigroup Inc to set up a joint-venture securities firm in the country, a move that is interpreted by analysts as part of the regulators preparation for the long-awaited international board in Shanghai. The international board – a separate board on the Shanghai Stock Exchange that will allow overseas companies to float shares on the A-share market – failed to debut last year even though the launch was strongly expected.

Other domestic long-term institutional investors – such as pension and public housing funds – are also urged to play a greater role in the country’s stock market. Currently, institutional investors in the Chinese stock market only hold 15.6 percent of stocks.

The stock market in China experienced wild fluctuations in 2011, finally falling over 20 percent. Banny Lam, economist with CCB International Securities Ltd, said increasing participation by intuitional investors in the stock market will generate returns and help stabilize the market.

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