China's Financial Reform Gains Steam

With a clearer outline and more concrete steps, China's financial reform is gaining traction amid calls to better facilitate the real economy and guard against risks.

The city of Yiwu, best known for its wholesale market in east China's Zhejiang Province, has joined a list of Chinese cities to carry out special financial reform programs and target innovation in both the financial system and practices, hopefully to boost international trade in the area.

The move by Yiwu, following other financial reform pilot zones in Wenzhou, Qianhai and Binhai, chimes with the State Council's official approval in late August to build a free trade area (FTA) in Shanghai, the country's economic hub.

Many believed Shanghai would further unleash the potential of China's much-said financial reform, which was also conveyed in Premier Li Keqiang's opening speech at the Summer Davos forum last week.

In line with the government's incremental steps in the past months, Premier Li pledged China would take active yet steady steps to further liberalize interest rates and exchange rates, make the yuan convertible under the capital account, as well as to reform financial institutions, cultivate a multi-layered capital market and strengthen financial supervision.

"Financial reforms in the past few months, including the relaxation of lending rates, were generally carried out in accordance with the reform package Li referred to," said Kuang Xianming, head of the economic research center with the China Institute for Reform and Development.

Kuang said Li's remarks point out that market-oriented reform will still be the core for the next round of financial reform. "It can be expected that China's financial reform may be gaining momentum in the period ahead," Kuang said.

In July, China began to allow banks to decide their own lending rates, but the deposit rates are still fixed by the central bank.

In his speech at Summer Davos, Li also said the country will "choose an appropriate time" to introduce the deposit insurance system, which is considered a key precondition for freeing deposit rates, the last and most important step of interest rate liberation.

Tan Yaling, president of China Forex Investment Research Institute, said the new leadership's decision to accelerate financial reform is positive, but suggested more work needs to be done on the systemic scale rather than on the local level.

"Financial reform should be based on a strong and balanced real economy and requires high professionalism. The influence and feasibility of Yiwu's pilot financial reform is still debatable given the quality of the local economy," Tan said.

She suggested the next round of financial reform should focus on the bigger picture of building a complete and sound financial market, as local reforms will only have limited influence.

"Local reform may be a bell ringer, but if a strong market is not established, it will bring speculative risks in the short-term," she warned.

Tan's warning reflected similar worries over local government debt and potential systemic and regional financial risks the world's second-largest economy may face.

Premier Li reiterated in the forum that financial system reform should be conducive to the real economy and economic restructuring, as well as benefit the livelihoods of more people.

According to Tan, the scheme to build the Shanghai FTA, with more details yet to be announced, should also start with how to boost trade and industries, rather than a mere discussion of financial tools and services.

"Only when trade flourishes, other plans can unfold," Tan said.

China's foreign trade unexpectedly slowed in June but has recovered for two straight months due to improving global demand and a firming domestic economy, with the trade surplus widening 8.4 percent year on year to US$28.52 billion in August.

Kuang Xianming said financial reform will bring more good to the real economy as it may force monopoly industries to retool themselves.

After freeing up the lending rates, banks will try to woo quality clients to rebalance credit structure. With credit resources no longer centralized in monopoly industries, the industries themselves may be driven out of the comfort zone for a reform, said Kuang.