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A ‘big bang’ tipped for China’s financial services
The new leaders of China are expected to “dismantle” the country’s multifarious capital controls, according to a research report from HSBC, called ‘China’s Big Bang’.
The report, overseen by Qu Hongbin, HSBC’s chief economist for Greater China, focuses on a series of steps intended to remodel the financial landscape.
The key forecasts are: liberalized interest rates; a doubling in the size of the domestic bond market; and the renminbi to become convertible. And all within five years.
According to last week’s ‘Week in China’ newsletter, a lot of commentators have cast the new elite as lacking in reform instincts. But Qu pointed out: “Five out of the seven new members (of the Politburo Standing Committee) built their careers in the 1980s and 1990s in the coastal regions, the frontline of China’s reforms and economic development. More importantly, we believe they no longer have the luxury of choice. The new leaders are under great pressure to address China’s structural problems and the only way to do this is to push forward with reforms.”
Behind much of the analysis in the report is a changing role for China’s banks, as the bond markets take on more of the task of financing economic growth. The switch is an essential one because of the current over-reliance on the banks for lending, as well as the glaring mismatch in funding long-term loans with short- term deposits. Additionally, local governments are struggling to service loan repayments, especially on infrastructure projects that will take more time to generate returns.
Fortunately, HSBC thinks there is a fairly immediate solution for resolving the imbalance: long-term construction bonds issued by the central government on behalf of local borrowers, who then finance future projects with the money raised, or repay current bank loans for earlier spending. Demand for the new bonds shouldn’t be a major problem either, Qu thinks, with RMB38 trillion (US$6.1 trillion) sitting in savings accounts, and local insurers and mutual funds now more interested in investing in this kind of debt.
Another positive is that, as the bond market matures, banks will shift some of their attention away from large, state-owned corporate customers to small and medium-sized enterprises, which contribute a disproportionate share of jobs and growth.
HSBC also has high hopes for further interest rate reform, following steps in June and July this year to loosen central control of how banks set their lending and deposit rates, ‘Week in China’ says. The next round of reform is likely to see rates for long-term deposits ad- dressed first, while demand de- posits (which account for about half of bank liabilities) will be last in the queue to be fully liberalized.
HSBC still expects to see China’s interest rates set by the market within three years.
The third major area for the reform agenda is the renminbi, which Qu says is already “making giant strides” towards global currency status. The expectation is that at least 12 per cent of China’s cross-border trade will be paid for in renminbi this year, and that the total will pass 30 per cent in three years time. This pick-up in volume is triggering a reaction in the capital markets as the renminbi gains traction as an investment option too. Here the reform agenda is evident once more, as Beijing opens up more channels for capital to flow in and out of China.
There are words of caution in Qu’s final analysis: that the dismantling of China’s current capital controls will have to be carefully sequenced. But again, the reform message is a clear one and HSBC expects the renminbi to reach full convertibility within five years.
