China’s Financial Risks
Viewpoints of Zhang Monan, a member of China Information Center, a member of the China Foundation for International Studies, and a researcher at China’s Platform for Macroeconomic Research.
The recent upheavals in the financial system of China, and the subsequent liquidity crisis caused global shivers. The Central Bank of China precipitated a liquidity crisis among banks that forced them to raise their short-term interest rates sharply higher. These drastic measures seek to stop the banks involved in complex transactions that involve hiding and securitizing risky loans, so that the regulators may not notice them.
The problem of the financial system is one of the main obstacles facing China. “In the coming years, the Chinese government will face major challenges in order to achieve stable economic growth, both inclusive and sustainable,” ponders Zhang Monan, renowned economist in the research of the Chinese economy.
The current Chinese financial condition is inseparable from its fiscal position, as banks are state-owned. However, in this scenario also appears local government’s risk. “The greatest threat for China’s medium and long-term fiscal situation is in the system of implied warranties which the central government has established in relation to the debts of local governments. Following the global financial crisis, local governments have borrowed large amounts of money from the banks to support the massive stimulus program in China, accumulating a debt worth USD 1.7 trillion.” Monan Zhang points out.
Local governments seek and arbitrate every means to finance themselves, using sophisticated financial engineering, through special investment vehicles. In this regard, says Zhang Monan, “China’s leaders hope to control the potential risks of the investment vehicles of local governments (Vigl) by limiting bank loans. The balance of bank loans to Vigl increased only slightly in 2012, to ¥ 9.3 trillion. However, Vigl obtained a large amount of funding in 2012 through the issuance of bonds and trust loans. Yet even with these funds, local governments have had to strive to pay their bills.” To fund their budgets have resorted to the sale of land.
Another common way to finance that governments have, in any country and at any level (national, regional, provincial or municipal) is falling behind on paying their bills, getting funding that generates the so called compulsive floating debt. Regional governments in China are no exception. “The risk from local government debt is further exacerbated by the massive amounts of debt acquired through explicit delays in payments, credits and guarantees,” Zhang Monan makes explicit.
An additional risk factor is the so called the Chinese financial system in the shadows, another potential threat to stability. “China’s financial stability is in danger, and lenders resort to unofficial channels to avoid stricter government regulations applied to the formal banking system. Perhaps the biggest risks stems from the rapid growth of the shadow banking system of China, “explains Zhang Monan.
All these risks apply pressure to the public purse, being a potential threat to the health of the Chinese fiscal accounts. In this regard, Zhang Monan says, “To manage the increasing pressure on public finances, China should establish systems of public budgets and fiscal restraint that are efficient. To this end, the government should strengthen financial supervision, improve budget management and improve operational efficiency of fiscal policies. ”
The role of monetary policy in this financial fiscal consolidation process is key. “As prudent fiscal and financial policies gradually stabilize China’s economy, monetary policy must remain neutral. The relaxation of monetary policy, i.e. the implementation of an expansionary monetary policy, would significantly increase the risks that stem from local government debt and the shadow banking system, while tight monetary policy would fully expose these risks, that pose a serious systemic threat, “explains Zhang Monan.
We are at a crucial turning point for the Chinese economy. “If they reach the right balance of vision and caution, Chinese leaders can address the accumulation of fiscal and financial risks. If these leaders fail to act decisively, China’s position as a leader in the global economy will hang in the balance, “points out Zhang Monan.