The main economic reforms envisaged in China by the 13th Five-Year Plan
From our seat IC&Partners Asia
The 13th Five-Year Plan envisages important reforms in China to secure and overcome distortions in the financial system, to guarantee greater transparency in the management of public resources by local administrations and overcoming the crony capitalism that has characterized the management of the State Owned Companies.
In particular, the Five-year plan stresses the need to reform China’s financial system that has long been elements of weakness and is still characterized by a top-type control, as it is influenced by a strong political and government interference.
The current Chinese banking system is headed by the People’s Bank of China (which has the function of the Central Bank since 1983, but in 2003 has given its supervisory role of the banking system to the China Banking Regulatory Commission) and revolves around the five largest commercial State-controlled banks: Bank of China, People’s Construction Bank of China, Agriculture Bank of China, Industrial and Commercial Bank of China, and Bank of Communications.
Despite their stock market listing, the top five Chinese banks are still heavily controlled by the government (only a minority of their shares is freely negotiable); as in other crucial areas of the Chinese economy, the Chinese government controls the banking sector and play both the role of owner and regulator, with consequent risks about lack of transparency.
The clearest evidence about the weakness of the Chinese banking system is represented by the low capitalization of banks and by the strong presence of non-performing loans: many of these bad loans were granted in order to accommodate political interests and relations rather than for reasons linked to their commercial profitability.
The major Chinese banks have had a steady increase in non-performing loans in recent years.
Much of the non-performing loans granted by major Chinese State-Owned banks are in favor of State-Owned enterprises which, although they are often less efficient, have more opportunities to receive loans because of their special relationship with the Chinese political and financial apparatus.
In addition, the rigidity of the Chinese banking system has favored the so-called shadow banking, i.e. the spread of financial companies that support small-medium enterprises with financial services in a different way, compared to the traditional banking system: these companies are financial intermediaries, while being more efficient than public banks, they can create financial instability as they are subject to fewer controls and provide fewer guarantees.
The Five-year plan provides for the strengthening of the regulatory bodies of the banking system and offer greater control over financial institutions in order to avoid systemic risks; moreover, the Chinese government aims to improve the system for granting loans by introducing criteria to analyze in more accurate and transparent way the risks associated with lending.
In addition, the Five-year plan aims to promote the modernization of China’s financial system with reforms that will liberalize the interest rates and will introduce better regulation of the stock and bond market in order to bring them to the same level of efficiency of the main financial markets in the world.
In fact, since there is not in China a mature financial market yet, today the prices of financial products are still strongly influenced by top-down decisions rather than market criteria: the monetary policy decided by the People’s Bank of China (that establish the interest rates) affects the entire financial system and, therefore, its dynamics do not fully reflect the real economy.
The modernization of the financial system also aims to increase the international use of the Chinese currency (Renminbi): in 2015 about 30% of China’s cross-border transactions were settled in Renminbi (in 2010 corresponding value was almost zero) and this is reducing the role of the USD.
The importance of the Chinese currency in trade and global financial transactions are increasing but still low (less than 3% of the total, as you can see in the chart below) compared to the economic position of the country: this is caused not only by the phenomena of inertia in the use of currencies but also by the poor financial integration of China with the rest of the world.
In order to promote the internationalization of the currency, the Chinese government has already launched a loosening of restrictions on the movement of capital, liberalization measures of the financial system, and a more flexible exchange rate. The further development of the internationalization of the Renminbi process and its emergence as a global reserve currency will depend on the timing and outcome of the permanent removal of restrictions on movement of capital.
Another fundamental reform in the process of modernization of China’s Five-Year Plan provided for in regard to the use of fiscal incentives and fiscal policies of the government with the aim of encouraging a rebalancing in the management of public resources between the central government and local governments. In fact, for long time the local governments used strong borrowing (or also opaque speculative operations) in order to implement development policies (apart from a few exceptions, the Chinese provinces over the past fifteen years have always had a fiscal deficit).
The Five-Year Plan provides for a tax reform that will enable local authorities to have adequate economic resources without having to resort to the sale of land use rights, which often led to phenomena of corruption, as well as conflicts between the population and local authorities.
The reform also aims to make more transparent and rigorous the use of public resources: in line with the new political course, there will be evaluation tools encouraging public officials to target the quality of development, not simply the increase GDP.
Another important economic reform envisaged by the Five-year plan covers State-Owned Enterprises, which still account for a significant part of the Chinese economy: the biggest Chinese companies are State-owned and their strength is a major obstacle to the full realization of a market economy in China.
Since 2003, the supervision on the State-owned Enterprises is gathered in the hands of the State-owned Assets Supervision and Administration Commission, but in their management there are still very strong government and political interference. In particular, each Ministry in charge of regulatory powers on certain industrial sector continues to retain significant powers of direction in the management of State-owned Enterprises that fall under its jurisdiction, including the right to appoint the directors.
In addition, from long time there is the consolidated practice to appoint the former directors of State-Owned enterprises in top government or political positions: this practice, along with the approval that directors of State-Owned enterprises should receive from the political and government authorities when they are appointed, it has increased the importance of patronage relationship with political power, reducing the importance of an evaluation criteria based on economic and managerial results of their management.
State-Owned enterprises represent the main operator in the most important industrial sectors and enjoy substantial privileges compared to private companies through the network of relationships with the political and government leaders and with bank system: the granting of loans with less onerous terms, preferential treatment in signing of contracts with public institutions, and less stringent criteria for access to stock-exchange listings.
The Five-Year Plan provides for important reforms to make more competitive State-Owned companies in the international markets and to minimize the phenomena of clientelism and corruption still present in their management.
The Chinese government aims to make more efficient State-Owned companies through a merger between companies operating in the same sector (to reduce their number) and through the adoption of a mixed pattern of ownership, with co-presence of public and private capital as shareholders.
In addition, the reforms will aim to improve the management of state-owned companies: on one hand by tying the remuneration of their managers to the economic efficiency, on the other hand by introducing control mechanisms to make their financial administration more transparent.
This new policy is leading the current reorganization and merger processes related to important State-owned companies in the industries of transportation, petrochemical, and energy power. The goal is to create very large companies that are more competitive globally and provide them with the financial strength to be able to make acquisitions of companies abroad.