Tuesday, November 15, 2011

China too at risk of financial turmoil

The International Monetary Fund [IMF] has warned that China's financial system is at risk from bad loans, booming private lending and sharp falls in property prices which could lead to "capital misallocation and the formation of bubbles".

State media reaction

In general China's financial sector was described as "robust overall", a line that made it into headlines of Chinese State run news outlets such as Xinhua. Running with the headline "China's financial system robust overall, further reforms needed: IMF", the propaganda mouthpiece of the Communist Party focused primarily on the positive points in the report.

Grabbing on key phrases such as the "remarkable progress" and "improvements" being made in various sectors, the article barely touched on the dire warnings set out in the IMF report [PDF].

The Xinhua piece referred to challenges and acknowledged that vulnerabilities "should be addressed by the authorities." But there was a general avoidance in mentioning the more worrisome predictions.

Concerning vulnerabilities

Western media, was more forthcoming, if a little sensationalist. The BBC, FT, Guardian, Telegraph and the Wall Street Journal all opened with the line concerning vulnerabilities in the financial sector.

Jonathan Fiechter, deputy director of the IMF Monetary and Capital Markets Department, says that while China's financial sector was "robust overall", inefficient credit allocation and other weaknesses needed to be addressed. "While the existing structure fosters high savings and high levels of liquidity, it also creates the risk of capital misallocation and the formation of bubbles, especially in real estate," he said. "The cost of such distortions will only rise over time, so the sooner these distortions are addressed the better."

According to the Financial Sector Assessment Program [FSAP] report, China's financial sector is confronting several near-term risks. There is a deterioration in loan quality due to rapid credit expansion and growing disintermediation by shadow banks and off-balance sheet exposures. In addition the FSAP report points to a downturn in real estate prices and the uncertainties of the global economic scenario.

Suggested reforms

The report, the first IMF review of China, was carried out jointly with the World Bank and puts forward several suggestions where reform is needed.

They include steps to broaden financial markets and services, and developing diversified modalities of financial intermediation that would foster healthy competition among banks.

A reorientation of the role of government away from using the banking system to carry out broad government policy goals is also required, the reports says, as well as allowing lending decisions to be based on commercial goals.

It also stressed the importance of upgrading the financial infrastructure and legal frameworks, including strengthening the payments and settlement systems, as well as consumer protection and expansion of financial literacy.

While Chinese authorities have begun to move on many of its recommendations, much of the criticism in the report has been broadly dismissed by China's financial institutions.

"not objective"

Aspects of the IMF reports were "not sufficiently comprehensive or objective," the People's Bank of China said in a reaction to the publication of the IMF's assessment.

The People's Bank of China [PBC] said the country had already moved away from administrative quotas on credit and towards an interest-rate based monetary policy. "We believe that, after years of reform, China's financial system has made considerable progress towards commercialization," a statement on the PBC website said.

While the PBC says they "are willing to further strengthen the collaboration and exchanges with relevant international organisations," the IMF report will nonetheless be unsettling in a global market which faces many obstacles.

As Japan yesterday officially came out of recession [Business Times], much of Europe is in financial turmoil and Britain is in danger of falling back into recession. The United States is also continuing to face difficult economic challenges.

The last thing the world wants to see is China falling down the same financial ladder. It can only be hoped that China takes on the advice of the IMF and other leading think tanks as opposed to following the usual belligerent line seen in other sectors.

tvnewswatch, London, UK

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