Last month, China announced three new ministerial officials to head its financial regulatory agencies: Shang Fulin to the China Banking Regulatory Commission (CBRC), Guo Shuqing to the China Securities Regulatory Commission (CSRC) and Xiang Junbo to the China Insurance Regulatory Commission. These three positions are vital to the Chinese economy. The banking and the securities regulators govern trillions of US dollars in financial assets, whereas the total size of China’s insurance market in 2010 was “only” US$790 billion.
The appointment of Guo and Shang, as well as the expected promotion to the Politburo Standing Committee of Wang Qishan, the vice premier in charge of economic and financial affairs, means that the financial “fire brigade” put in place by former Premier Zhu Rongji remains largely in place. As such, future policymaking in China’s financial sector should remain relatively consistent and perhaps even more autonomous from other parts of the state apparatus than it is currently. But what kind of policies can we expect?
Capitalism with Chinese characteristics
The published work of Shang Fulin and Guo Shuqing suggest that both remain staunch supporters of the state-dominated financial system that is the status quo. Of the two, Guo supports more innovation and diversification in financial products, although he does not advocate any fundamental overhaul of the financial system.
Guo’s penchant for financial innovation is usually seen as positive. Within the framework of China’s repressed financial system, however, this stance has produced undesirable results. For example, Guo has favored using “multiple channels” to finance infrastructure projects, including municipal investment companies. Today, these investment companies are saddled with well over RMB10 trillion in debt.
Shang Fulin, meanwhile, has been outspoken in his praise of market capitalism, but he too has failed to lead any dramatic reforms. Shang’s views were shaped by the intellectual fervor of the 1980s, a renaissance after the deep freeze of the Mao period in which young scholars like Shang questioned many of the fundamental tenets of socialism. In a 1996 essay, he argued that a healthy financial system could exist “only if both investors and operating firms take responsibility for their own actions.” He further contended that the state’s systematic intervention in the economy created strong moral hazard at the enterprise level, leading to investment and inflation cycles.
Fifteen years later, these same cycles still plague the economy. While Shang clearly understood the challenges facing the Chinese financial system, he never argued in favor of obvious reforms to fix these problems, such as interest rate liberalization. In 1998, in fact, Shang argued that too-high interest rates were raising the cost of investment for state-owned enterprises (SOEs). He has also praised the central bank for lowering long-term time deposit rates and lending rates, thereby allowing banks to maintain their net interest margins and state-owned borrowers to pay less interest.
Shang knew that SOEs were the source of many problems for the Chinese financial system, but he expected this to change as SOEs restructured and listed. Unfortunately, his optimism remains unrealized. Although he managed as head of the CSRC to make the shares of listed SOEs fully tradable, these companies continue to rely heavily on state financing.
Shang showed a further tendency to maintain the status quo as president of the Agricultural Bank of China from 2000 to 2002. His main priority was to maximize deposits to finance Beijing’s policy and commercial lending objectives. Instead of combating the bank’s enormous pool of non-performing loans, Shang sat on the problem through his tenure. Those NPLs were eventually transferred off the bank’s balance sheet to an unnamed asset management company.
In contrast, Guo Shuqing, the new head of the CSRC, has been hailed as a maverick, largely because he studied in the UK and has more experience with foreign systems. Yet his past writing and actions reveal a more complicated picture.
Guo also emerged from the Cultural Revolution a young, eager intellectual excited about the prospect of a market economy in China. He has argued throughout his career that the state’s support of loss-making enterprises has skewed China’s growth model excessively towards investment, and recently he has highlighted China’s growing inequality.
However, Guo also maintains a strong statist bent. In a 2002 essay, he argued that China’s vast pool of savings wasn’t being used efficiently to finance investment growth. In a recommendation that still affects how the Chinese government treats local financing, he argued that “the construction of basic infrastructure should be divided into commercial, semi-commercial, noncommercial types,” each with different methods of financing. Furthermore, “the government or state insurance companies should set up funds which channel money into infrastructure such as electricity, highways, water.”
Guo’s recommendations gained traction, leading to the rapid proliferation of municipal investment vehicles in China. The weak cash flows of these vehicles will continue to plague the balance sheets of China’s banks for years to come.
Guo has been outspoken in the past about changing the status quo. As the head of SAFE, he criticized China’s policy of permitting capital inflows but limiting outflows for exacerbating capital imbalances. He has also argued that the opening of China’s capital account is inevitable. Such outspokenness has certainly earned him his reputation as a maverick.
As the head of CSRC, Guo may continue to advocate a more vibrant bond market. But without interest rate liberalization, China’s bond market seems unlikely to take off. As long as rates for most bonds remain artificially low, the majority of buyers and sellers will continue to be state-owned entities.
We will have to wait and see whether these new technocrats push for fundamental reform of the state-dominated financial system. The first step on such a path would undoubtedly be interest rate liberalization, which would guide wealth towards households and increase the cost of borrowing for SOEs and local governments. Observers attempting to divine the future policies of China’s new regulators would be wise to watch this debate.
Victor Shih is an associate professor of political science at Northwestern University