Typically, when the Chinese government wants to introduce reforms, it trials them in select locations for a year or more before rolling them out to other parts of the country. However, this is not quite the story with the wide-ranging financial and banking reforms taking place this year in Wenzhou, Zhejiang province. There is more here than a mere pilot project. Wenzhou was selected, it would appear, to achieve a specific effect and to make a small but significant political statement.
Wenzhou is quite unrepresentative of the rest of China, which at first sight makes it an odd choice for experimentation with policies that will be applied nationwide. With state enterprises making up only around 10 percent of its companies and contributing less than 4 percent to output, the city's economic base is overwhelmingly private sector.
Nationally, of course, state sector enterprises still dominate. Yet it is bad state sector practices that are the root cause of most of the problems in the financial sector in China. Massive debt has built up over the years because of the cozy relationship between state banks, state-owned enterprises and local bureaucracies. The authorities have taken substantial steps to restore China's banks to health, injecting new capital and transferring bad debt to asset management companies, but they are still struggling. Whereas the non-performing loan (NPL) rate at a leading state bank like the China Construction Bank is officially calculated at 14 percent, in institutions in Wenzhou, it is put at under 5 percent.
The NPL rate is low in Wenzhou precisely because it has long had a weak state sector and a thriving private sector. But Wenzhou's financial institutions are not benefiting by as much as they might from this benign commercial environment. Much private sector activity takes place informally, outside the state-sanctioned and state-regulated system. Private enterprise has boosted personal wealth, with individuals lending on to individuals rather than depositing their savings at the banks. The authorities have clamped down on irregular practices in other places, encouraged no doubt by state interests, which would like to preserve their privileged position in local economies. But in Wenzhou, such practices underpin an economy that has never been able to rely on the state sector.
In this context, two of the principal reforms trialing in Wenzhou are especially relevant. Financial institutions in the city are being granted greater latitude in setting deposit and lending rates and the authorities are encouraging small loan schemes. Higher deposit rates should raise the incentive to save. Small-scale borrowers will be able to approach banks and credit co-operatives, which should be able to provide a better service at more affordable rates than informal lenders. Those who might have lent money on an informal basis may find that the financial institutions now offer a better return at far lower risk to their capital.
As capital becomes increasingly available, some of the excesses of the irregular financial system will die out, including, for example, loan sharking. Further up the borrowing scale, the reforms are intended to open capital to small and medium-sized private enterprises, which have generally struggled for access in China.
Private sector needs
In short, the reforms in Wenzhou are meant to bring practices and products into line with local needs. These are primarily private sector needs, much of it demand for small-scale credit. In this regard, Wenzhou is ahead of the game. The rest of the economy will move towards the Wenzhou model as the private sector builds in importance.
The political signal that Wenzhou's reforms are intended to send to the rest of the country is that it need not worry about the implications of a growing private sector to local economies. Indeed, like Wenzhou, local economies will benefit. Private initiative can be brought into the mainstream by judicious market reform, and excesses regulated.
The London-based Royal Institute for International Affair's Stephen Green is an expert on capital intermediation in China. He says the reforms in Wenzhou are of symbolic relevance: "They argue the case for reforms outside Wenzhou, but because Wenzhou is a unique economy, there are few practical lessons." He adds: "Interest rate liberalisation, lending schemes, private capital introduction have all been basically decided on for China. Wenzhou is an easy way to show it is possible, politically."