Shanghai Report: Reform with Chinese Characteristics

posted by Marsha Vande Berg on June 23, 2016 - 5:30pm

The Lujiazui Forum, June 11-12 in Shanghai featured a gathering of senior level Chinese officials and prominent academics to talk about the economy and how the financial sector can contribute to overall economic growth. The annual gathering is named for the Lujiazui neighborhood in the Pudong district of Shanghai. Shanghai is positioning itself for rapid emergence as an international financial hub.

The meeting of senior officials focused on how the sector can boost the economy working in tandem with aggressive state-led initiatives including the One Belt One Road (Belt and Road) Initiative, the Silk Road Fund, the Asian Infrastructure Investment Bank and the New Development Bank, formerly the BRICS Development Bank, a multilateral institution established by Brazil, Russia, India, China and South Africa.

Hu Xiaolian, chairwoman of China’s Export Import Bank and a panelist in an early plenary session, discussed how the policy bank already is providing deep-pocketed support on behalf of the ambitious Belt and Road initiative. She said the bank increased its RMB-denominated loans to countries within the Belt and Road initiative by 45 percent over last year.

Separately, the New Development Bank plans to issue RMB-denominated bonds in China while Hong Kong will step up its efforts to enhance the workings of the Shanghai-Hong Kong Connect, a cross-border digital pipeline facilitating the trading of China’s A-shares. A plan is also afoot to extend the network to Shenzhen and eventually to London.

A segment of the nearly two-day forum was dedicated to celebrating what was labeled a  “golden era” in a growing financial link between Shanghai and London. In addition to the possibility of a Shanghai-London Connect, discussions currently include exchanging permission for fund houses to sell products in each other’s market. It also was reported that the London exchange had issued its first RMB-denominated bond the week prior to the Shanghai meeting.

The government’s goal of securing internationalization of China’s currency is at the heart of these efforts, and by extension serves as the driving motivation behind the 13th Five-year plan, China’s chief blueprint for economic development. The intention to usher in global usage of the currency also helps explain the dynamic of current reforms, which forum participants referenced repeatedly as supply side structural reform.

Initially, it seemed that the reference to structural reform was literal – underscored as the tagline to the 13th Five-year plan – and its effect was to overshadow and even dismiss the fact of still incomplete capital and financial reforms. The 12th Five-year plan – known by its own tagline, letting market forces play a decisive role in moving China forward – had trumpeted reforming China’s capital and financial markets.

But that was not to be the case. Instead, the references to supply side structural reform were meant to be inclusive of the financial sector. There were two cases in point. The discussions about fintech emphasized the arena’s emerging competitive influence on China’s banking sector but simultaneously raised well-deserved concerns about how to regulate this arena of growth without stifling its innovation. The sector is growing faster in China than anywhere else in the world.

There was also discussion about China’s insurance sector, dominated by state-owned enterprises and now implementing the Chinese version of international best practices, similar to the Basel rules for the global banking industry. The effect of implementing C-ROSS would be comprehensive and allow competitive forces to shape the sector’s practices.

Instead of administrative fiat, it became clear that the objective of the 13th Five-year plan is to provide space for competitive forces – in other words, the decisive market forces – which will drive the shape of the economy and hopefully spur growth alongside China’s international influence and reach.

The analysis offered a peg for understanding the Chinese perspective on the recent announcement following the annual Strategic and Economic Dialogue between US Treasury Secretary Jacob Lew and his Chinese counterparts in Beijing. China would be increasing the RFQII quota for large, institutional investors who want to increase their RMB exposure to China.

At the same time, US authorities agreed to designate US-based banks as clearinghouses for RMB trade, in line with similar facilities in Hong Kong, Singapore and London.

Despite MSCI’s announced decision (within days after the Shanghai Forum) not to include a Chinese A-share weighting in its emerging market index, the interest in emphasizing more foreign investment in China’s capital market was clear. Qi Bin, director general for international affairs at China’s securities regulator told the audience, chided foreign investors who dally, waiting for the perfect circumstances to invest in Chinas stock market and miss the opportunity.

(Officials with MSCI Emerging Markets Index, followed by managers of $1.5 trillion, said a China weighting may be considered again later but in the meantime, outstanding issues, including those raised by last year’s near meltdown of China’s capital market, should be resolved.)

The Chinese-style capital and financial market is a matter of timing. The initial objective is to provide the space that can allow market forces to shape outcomes.

If all goes as planned, it may well mean that the tagline for the 14th Five-year plan reads something like, reform accomplished. But for some western observers, that is only realizable if the government also succeeds in loosening its grip on the overall workings of the world’s second largest economy.

I participated in the Lujiazui Forum in Shanghai in June 2016 as a member of the Academic Committee of the International Finance Forum, Beijing.