Mitigating risks under ‘ new normal’
The thing that always strikes me when I visit Beijing is the energy. I feel it when I visit our clients – among them China’s biggest banks and investment funds. I feel it in the engagement of Chinese partners with Michael Bloomberg’s initiative to make New York into a hub for yuan internationalization. That energy makes me optimistic about China’s future.
Clearly there is room to grow. Indeed, looking at some of the early numbers, 2017 is shaping up to be another strong year. At the same time, it is also clear that there are risks and uncertainties, and we are right to pay attention to them. That’s how we can stop risks from turning into realities.
Now, risk is a big topic, and if we want a complete assessment we need to think about protectionism in trade, the slowdown in real estate, shifting international relations and other factors.
The starting point for some concerns about China’s financial sector is the very rapid growth in credit that we’ve seen in recent years. That started as a legitimate response to the US financial crisis. But my sense now from speaking to global investors and analysts is that lending has run too hot for too long, and that the risks are starting to outweigh the benefits. We’ve seen how that movie can end, in the US in 2008 and in Greece and other European countries in 2011. Of course, fans of Hollywood know that sequels can sometimes be better than the original, and China has some forces for stability which other countries lack. Even so, credit growth can’t outpace the real economy forever without a significant increase in stress.
In China, we’ve observed the pressure building across multiple axes:
We see it in continued concerns about the way credit is allocated – too much is going to low- return projects in traditional industry, but not enough to dynamic new- economy firms.
We see it in the rapid inflation and deflation of bubbles in China’s financial sector – most visibly in equities in 2015, but also in other asset classes.
We see it is continued pressure of capital outflows. That pressure could increase as the Fed moves further into its tightening cycle.
Our experience around the world, and our foundational belief as a company, is that an important part of the answer to all of those problems is having financial markets that are more transparent, more integrated and more complete.
More transparent financial markets are more efficient, generating more growth and jobs in the real economy, with less expenditure of credit.
More integrated financial markets create a path for investors to participate in global markets, and guard against the bubbles that pop up when capital is trapped behind national borders.
More complete financial markets, with investors deploying a sophisticated set of instruments to manage risks, are less prone to destabilizing herd behavior.
Let me give you a concrete example of how – at its best – that can work.
Global Indices have a way of integrating financial markets, moving capital across borders as it follows the lead of global benchmarks. In March, for the first time, Bloomberg included Chinese bonds in two new global fixed income indices. That opens a door for the biggest global funds to put capital to work in the China market, and a new way for global inves- tors to analyze China’s vast interbank bond markets.
In parallel, the People’s Bank of China gave overseas investors access to China’s foreign exchange derivatives market, making it possible now for them to manage risk on their currency exposures. This access to a more complete set of financial instruments for hedging, removes a significant barrier to market participation.
Over time, the combined impact of those two moves has the potential to balance out China’s cross- border capital flows, easing concerns about one- way capital outflows.
A more open fixed income market, with some of the smartest investors in the world putting their money to work in China, will increase the efficiency of credit allocation – a necessary step toward deleveraging.
Now it goes without saying that timing and sequencing are important. I think China’s own securities regulator Liu Shiyu put it well when he said that only when the “breeze is still and the waves are quiet” is the time right for reform.
But what’s also clear is that from the special economic zones that started China’s reform process in 1980, to the entry into the WTO in 2001, to Chinese President Xi Jinping’s decision to deepen reform at the Third Plenum in 2013, China has been at its best when at its boldest. That’s the spirit that has driven almost forty years of reform and opening, and that’s the spirit that will drive forty more.