Finance must resume role of serving real economy
As long as the real economy is not strong, while profitability in the financial sector far exceeds that of the real economy, capital will be drained from industries, leading to the further contraction of the real economy.
The relationship between the real economy and the financial sector has always been the core subject of macroeconomics. In essence, positive interactions between the two are not only the basis of national financial stability and security, but also the foundation of sustainable development of the national economy and even the world economy.
However, since the 1980s and 1990s, the growth divergence between the financial sector and the real economy has become one of the most marked and universal characteristics of the world economy. That divergence was also the major cause of the global financial crisis in 2008.
To a certain extent, the divergence between the financial economy and the real economy, namely investment being diverted out of the real economy, is especially prominent in China. This directly points to the substantial increase in money supply and the sharp decrease in the capital utilization ratio.
In recent years, the proportion of the financial sector in GDP has been on the rise, with the growth rate of financial assets far exceeding that of the real economy. From 2001- 05, the added value of China’s financial sector accounted for 4.4 percent of GDP. The figure hit 8.3 percent in 2016, higher than the target of 5 percent shown in the 12th Five- Year Plan ( 2011- 15) for the development and reform of the financial industry.
The values of various financial assets and real assets can also be used as a gauge of the divergence between the financial sector and the real economy. According to official calculations, China’s real assets are currently valued at about 380 trillion yuan ($ 57 trillion), including 160 trillion yuan of real estate, 150 trillion yuan of non- financial corporate assets, 50 trillion yuan to 60 trillion yuan of land and resources, and nearly 10 trillion yuan of vehicles, among others.
However, the size of the country’s financial assets has reached nearly 450 trillion yuan, excluding derivatives, equivalent to almost seven times the GDP. In this category are at least 200 trillion yuan of bank currency assets, nearly 100 trillion yuan of bonds, and more than 100 trillion yuan of various wealth management assets. Moreover, financial assets have increased by 30 trillion yuan to 40 trillion yuan annually in recent years.
Despite its short history, China’s financial system has expanded rapidly since 2010, leading to increasingly prominent externalities.
On the one hand, the real economy needs sufficient capital support from the financial system, but in view of the still underdeveloped capital market, bank loans remain the major financing channel.
On the other hand, increased bank credit has led to massive liquidity, resulting in various elements circulating within the financial system and exacerbating the distortion in market allocation of resources.
Given the low rates of return on investment, the real economy is facing difficulty in attracting capital. Due to factors such as overcapacity and rising costs, China’s investment return rate in the real economy has continued to decline in recent years.
For example, the return on equity ( ROE) in the manufacturing sector fell from 6.7 percent in 2006 to 5.4 percent in 2015. Meanwhile, the leverage ratio at non- financial enterprises surged from 120.7 percent in 2010 to 162.8 percent in 2015, underlining the high leverage risk in the real economy.
It was against the background of these growing risks that the National Financial Work Conference, held in July, set the tone for China’s financial development in the next five years, em- phasizing that the financial sector must fulfill its original purpose of serving the real economy. The meeting also urged the financial sector to improve service efficiency and quality, and to channel more resources into major and weak areas of the nation’s economic and social development. Fundamentally speaking, there is a reciprocal relationship between the financial sector and the real economy. As long as the real economy is not strong, while profitability in the financial sector far exceeds that of the real economy, capital will be drained from industries, leading to the further contraction of the real economy. Therefore, the nation’s macroeconomic policy should focus on “making the real economy stronger.” The government should help raise the ROE in real- economy enterprises by improving their productivity and competitiveness, enhancing investment efficiency and the efficiency of resources allocation, and lowering the tax burden, so that mismatched funds can actually flow into the real economy.