Financial reform becomes urgent as economy slows
AMcKinsey report titled China’s Choice: Capturing the $5 Trillion Productivity Opportunity resurfaced recently. According to its calculations, China’s financial sector generated more than 80 percent of the country’s total economic profits in 2015. It is not healthy to see economic profits highly concentrated in the financial sector, which is to the detriment of economic development.
In the meantime, the cost of delay in solving financial problems will be high. The forward-looking forecasts for China’s financial sector and economic situation are gradually coming true.
The structural distortions in resource allocation persist in the Chinese economy, accompanied by unsolved problems facing the financial sector, which is why the report – issued in 2016 – still deserves attention and reflection today.
As the McKinsey report pointed out, there are serious structural imbalances and distortions in resource allocation and income distribution in China’s economic structure. The distorted financial sector has allocated most of the economic resources to low-efficiency State-owned enterprises (SOEs), making it hard to improve the efficiency of the overall economy.
Meanwhile, the profits of the real economy are highly concentrated in the financial sector, which is mainly composed of State-owned financial institutions. That situation represents some implicit unfairness for ordinary people and private enterprises. It is also a factor behind companies’ high operating costs as well as sluggish household consumption.
It is worth noting that the report estimates Chinese SOEs get more than 50 percent of total bank lending, which has been a lifeline for many unproductive and poorly performing companies. Such companies are particularly prevalent in traditional manufacturing sectors such as metals, mining and chemicals.
In comparison, in the US, the distribution of economic profit is more diversified across different industries and resonates with the economic cycle. As regards the bad debt problem for the banking industry, the report assumes that banks may pay a heavier price if they continue to lend to risky companies while their performance keeps deteriorating.
Just as the report forecast, under the pressure of a slowing economy, falling profit levels, stringent supervision and deleveraging, the Chinese banking industry is now facing rising non-performing loans (NPLs), declining profits and lackluster growth. The report also stressed that the investment-led growth model would be hard to sustain, and it should shift toward a growth model centered on productivity.
China’s labor productivity is 15 to 30 percent of the average in OECD countries, and only 20 percent of Chinese companies see their productivity reach the level of developed countries. The productivityled model can not only generate longterm growth, but can also substantially reduce the risk of a hard landing for the Chinese economy and change the economic structure. According to figures from the China Banking and Insurance Regulatory Commission, from 2014 to the end of the third quarter in 2018, the outstanding NPLs of domestic commercial banks more than doubled from 840 billion yuan to 2.03 trillion yuan, with the NPL ratio rising from 1.25 percent to 1.87 percent.
The continuous increase in the NPL ratio has greatly affected banks’ profitability, with the net profit growth rate of the domestic banking industry down from double digits to 6 percent in 2017. Statistics for the third quarter of this
year showed that outstanding loans to SOEs and collective enterprises accounted for 61 percent of total lending, much higher than the 2016 level. The unbalanced allocation of financial resources has led to the deteriorating environment for private enterprises.
In the current situation, in order to maintain economic growth and promote economic restructuring, it is necessary to start from the transformation of the financial sector to overhaul the allocation mechanism for financial resources.
This will meet the needs of resource allocation and economic restructuring, as well as the development needs of the financial sector.
Establishing a financial system to address the financial resource allocation needs for small and mediumsized private enterprises and break the monopoly of State-owned financial institutions is the main direction of the structural adjustment.
Take loans to micro-sized and small firms as an example. China had nearly 75 million such companies as of the end of 2017, posing fast-growing demand for financing. At present, domestic financial institutions that mainly serve SOEs can hardly provide effective services to those smaller businesses, which calls for regulatory guidance on the transformation of State-owned financial institutions. In addition, market barriers should be lowered so as to encourage the participation of private financial institutions.
The slowdown of China’s economy has exposed longstanding structural problems in its financial sector. The distorted distribution of economic resources needs to be corrected. As far as economic structural reforms are concerned, the industrial transformation of the financial sector has become an urgent task.
The slowdown of China’s economy has exposed longstanding structural problems in its financial sector. The distorted distribution of economic resources needs to be corrected.
The article was compiled based on a report by Beijing-based private strategic think tank Anbound. bizopinion@globaltimes.com.cn