A presentation given by Dr Simon Taylor at Cambridge Judge Business School to the Cambridge Chinese Business Network (CCBN).

1. Cambridge Judge Business School
Like dismantling a
nuclear bomb:
liberalising the
Chinese financial
system
Simon Taylor
Director, Cambridge Master of Finance
CCBN

2. The message
Liberalising a distorted financial system is dangerous
China has a very distorted financial system
And it is the largest attempted liberalisation in history
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3. Liberalisation is like un-damming a river
3

4. Financial liberalisation is dangerous
Source: IMF “Do inflows or outflows dominate?” WP 13/189 http://www.imf.org/external/pubs/ft/wp/2013/wp13189.pdf
Financial or exchange rate crises following capital flow
liberalisation
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5. The context: rebalancing the Chinese economy
Rebalancing needed:
From state to private sector
From manufacturing to services
From investment to consumption
Source: IMF Article IV report 2013
http://www.imf.org/external/pubs/ft/scr/2013/cr13211.pdf
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6. All require (among other things) liberalisation of the
financial system
1. Internal: Market based interest rates
2. External: Allowing free capital flows into/out of China (“internationalisation of
the RMB”)
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7. The government intends to liberalise
“Since the onset of the new millennium, China has clearly put forward the strategic objective
to build a market-oriented and more open economic system.”
Liu Shiyu, Deputy Governor, People’s Bank of China, 2013 (*)
“We need to ensure that the market plays the decisive role in allocating resources and make
the government better play its role, vigorously advance reforms conducive to economic
structural adjustment, remove constraints on market actors and efficiently allocating factors
of production, fully tap the creative potential in society, promote fairness and justice, and
enable everyone to share in the fruits of reform and development.”
Premier Li Keqiang, report to National People’s Progress, 2014
(*) in Das, Udaibir S.; Fiechter, Jonathan; Sun, Tao (2013). “China's Road to Greater Financial Stability: Some Policy Perspectives” (IMF)
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8. People'sBank of China
Banks
Securities companies
Insurancecompanies
8
China’s financial system is dominated by banks
Holdings of financial assets, 2012
Source: PBOC

9. State Council
State-owned Assets
Supervision and
Administration Commission
123 Central State-owned
Enterprise Groups
National Development
and Reform Commission
China Banking
Regulatory Commission
China Insurance
Regulatory Commission
China Securities
Regulatory Commission
China Import-Export
Bank
Agricultural
Development Bank of
China
Administrative reporting line
Regulatory reporting line
Ownership based on
equity investment
Ministry of
Finance
People’s Bank of
China
China Investment
Corporation
Central Huijin
Investment
Agricultural Bank of China
Bank of China
China Construction Bank
Industrial and Commercial
Bank of China
China Development Bank
Huarong Asset
Management Company
Orient Asset
Management Company
Huida Asset Management
Company
Cinda Asset Management
Company
Great Wall Asset
Management Company
SAFE Investment
Corporation
State control of key banks
Source: Walter & Howie (2011) “Red Capitalism” Appendix
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10. The economics of liberalisation (1)
Interest
rate
Quantity of
lending
Demand
for loans
Supply of
funds
Market clearing rate r
q*
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11. The economics of liberalisation (2)
Interest
rate
Quantity of
lending
Demand
for loans
Supply of
funds
Market clearing rate r
Government set rate g
q2q1
Excess demand q2 – q1
Results in:
1. SMEs starved of credit
2. Depositors looking for
better rates
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12. Non-bank lending has grown dramatically since the
financial crisis
Total social financing (RMB trillion)
Source: IMF “China’s monetary policy and interest rate liberalisation” WP
14/75) http://www.imf.org/external/pubs/ft/wp/2014/wp1475.pdf
WMP rates and bank deposit rates
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13. International capital flows have become less restricted
1997
2010
Source: IMF “Effects of capital flow liberalisation” WP 12/275
https://www.imf.org/external/pubs/ft/wp/2012/wp12275.pdf
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14. But not China’s capital account
Source: IMF “Do inflows or outflows dominate?” WP 13/189
http://www.imf.org/external/pubs/ft/wp/2013/wp13189.pdf
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15. The restrictions are gradually being lifted
Source: IMF “Do inflows or outflows dominate?” WP 13/189
http://www.imf.org/external/pubs/ft/wp/2013/wp13189.pdf
Qualified domestic and foreign institutional investor flows
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16. Huge FX reserves are evidence of managed exchange
rate
0
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
China’s foreign exchange reserves (US$ billion)
(*) End of Q1 2014
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17. Liberalising China’s international capital flows could
bring big benefits
Effects of liberalising China’s capital flows (%)
Source: IMF “Effects of capital flow liberalisation” WP 12/275 https://www.imf.org/external/pubs/ft/wp/2012/wp12275.pdf
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18. China could see 15-20% of GDP worth of outflows
Source: IMF “Do inflows or outflows dominate?” WP 13/189 http://www.imf.org/external/pubs/ft/wp/2013/wp13189.pdf
China
India
Equivalent to:
0-2% of US equities
1-3% of US bonds
4-10% of EM equities & bonds
Goldman Sachs estimate $6
trillion of Chinese outflows
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19. Some things to worry about
Mass corporate bankruptcies: higher market interest rates put many highly
indebted businesses into crisis
Japanese-style bubble and bust: surge in RMB followed by further asset
appreciation then collapse
Real estate market collapse: sudden portfolio shift from domestic property to
foreign assets, causing banking crisis
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20. China’s debt is now high for a country of its income per
head
Source: IMF Article IV Report 2013
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21. China’s exceptionally high savings and investment rates
Source: IMF Article IV reports
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22. Household savings and investment
Household savings are high: removal of the “iron rice-bowl”, one child policy
Where do you put your savings?
Bank – low interest rates
Stock market – not trusted
Bond market – barely exists
Mutual funds – invest in the above, not trusted
Foreign assets – not allowed
Real estate – yes!
So, on top of genuine need for new housing, the Chinese economy is
systematically biased towards investing in real estate
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23. The real estate market: is it a bubble?
Peak investment in housingHousing inventory
Share of housing stock built before 2000
Breakdown of fixed asset investment 2013
Source: Nomura Asia
Insights 14 March 2014
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24. The Japanese nightmare: index of property prices
Commercial
Residential
Industrial
Source:
Japanese Real
Estate Institute
http://www.reinet.
or.jp/en/pdf/2013/
Nov2013-Ur-
Nationwide.pdf
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25. Reasons to be hopeful
Not going first: China can learn from other countries’ experience
Track record: China dealt effectively with a serious banking problem in the late
1990s
Pragmatism: the government will not adopt a “big bang” approach but steadily
move in the right direction
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26. s.taylor@jbs.cam.ac.uk