May 27th, 2015 Bridge Cafè (Wudaokou)
Prof. LIU Qiao, Professor of Finance, Associate Dean, Guanghua School of Management, Peking University
China has been one of the major countries that has been able to overcome the pain of the 2008 global financial crisis faster. Not only that, it has also opted for policy measures that have supported other economies, filling in the holes of the financial sector. However, being strong during the crisis does not mean that China’s financial system is free from facing its own pitfalls and challenges. Currently, the most compelling problem in China is the lack of efficiency, as explained by professor Liu Qiao, associate dean of Guanghua School of Management, Peking University.
Talking about present financial scenario, along with the challenges China has to deal with at central and local level, Prof Liu argued that China needs to focus on a new financial model. Currently, 16 banks account for more than 50% of the profits of all the 2700 companies listed on the financial market. This suggests that the market is not diversified, but rather strictly concentrated in just a few hands. Of course, every country has its own characteristics, but it has to operate within a complex and interconnected system, that’s why we can say that finance is both local and global. China could follow its own set of practices, shaped according to its own economic model, institutions, culture and history, but we should always keep in mind that the financial market is global and that financial intermediation is universally held.
Prof. Liu made a distinction about finance at the local level and global level by presenting some of the anecdotes of China’s financial system. The central government hasn’t tried much to have control over the expenditure of local governments and the way they have tried to generate capital in the past. This has left space for the rise of corruption, causing even bigger problems now. In order to resolve the issue of corruption at the local and central level, a new financial system is in need in China.
Reaching out towards the “New Normal”, China needs to strike a new balance between investment rate and return on invested capital (ROIC). In the last few years, Chinese growth has been heavily relaying on investments, but the majority of Chinese firms are not efficient in using this high investment rate.
Prof. Liu introduced then four scenarios of China’s economy according to different interactions between ROIC and investment rate: i) fast and sustainable growth (high ROIC and high investment rate); ii) status quo (low ROIC and high investment rate); iii) mid-income trap (both low); and iv) new normal (high ROIC and low investment rate). Here, he said that ROIC would depend on the level of efficiency that would be performed in the financial sector. Without a new kind of finance in China, the economy will not be able to overcome its major problem, inefficiency.
Considering the presence of one hundred Chinese firms in the Fortune 500 list, we should also underline that only 8 of these come from the private sector, the rest being big state-owned enterprises. In addition, 16 are not making any profits, they are still alive only because heavily subsidized by the state. Therefore, when evaluating China’s economy, we should always not only look at its size (or the quantity of big Chinese firms growing globally), but most of all at its quality, aka efficiency is the key. The economic growth model employed in the past decades was investment led, making it easier to have large sized companies, but not innovative ones.
Small and private companies, then, found it hard to obtain resources on the normal financial market. In response to this, we are witnessing the rise of a new kind of finance, the so-called finance 2.0, thanks to the role of internet financing. More and more companies can get access to it: last year over two thousand lending platforms lent more than four billion Renminbi. Also ordinary people can get loans from this kind of service, with a sort of revolution of the entire system. Yuebao, for example, has become the largest fund in China and now ranks six in the world, a result achieved in less than a year. The success of this kind of platforms can be explained if you take a closer look to their customers: those groups of people that have been long ignored by banks. Building up the core activity of the platform around what the customer asked and needed has created a more efficient product.
After highlighting the challenges that the system has to face, prof Liu underlined his positive attitude towards the future. In 2030 the nominal GDP in China will reach 300 trillion RMB, five times larger than now, while the estimated value of financial assets will be 900-1200 trillion RMB (consider that right now ICBC has “only” 20 trillion RMB of assets). The economy will grow and there will be an outstanding improvement in the educational level of the population: half of the 400 million people born after 1990 will certainly have a college degree, and this huge source of qualified people will be employed for improving the quality of the entire system.
Q & A
Answering to the question related to over-capacity of Chinese economy and its official line of investing abroad, Prof. Liu said that this is a problem that might be overcome with the new project of the “One Road One Belt”, even though it has geopolitical dimensions that must be taken into account. Infrastructure development will be also an option for dealing with this problem.
In another question related to reforms in China, Prof. Liu stated that there are reforms going on in the sector such as changing IPO mechanism, deposit insurance system, making interest rates market forces and other pro-market oriented policies. The big trend that could be easily seen in China now is that it is heading towards market-based decisions. However, he says, part of the problem is due to the old financial system.
Addressing the question whether local governments’ debt in China is a major challenge and what will happen to it in when new finance will start functioning, Prof. Liu said that this problem is there but it is not as big as it has been portrayed. The issue of transparency is way more important and might pose some challenges in the future as well.