China’s financial system was facing higher risk than that of the US before the global economic turmoil a decade ago, former finance minister Lou Jiwei has said. China’s financial system had become “severely distorted”, Lou said while speaking at Forum in Beijing recently. The “likelihood of China generating systematic financial risks is pretty big”, the Hong Kong-based South China Morning Post today quoted the 68-year-old leader as saying. The distortion was exemplified by the high cost of financing in China despite the loose monetary environment, Lou said. “Compared to the US financial market 10 years ago, (when) the risk and return on derivatives were defined and the products were registered (with regulators), China’s (financial market) is more messy,” said Lou, who was the finance minister during 2013-16. “The real risks and returns can only be determined after looking into the underlying assets,” Lou, who is currently the Chairman of the China’s National Social Security Fund, said. Lou, who helped shape China’s economic reforms, has been an outspoken figure since leaving the main policymaking arena and is generally regarded as a reformist. “China’s ratio of M2 (a broad measure of money supply) to gross domestic product has surpassed 200 per cent, which is more than twice that of the US, yet the average Shanghai interbank offered rate is 4.09 per cent, far higher than the 1.1 per cent in the US,” he said.
According to official figures, the M2 money supply at the end of December was 167.68 trillion yuan (USD 26.5 trillion) or 203 per cent of China’s nominal GDP in 2017. Lou said the slowdown in growth seen in recent years suggested that the effect of monetary expansion on the economy was weakening. “Further stimulus will worsen monetisation and encourage financial speculation, but have only a limited effect in driving growth,” he said. Meanwhile, the “dazzling” array of financing channels and organisations – from Ponzi schemes to peer-to-peer lending platforms, insurance products and capital pools – had resulted in a complex fundraising environment, Lou said. Also unique to China were the “many financial or quasi-financial institutions that try their best to bypass financial regulation,” he said.
“The overlapping of derivatives results in much higher fundraising costs, worsens the operation of Chinese businesses and disguises the risks,” he said. Lou also cautioned about China’s increasing regional debt burden which would limit any room the government had for fiscal or monetary stimulus in the future. “The local government debt risk has shown up after years of heavy infrastructure construction and it is inappropriate to increase debt in these areas,” he said. The state-run Xinhua news agency reported on January 17 that the balance of local government debt stood at whopping 16.5 trillion yuan ($USD 2.6 trillion) by the end of 2017.
But the government plays down the risks, saying the debt limit is below the government ceiling of 18.8 trillion yuan. Last month, local governments raised 32 billion yuan (over USD five billion) through debt issues as China continued the investment driven growth to halt the slowdown of the economy, which last year grew by 6.9 per cent totalling to about $12.84 trillion. President Xi Jinping has made tackling financial risk a priority over the next three years while the government has set up the Financial Stability and Development Commission to coordinate efforts to contain crisis.