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China: Economic Transformation and Financial Reform; Speech by John Lipsky, First Deputy Managing Director, International Monetary Fund
May 13, 2011
Good Morning. It is a great pleasure and honor to have the opportunity to address such an eminent gathering of officials, finance experts, and distinguished guests. I am particularly grateful for the chance to discuss the path ahead for China’s economy in the context of the broad issues that are being explored during this historic Forum.
In my remarks today, I would like to address one aspect of China's economic transformation that has important implications for investors and policy-makers here and around the world, including for sovereign wealth funds. That is: the role of China's financial sector reform in promoting more balanced and sustainable growth. This is an area that has received prominent attention in the 12th Five Year Plan, reflecting a clear recognition that a reformed financial system will provide an important boost to the the desired transformation of China's economic growth model. In fact, this goal was featured prominently in Vice Premier Li Keqiang's important address yesterday to this Forum.
Of course, China was on a firm trajectory toward a more modern and reformed financial system prior to the global financial crisis. Tremendous progress had been made to commercialize the large state-owned banks and to increase their efficiency and profitability. In particular:
And then came the global financial crisis, a product of excessive risk-taking, compounded by regulatory and supervisory failures that massively damaged financial systems in both the United States and Europe. The result was a deep recession -- while a much deeper downturn was averted only by the concerted action of policymakers around the globe, who provided unprecedented amounts of budgetary and monetary stimulus. China played a highly constructive role in this collective effort, reflecting its expanding role and responsibilities with regard to global economic governance.
While hit hard by the global downturn through trade channels, China emerged largely unscathed from direct contagion to its financial system. Nevertheless, the very rapid expansion in lending that formed part of China's anti-crisis effort may prove to have costs that will become evident only over time, if credit quality problems surface later.
However, I would argue that the global financial crisis had another, more subtle impact in China. As financial systems across the globe suffered severe strains, Chinese policymakers paused in their plans for financial reform. After witnessing the dramatic crisis in major, well-established financial markets, this was a natural response. But it is not the appropriate response for China over the longer term. Thus, it was particularly encouraging to note the important role assigned to financial sector reforms in the 12th Five Year Plan.
Not only will successful financial reforms support China's domestic economic development, but this issue also has a bearing on the outlook for China's external imbalances. This is because there are three broad aspects of China's current financial system that tend to dampen consumption, boost corporate savings, and distort economic decision-making.
So what is to be done?
A well- designed program of financial reform can make an important contribution in helping China to meet its goal of accelerating the transition to better balanced economic growth. While this process is recognized widely to be in China’s broad economic interests, it also is in the commercial interests of the banks themselves. This is of central importance to the China Investment Corporation (CIC), given that it owns substantial stakes in China’s banking system.
What’s wrong with the status quo, this raises the question? After all, China’s financial system has not stood in the way of a remarkable period of strong growth, while steering clear of serious financial sector volatility. In my view, however, the prospective value of reform is increasing as the economy matures and becomes more complex.
Implementing the reforms that are needed will require a clear roadmap and careful sequencing. There is no single superior approach for use in all cases. But experience suggests that the key elements of any plan could include:
As a more robust system is put in place of monetary control, market-determined asset prices, a strong prudential regulatory system, and more flexible exchange rate, China will be well-positioned to gradually free-up the existing controls on capital flows. Such steps also will permit China to internationalize the renminbi at an appropriate pace, thus making its currency more freely usable for international trade and finance.
Over time, China's currency no doubt will become a serious candidate for inclusion in the IMF’s SDR basket. Indeed, the SDR's future role is being examined as part of the efforts by the IMF and the G-20 to improve the international monetary system. The goal is to augment the supply of safe global assets, improve the provision of crisis-related liquidity, reduce the impact of exchange rate volatility among major currencies; and ultimately to reduce the perceived need for international reserve accumulation.
I'm sure it is recognized that many of the themes I have discussed today already are outlined, in broad terms, in the 12th Five Year Plan. In the coming years, the Chinese authorities intend to strengthen and improve financial oversight, to develop financial markets and encourage financial innovation, to have interest rates determined by market forces, and to make the renminbi more freely usable in international transactions. I should also note that the IMF has been working intensively with the Chinese authorities over the past year, as part of the Financial Sector Assessment Program — or FSAP — to identify and prioritize the principal tasks needed to further strengthen China’s financial system. I am confident that this collaborative effort is proving to be useful, by adding IMF experts' unique international experience to help support China's financial reform.
To sum up, I am highly confident that China's planned financial reforms will prove to be fundamentally positive for both China and its international partners. I see no reason why the bulk of the reform agenda won't be accomplished within the time frame laid out in the 12th Five Year Plan. The process will need to be handled skillfully and flexibly. Undoubtedly, there will be unexpected developments along the way that will require good judgment and innovation. I am also confident that with clarity of purpose, intellectual rigor and practical skills, China will achieve its goals.
As we all recognized following the 2008/2009 Great Recession, financial sector reform is a key global task, and it is as yet unfinished. Thus, through its participation in such international fora as the G20 and the Financial Stability Board, China will be able to draw on its partners' expertise, as well as offering its own perspective in this area. And in this — as in so many other areas — China will be stepping forward into a more prominent role. The expert and generous hosting by the CIC of this Forum is one example of this, and I know we all look forward to the future progress and contribution of the IFSWF under Chairman Jin's excellent leadership.
Thank you for your attention.
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