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Path key to success of financial reform

By Zhang Monan: 0 Comment(s)Print E-mail China.org.cn, March 13, 2013

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Zhou Xiaochuan (1st R), China's central bank governor, speaks at a news conference on China's currency policy and financial reform held by the first session of the 12th National People's Congress (NPC) in Beijing, capital of China, March 13, 2013. [Xinhua/Wang Peng]

The ongoing 2013 NPC and CPPCC meetings have showed insofar that they are more likely to establish a timetable for ongoing reform efforts and create an effective roadmap to China's future.

Compared to other areas, reforms targeting China's financial sector are accelerating and have surpassed previous expectations. Financial service problems cannot be solved through simple policies. The Chinese leadership must first choose a reform path to follow, and then aggressively pursue such a path. Domestic and international experience has shown that Chinese financial reform can follow one of two paths: "bottom-up" reform and "inside-out" reform.

At the end of last year, Zhou Xiaochuan, governor of China's central bank, recalled, at the International Finance Forum, China's experiences with the 10 "bottom-up" financial pilot reform programs. He said that these programs have become significant parts of the ongoing financial reform in China, and have helped create innovation pilot areas such as Tianjin Binhai New Area, Wenzhou Area and Shenzhen's Qianhai Area.

China's financial reform has been the subject of controversy in recent years, as scholars and government officials debate the merits of "top-down" vs. "bottom-up" reform.

As market-oriented reforms will be the way forward, and will include changing interest and exchange rates, as well as RMB internationalization, this will be a typical example of the "bottom-up" reform.

Zhou Xiaochuan has also stressed the importance of local financial reforms because of unbalanced regional development, resource scarcity and disparate financial instruments and regulations.

For example, the Tianjin Binhai New Area, Shenzhen Qianhai and Wenzhou all have their own advantages and functions. Binhai has a large proportion of large manufacturing enterprises; Qianhai in Shenzhen has built itself around modern service industries; while Wenzhou has a robust supply of SMEs. China must learn from the experience gained through local practices if it wants to find suitable models for national reform.

China's second path to financial reform should follow an "inside out" pattern. Deep going reform in China's financial sector is accelerating. Take the internationalization of RMB as an example, the process has quickened over the past two years. According to data released by China's central bank, cross-border trade paid in RMB settlements showed explosive growth, reaching 2.94 trillion yuan (US$467 billion) at the end of 2012, 821-time increase since the pilot program was introduced three years ago.

Exchange rate reform is the endogenous evolution of a country based on the structure and progress of its economic development; therefore it must follow an endogenous view of progressive law. A currency's path to international recognition depends on two factors: breadth and depth of financial products and services, and the openness of capital accounts. Both these factors reinforce one another. Flexible capital accounts build upon the maturity of the domestic financial sector. The more developed the sector, the higher efficiency of its financial institutions.

Of course, we must admit that the Chinese financial system is not yet mature, with lower capital utilization efficiency, lower proportion of direct financing and structural defects within the investment and financing market. This impacts the flow from saving to investment, causing an outflow of domestic savings and the balance of payments surplus to the international financial markets.

Therefore, the primary task is to develop the domestic financial market, expanding its depth and breadth, increasing the proportion of direct financing, and building the market with foreign financial transactions service capabilities. A strong domestic financial market is the basis of the RMB internationalization.

In addition, when compared to developed Western countries, China's balance surplus is primarily the result of foreign exchange assets and lower monetary policy flexibility, making it difficult to deal with complex environments. The future focus should be based on the international balance of payments, and then on the formation of a new money creation mechanism based on domestic credit.

China should make the RMB more flexible as a precautionary measure to deal with complex financial situations. It should also maintain the independence of anti-inflationary monetary policy to avoid it being influenced by capital flows. The RMB should also gradually wean itself from its dependence on the U.S. dollar and achieve the transition from "referring to a currency basket" to "pegging a currency basket."

Finally, debt problems faced by local governments in recent years have forced top decision-makers to accelerate the development of direct financing channels, primarily through bond markets. To create a larger RMB funding pool, China should expand the scale of the RMB bond market to promote the use of RMB in overseas investments, financing and reserve holdings.

In next 5-10 years, China will become one of the important foreign investment powers in the world. China must encourage international and domestic circulation of the RMB and improve capital pricing rights as well as the influence of RMB in global markets.

The author is a researcher with the State Information Center.

This post was published in Chinese and translated by Wang Zhiyong.

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