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The kindergarten candy shelf is a constant battleground. The teacher thinks it wiser to distribute the candies directly. Some of the kids, however, are already trading the candies among themselves, turning a deaf ear to the teacher. The kids do not ever worry of candies running out. Come rain or shine, they hope to get the hand out of candies first.
This is the state of China’s current financial market.
This is also exactly what Ms Zhang Xiaohui, Director-General of the Bureau of Monetary Policy, People’s Bank of China, told commercial bankers in a meeting on June 21. She pointed out that the financial market perennially harbours the illusion that there is unlimited cheap money. She criticised that commercial banks have more interests in borrowing and lending with each other, rather than boosting the economy in any real way. Some commercial banks felt that with the slowdown of economic growth, there would be a new round of stimulus policy, so they tried to move faster than their competitors, by expanding the credit as quickly as possible. Ms Zhang warned the overstretched lenders to stop these ‘ill habits’ immediately.
Ms Zhang’s speech was made right after the panic in the Chinese inter-bank market on June 20. Liquidity on the market was tightened since mid-May, but the financial market seemed not to worry about it, because they believed that the central bank would bail them out.
This, of course, is not without precedent. Not for nothing has the People’s Bank of China been nicknamed here as “Mother Central Bank”. There’s always that frosted bottle of coke to quench the thirst of the financial market.Things took a rather surprising turn this time around. All of a sudden, the ‘loving mother’ became a ‘stern father’. Even when the liquidity was sucked out of the market and the short-term interbank rates were pushed to record high – banks charged each other 25 per cent for overnight money – the central bank refused to give a hand.
My sympathies lie with “Mother Central Bank”. China’s financial institutions have been spoiled. They are used to making painless, easy money. People with saving accounts have not much choice really but to deposit their money in the bank with a negative real interest rate. In the aftermath of the global financial crisis, in order to save China from an economic stalemate, state-owned enterprises and local governments are encouraged to borrow as much, and squander it on real estate or reckless infrastructure projects. Now it’s time to ring the alarm bell. The party is over.
Time for strident action
But how strict the central bank can be is yet unclear. After the interest rate hike on June 2o, the stock market fell hard on June 24. The Shanghai Composite Index suffered its worst one-day percentage loss in nearly four years, plunging 5.3 per cent. The Shenzhen Composite Index also dived 6.1 per cent. The central bank discreetly changed its tune and quietly injected liquidity. The message: ‘This time I will forgive you, but no more’.
But isn’t this maybe more of a lesson for the mother? Firstly, the central bank did a right thing at the wrong time.It should have paid more urgent attention to the rapid expansion of China’s shadow banking system – which often means the off balance sheet wealth management products (WMP) and trust products – and the mounting local government debt. Now, when the growth rate keeps falling, the central bank has less and less room for manoeuvre. If it further tightens the monetary policy, the real economy would become the real victim, because high interest rates encourage risk-taking speculation, and manufacturing sectors can easily be squeezed out.
The possibility of something going awry is bigger than ever. Right now it’s only liquidity shortage, but what if smaller banks or other financial institutions have a liquidity crisis? In the eventuality, Chinese government can, of course, pacify the panic by reacting quickly and decisively. But what if some wealth management products or local bonds default? Well, if the scale and situation can be controlled, it may inversely help in sending out a message to the rest. As the old Chinese saying goes: Kill the cock to warn the monkey.
But the shadow banking system connects the commercial banks, local governments, real estate developers, export companies, and retired people who bought the WMP, could not it then trigger a chain effect and create a perfect storm?
The teachings of the legend of Great Yu
True, there is not much that the monetary authority can do. It should strike a balance between ‘too tight’ and ‘too loose’. But the pains/tremors felt by the financial markets are symptoms of the real economy. It might be worthwhile now to ask the question — Why does money keep flowing into the real estate sector? Because the future for the manufacturing sector is gloomy. Labour costs have increased dramatically. External demand is still sluggish. Small and mid-sized companies are short of liquidity ahead of the large state-owned enterprises.
The Chinese government would do well to learn from the legend of Great Yu. About five thousand year ago, there was a catastrophic flood. Great Yu’s father, Gun, was ordered by the emperor to control the flood. Gun did nothing but build a lot of dams to stop the water. Finally the dams were inundated, giving rise to a fiercer flood. Great Yu chose another approach. He dredged the rivers and channelled the flood into the sea. This is what the Chinese government should do.
Liberalising the service sector, including health care, finance, transportation, communication, opening it up to both foreign investors and domestic private investors. Lending a helping hand to the start-ups, small and mid-sized enterprises. Spending more on public goods to make people feel more secured and willing to spend more. Only this can wish away the flood in China’s financial market. All the water will lead to the ocean, the greater collective, as we hoped for.