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Economists on Li Keqiang's New Slogan
Summary:An interview with three economists about the challenges of directing credit towards the real economy against a backdrop of slowing growth.

By Kang Yi (康怡)
Issue 626, July 1, 2013
News, page 5
Translated by Zhu Na
Original article: [Chinese]
Now that market liquidity appears to be tightening, the direction of China's monetary policy has once again become the focus of attention.

On June 28, Zhou Xiaochuan, the governor of the People's Bank of China, gave a speech at the Lujiazui Forum. During his remarks, Zhou said that "The PBC will continue to implement a sound monetary policy, make the policy measures more forward-looking, better-targeted and more flexible, and conduct preemptive adjustments and fine-tunings in a timely and appropriate manner."

Zhou also said the central bank would on the one hand work together with relevant authorities to guide financial institutions to provide rational credit supply, properly manage the total volume of assets and liabilities as well as maturity structure, support the structural adjustment, transformation and upgrading of the real economy. In addition, a number of monetary policy instruments and measures will be adopted to adjust market liquidity timely, maintain overall market stability and create sound monetary conditions for the stable performance of the financial market and overall economic development.

Given recent statements from top leaders about the need to "use new capital well and revitalize existing assets" (用好增量、盘活存量), how are we to understand current monetary policy settings?

How will monetary policy work alongside the push to restructure the real economy? What are the risks involved? What's the outlook for the macroeconomy in the second half of the year?

The EO put these questions to Lu Feng (卢锋), Vice Dean of National School of Development at Peking University; Pan Xiangdong (潘向东), Managing Director and Chief Economist of China Galaxy Securities and Wu Xiaoqiu (吴晓求), head of Financial and Securities Institute (FSI) of Renmin University of China.

The Economic Observer: What's the best way to understand this slogan of "use new capital well and revitalize existing assets" (用好增量、盘活存量) which has been frequently used by top official recently?

Lu: It can be understood from different perspectives. From a broad perspective, it is to improve the efficiency of financial resource allocation. To really put limited financial resources to the best use possible - that is to use it in areas which can promote real growth of the Chinese economy, this is an issue of efficiency.

But I think the government also has other shorter term interests in drawing attention to this issue, it might be related to the fact that in the past there were periods when economic growth was actually quite strong, but investment in some fields wasn't efficient. Some investment projects had problems related to price distortion and some even involved high leverage and other risk factors.

For example, local government debt. Some local debt has been taken on to invest in project that are not suited to local economic growth levels. A newly released report by National Audit Office (NAO) reveals that some local debt has now got to the situation that "new loans are being acquired to repay old debts" (借新还旧). So, if we consider the thinking behind the "use new capital well and revitalize existing assets" (用好增量、盘活存量) slogan from this perspective, if the problem of "new loans being used to repay old debts" cannot be solved in a timely manner, credit reserves will be devoted to these legacy problems and it will be difficult to use them effectively.

Wu: It means that good use needs to be made of newly-issued loans and new capital, but on the premise of promoting reform, these funds cannot be directed to sectors with significant over capacity or industries that are heavily polluting or lacking core competitiveness. It is very difficult to revitalize capital reserves (盘活存量), but it's something that needs to be done. With more than 100 trillion yuan of M2 (a measure of money supply), China has one of the largest pools of money of any country in the world, but the efficiency with which this money is used is very low.

EO: If the slogan means that some funds need to be squeezed out and put into the real economy, what methods are there to exert pressure on funds? How do we revitalize funds? What are the policy implications?

Wu: We can't think of it as simply giving over 100 trillion yuan to enterprises in loans, this is not realistic. It is also unrealistic to directly lend to small- and medium-sized enterprises, this is because commercial banks are concerned about risk. Without a risk-filtering mechanism, these funds won't be lent out, These institutions need to ensure that funds are lent out in a secure way.

So, what kind of mechanism can effectively reduce risk? Only through the market, the market can discover a suitable position, find an equilibrium between risk and returns. In academic language, it called "stretching the money chain" (把货币链条拉长), to turn M1, M2 to M3, M4 and M5, turn the existing monetary reserves, whether in cash or deposits, into securitized financial assets.

Stretching the money chain is a process a country goes through when it is deepening its financial structure and making the structure of its financial system more market based.

It's also a process that benefits the development of a country's financial system. In order to revitalize funds, you cannot simply rely on banks to channel loans to the market, you need to use market techniques and market vehicles to direct funds.

Pan: The policy in 2008 mainly stimulated traditional industries, most of which are involved in infrastructure construction, and wasn't closely tied to the economy, and the wealth created by the whole society accumulated in the banking system and the real estate market. Financial resources were mainly allocated to four areas: local government financing platforms, the real estate market, the banking sector and industries with overcapacity. Other industries were only able to develop with great difficulty. Therefore, these four industries urgently need to go through a period of deleveraging and other industries need more investment. This is the logic of "revitalizing capital reserves."

In the future, if we want to revitalize capital reserves, then we need to try to gradually liquidate the debts of local government financing platforms and the real estate sector. We also need to clean up the development of shadow banks. Of course, this might impact on the real economy and financial markets, but this impact can be resolved, for example, we can reduce interest rates significantly or lower financing costs and improve the financial environment.

EO: Currently, reducing risk has already become the deciding factor when it comes to the task of implementing macroeconomic controls. What are the potential difficulties of this process?

Lu: The biggest difficulty is to do with the fact that behind the risk are assets, and behind these assets are property rights and, in the end, during the process of managing these risks, it will be hard to avoid making changes to the past investment pattern and financial set-up. The changes will have an impact on some related vested interest groups. Therefore, during the process of managing and reducing risk, it will be hard to avoid "moving somebody's cheese" and this will mean that it will be hard to avoid some contests.

Pan: It is difficult for funds to withdraw from the above-mentioned fields, and wealth management products sold by banks are still in the process of expanding, if they withdraw immediately, it could involve breaking the contracts of some of these financial products. Secondly, if funds withdraw from local government financing platform, will there be problems for the operation of local governments? Will local governments come into conflict with the central government? These concerns all need to be taken into consideration.

Third is the real estate sector. If a real estate sector encounters some problems, will it ignite the systemic problems of the Chinese economy? Everyone has these kinds of concerns, and it's because that many have these concerns, that it can turn into a drag on efforts to reform. But if we don't try and solve these problems now, the future cost will be even higher.

EO: How do you judge the trend of the macroeconomy?

Lu: My judgment on China's macroeconomic situation is that Chinese economy growth is trending slower and there is still a risk of slowing further.

Although there are currently various views on the outlook for the macroeconomy, the consensus seems to be that downward pressure persists.

Firstly there are external reasons. The economic growth rate in the first quarter in U.S. was 2.4 percent, which is relatively better, some experts think that the U.S. economy is at a very good state at the moment. But overall, the U.S. economy and the economies of other developed countries are still weak following the financial crisis. As the U.S. begins to withdraw from its policy of "quantitative easing," for a certain period of time the impact of the external economy on China's economy might sometimes be good and sometimes bad, sometimes high and sometimes low, but overall it's likely to be more of a drag than a positive factor.

Then there are the more important internal factors. I, personally, think it might be related to some high-leverage or high risk factors which accumulated in the process of rapid economic growth in China over the past decade or since around the financial crisis. The priority of the current government in relation to addressing these factors might be higher than for the previous government. The reduction of financial risk might put the brakes on economic growth to a certain extent over the short term, although in the long-term it will be good for the return of domestically driven, relatively quick growth for the Chinese economy over the long term.

Pan: Financial sector risks have not yet been resolved and we still haven't seen the beginning of a new economic cycle in the real economy. As the existing problems are yet to be resolved, as the process of dealing with existing problems continues it might have a large negative impact on the real economy and the economy could decline further in the future.

After that, we'll go through a period of monetary easing that stimulates the real economy. This is an ongoing process, currently we're still in the process of reducing risk. Therefore, I predict that in the future the economy still faces a further slow down in growth.

Editor's Note: Some of the answers have been shortened in the translation process.


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