Photo: Sina Finance

By Ouyang Xiaohong (欧阳晓红)
Issue 626, July 01, 2013
Market, page 18
Translated by Zhu Na
Original article: [Chinese]

A sudden interbank liquidity crunch in June sent a ripple through the market and showed that the Central Bank is tightening monetary policy on banks and exhibiting its intolerance for off-balance sheet financing.  

Government leaders are now frequently mentioning the slogan, "Use new capital well and revitalize existing assets” (用好增量、盘活存量).

The Economic Observer interviewed Wen Zongyu (文宗瑜), director of the Research Institute for Fiscal Science at the Ministry of Finance, for insight into China’s economic situation and the goals of decision makers.

Economic Observer: How should we understand the term “revitalizing existing assets?”

Wen Zongyu: Recently, a series of economic data and phenomena has shown that China’s economy has entered a window for structural adjustment and transformation. It’s a period when we have to reform. For example, government and business debts are entering a peak period of repayment. If defaults spread, it will cause financial risk.

The Central Bank aims to prevent systematic financial risk through enhancing supervision over inflated asset prices and inhibiting highly-leveraged financing in the real estate industry. Therefore, while using new capital well, we need to make considerable efforts to revitalize existing assets, solve structural liquidity difficulties and guide more currency into the real economy.

So, we may as well look at “revitalizing existing assets” from three aspects: asset bubbles, the 28 trillion yuan investment reserve derived from the 4 trillion yuan economic stimulus that’s led to enormous industrial overcapacity, and wasted or inefficient capital reserves absorbed by overcapacity.

The budget deficit has increased and fiscal revenue growth from January to May slowed. We can see that proactive fiscal policy and the government’s ability to invest great amounts have become marginalized.

Moreover, the new government is already aware that relying on the past method of injecting stimulus won’t help the economy regain its driving force. Only by de-leveraging, reducing debts and revitalizing reserves can liquidity flow and gradually return the economy to a healthy normal state.

EO: How much capital reserves does China have? And how can they be revitalized?

Wen: At the end of May, M2 [a measure indicating the amount of currency and time-related deposits in circulation] had exceeded 104 trillion yuan. Loan reserves are already very big, although during the process of structural adjustment commercial banks’ liquidity will be tightened. Some banks will even have difficulty settling debts, but this is the labor pain needed to give birth to reform.

In terms of revitalizing investment reserves, “revitalizing” means appropriately reducing investment - especially in a number of industries with overcapacity. Some projects that have been approved by NDRC but haven’t started or have just started construction should be halted, since the industries they’re in already have overcapacity. The approval of NDRC is an administrative guide, while stopping construction is up to the market. Only in this way can capital reserves and liquidity be revitalized.

In terms of revitalizing production capacity reserves, this entails closures and liquidation in industries with overcapacity exceeding 70 percent; as well decreasing overall inventories and production capacity. The biggest obstacle in doing this is local governments and commercial banks. If they’re not determined to lower production capacity, then liquidity will break down further and there will be greater risk. In the process of lowering capacity, administrative power needs to play a role, but the role of the market needs to be emphasized more through mergers, acquisitions and restructuring.

In terms of capital reserves, adjustment of the reserve structure is needed; as well as guidance of money away from asset bubbles and into the real economy.  

For the loan reserves on the balance sheet of commercial banks, we need to stop administrative interference in loan extensions. About 13.2 trillion yuan in local government debt will come due between 2013 and 2015. The loans that are due this year should not be extended. If we can make structural adjustment on loan reserves, then it will greatly improve liquidity. Once money doesn’t flow, problems will be exposed. Revitalization of reserves is ultimately about solving two problems: improving liquidity and improving the efficiency of capital; and the former is most important.

EO: Recently, interbank market liquidity has seriously declined. What do you make of this phenomenon?

Wen: The market is now very panicked, but the government is very calm. Currently, the liquidity crunch is still a structural matter. As long as the government conducts proper guidance with proper macro-control coupled with deep economic structural reform, the risk can be gradually resolved. 

China’s short-term financial risk is still controllable. Financial markets and the securities market won’t collapse. We haven’t yet reached Lehman-level risk like the U.S. had in 2007. But we must deepen economic structural reform.

According to signals from the top level of the State Council, decision-makers plan to let the potential risk in economic operations be fully exposed, and then to take appropriate measures accordingly.

It’s projected that after the Third Plenary Session of the 18th Central Committee in September, more powerful economic reform measures will be introduced to drive economic growth and promote restructuring.

The market needn’t be nervous. The main reason for the “money shortage” this time was the structural strain caused by the misallocation of capital. It’s not crisis time yet. There was still 7.7 percent growth in the first quarter and 7.5 percent in the second quarter.  

EO: What kind of restructuring does the government want to achieve?

Wen: The government’s policy focuses on structural adjustment and reform, but not “rescue.” The ultimate goal is to let finance support the real economy.

However, getting liquidity to flow into the real economy relies on solving two problems: the self-transformation of financial institutions and the fall of certain prices back to where they should be. Nowadays, asset bubbles have completely distorted the market, resulting in investors abandoning the real economy.