Abstract: As China ushers in a new year of economic recovery, the government could consider five issues: 1) recognize the causes of the economy's decline and implement stimulus policies, 2) stimulate the role of the market and create a good business environment, 3) remain vigilant against financial risks during recovery, 4) adapt to the two-way fluctuations of the RMB exchange rate, and 5) allow banks and other financial institutions to help the market achieve effective resource allocation and support high-quality development of the real economy.
The Chinese economy has just started on its journey to a strong recovery. The people and governments at all levels have a strong desire and motivation for high-quality development. Without unexpected cases like the war in Ukraine, China can achieve a relatively high speed of development this year. However, there are still some issues that need attention in the process of economic recovery.
I. RECOGNIZE THE CAUSES OF THE ECONOMY'S DECLINE AND IMPLEMENT STIMULUS POLICIES.
Multiple factors have contributed to China's economic downturn in recent years, including 1) the slowdown as a result of transforming its development mode, supply-side structural reforms, and replacing old growth drivers as China has now reached a high-quality development stage; 2) trade conflicts with the United States and international geopolitical conflicts; 3) the shock of the Russia-Ukraine conflict on the international economic order and other effects on China's economy; and 4) the slowdown as a result of transforming its development.
The first three of the aforementioned factors will be long-term influencing factors, while the fourth will be relatively short-term influencing factors. These factors demonstrate that the pressure on China's economy is not cyclical, implying that simple aggregate stimulus policies will not suffice to repair the economy. For example, thanks to the easing of China's Covid policies, a significant portion of the pandemic's pent-up consumption and investment demand will recover quickly, without the need for stimulus policies. The strong recovery of consumption, catering, tourism, film, entertainment, transportation, and other sectors during the Spring Festival was not the result of macro stimulus policies. Long-term and short-term stimulus policies should be implemented independently.
After policies to reduce overcapacity, reduce excess inventory, deleverage, lower costs, and strengthen areas of weakness, as well as US-China trade frictions and the three-year pandemic control, the Chinese market has been cleared to a significant extent. Some supply-side structural reform goals include the elimination of zombie enterprises, high-energy-consuming enterprises, and enterprises with excess production capacity. Others are unintentional clearances caused by unexpected factors such as the pandemic. Despite the fact that supply-side structural reform is a long-term process, China's market is "excessively cleared" in terms of total volume, creating enormous market space for economic recovery. Instead of returning to the old development model simply to stimulate the economy, China should seize the opportunity to accelerate supply-side structural reforms. To implement macroeconomic policies, China must guide the market with a long-term goal in mind; in the short term, China must stimulate market vitality to achieve the goal of repairing the economy.
China's infrastructure development, infrastructure technology, and infrastructure capabilities have been world-leading. Infrastructure investment used to have a greater and all-encompassing impact on its economy because the infrastructure was backward and in short supply. It is now making up for past shortcomings and continuously improving so that additional large-scale infrastructure investment is a waste of resources with limited economic pull. In order to meet the requirements of quality development, macroeconomic policy should reduce infrastructure investment and redirect resources to stimulate strategic new industries such as high technology, modern agriculture, green economy, and new infrastructure.
II. STIMULATE THE ROLE OF THE MARKET AND CREATE A GOOD BUSINESS ENVIRONMENT.
Allowing the market to decide on resource allocation necessitates extensive market knowledge. The government's role is required to ensure the market's effective operation, stimulate the market's positive role, and restrain the market's negative role, which requires a thorough understanding of the market.
Enhancing the government’s role is not to replace market participants or to build a new economic domain outside the market. Instead, it’s a means to the end of giving greater play to the market itself. Governments at all levels should build a better understanding of the market, and transform their roles with a greater emphasis on providing guidance and regulation for the market in order to improve the business environment. Any “help” or “support” to businesses divorced from the market is a de facto intervention in business operation and distortion to the market.
Improving the compliance of local government investments is fundamental to resolving implicit debt risks. Each of the post-downturn economic recoveries in history has been accompanied by surging local government debts and mounting risks, and new risks usually turned up before the old ones were addressed. China needs to prevent this from happening again this time.
China’s economic recovery in 2023 will be bumpy. Some of the regions and industries could see temporary overheat, while some other sectors and businesses could fail due to the changed demand landscape and the global supply chain reshuffle. None of these is unexpected; all are normal amid economic restructuring, and the government should not take any hasty move to intervene unless it sees systemic risks. It takes time for the market to recover, and uninterrupted stimulus and intervention would only add to the risks and uncertainties.
Local governments must respect the decisions of market participants when implementing industrial policies. China strives to boost its high-tech and other emerging sectors, for which strategic chokepoints must be removed with concerted efforts at the national level, and that’s where the government has a role to play. But local governments have attached greater importance to quantified GDP targets, and other so-called “l(fā)ow-end” sectors could be squeezed out by the better-supported high-tech and digital sectors, and it would be problematic if such extrusion happens on a large scale. All market participants have the right to invest and operate independently regardless of what sector they belong to as long as they are compliant with applicable laws and regulations on environmental protection, safety, and others. This is more effective than policies in boosting entrepreneur confidence in the market.
All businesses deserve the trust of the market, rather than public sympathy, regardless of their ownership. Only with trust can they invest, trade, and finance. Entrepreneurs can venture and innovate, but only when they are honest and observe the law. In turn, the market’s trust is also important for the government: the market is composed of not just buyers and sellers; government participation, laws, and regulations also have profound implications on how the market runs. Building the confidence of entrepreneurs and the market is actually an effort to win the market’s trust.
III. REMAIN VIGILANT AGAINST FINANCIAL RISKS DURING RECOVERY.
Different sectors and industries are expected to rebound at different stages of economic recovery. Tourism, catering, entertainment, transportation, and other service sectors would come back to life earlier than the others, followed by associated production and logistics sectors before they could drive the normalization of other sectors. At the same time, some of the businesses would resume their presence in the supply chain and engage in its restructuring. Finally, the general economy would get back on its feet boosted by policies and large project investments, which could provide high-quality assets and investment opportunities for financial institutions including banks and investors while incurring implied risks, requiring them to keep a clear mind despite the heated economy.
The first of these potential risks is temporary overheating of some of the sectors, industries, or regions.
The second risk happens to Covid relief supply providers. Despite elevated performance over the past years, they could suffer losses or even collapse should they fail to transform in a timely manner with Covid becoming history and controls removed, and that would add to non-performing asset risks facing financial institutions. Banks and other lenders should start to screen the risk with their existing clients, and work to resolve it while the borrowers are still in relatively good shape.
Third, domestic and global supply chains were disrupted due to a number of factors, e.g. industrial restructuring, the transition to new dynamic energy, international political and economic competition, the Russian-Ukrainian conflict, and the impact of the covid-19 pandemic. Some of the supply chains have been suspended, some fractured, and some have been restructured. Along with the development of the pandemic and relative control policies, some enterprises have returned to their original supply chains very soon, some adapted to new ones, while some failed both ways. Such enterprises eventually went bankrupt and left non-performing financial assets.
Fourth, during the three years of the pandemic, banks have provided a large number of loans to small and micro enterprises, making a significant contribution to stabilizing the economy, growth, and employment. In this regard, the government and regulatory departments have introduced many targeted measures, for example, lowering interest rates, enabling loan renewal without paying off the principal, and allowing deferment of principal and interest payments. Such measures have not only led to rapid growth in loans to small and micro enterprises but also helped them maintain the high quality of their asset. With policy adjustment and consequent changes in the market demand, micro and small enterprises with poor operating ability and market adaptability are bound to encounter operational difficulties and some may even have to close down. The second half of the year may see an increased risk of non-performing bank loans held by small and micro enterprises. Regulators and commercial banks should be prepared with risk management plans in the first half of the year as loan issuance to small and micro enterprises is to return to a normal state.
IV. ADAPT TO THE TWO-WAY FLUCTUATIONS OF THE RMB EXCHANGE RATE.
Judging from the changes in the RMB exchange rate in 2022, the year 2023 does not see a unilateral pressure of devaluation. RMB exchange rate fluctuations are not determined by people’s active interventions or China's own economic development. Since the country’s economy is deeply integrated with the global economy and the RMB has become an important settlement currency, any shock in the international economy can affect the RMB exchange rate. Even with a strong Chinese economy, the Fed’s rate hikes and tapering, rising commodity prices, or a sudden change in risk appetite in the global financial markets could lead to RMB depreciation.
In 2022, downward pressure facing the Chinese economy dragged the RMB exchange rate. However, instead of developing a depreciation trend, the RMB remained resilient amidst fluctuations, despite the rate hikes in the US and Europe, which could be attributed to the rising food and energy prices, high inflation rates, and sluggish economic growth in the West caused by Russia-Ukraine conflict and sanctions on Russia.
Meanwhile, it is important to recognize that exchange rate fluctuations have both negative and positive sides for a country's economy. It is generally accepted that the appreciation of a local currency would benefit a country’s imports and depreciation would benefit exports. Changes in the exchange rate usually affect capital inflows and outflows, while at a deeper level, they can also influence the structural transformation of domestic industries. However, the influence varies among different industries and enterprises, and cannot be generalized as the effect on imports and exports, capital inflows and outflows. Tailored measures should be adopted while taking into account the varied relations between business and exchange rates.
As China accelerates its pace of reform and opening up, and the RMB becomes more internationalized, the RMB exchange rate can be subject to changes in international politics and economy at any time, a new norm to which relevant departments and market players need to adapt. As regulatory departments, the People’s Bank of China and the State Administration of Foreign Exchanges are expected to roll out more innovative tools to maintain the stability of the RMB exchange rate and manage capital inflows and outflows in an orderly manner while refraining from interfering with the market. Capital flows include both RMB and foreign currencies, not merely foreign exchange.
V. BANKS AND OTHER FINANCIAL INSTITUTIONS SHOULD BE ALLOWED TO HELP THE MARKET ACHIEVES EFFECTIVE RESOURCE ALLOCATION AND BETTER SUPPORT THE HIGH-QUALITY DEVELOPMENT OF THE REAL ECONOMY. SOME REGULATORY DIRECTIVES SHOULD BE MODIFIED OR EVEN ABOLISHED.
In terms of inclusive finance, small and micro enterprises financing, and loans to farmers as a percentage of credit assets, China is a world leader. This is a very good phenomenon. However, it must be recognized that this indicator is not the higher the better.
First of all, the share of micro and small enterprises and farming operations in the economic system is not the higher the better; second, at different stages of economic development, the proportion will change accordingly; third, for micro and small enterprises, most of their development is through self-accumulation, and even if they utilize credit financing, most of them maintain a low leverage ratio. Experience shows that those who rely on high leverage will fail soon most of the time; fourth, the opening and closing of micro and small enterprises are initiated by business owners themselves, which is a normal market phenomenon and a demonstration of market vitality. Those closedowns due to operating loss usually relate to the business management ability of the operators, and cannot be solved by credit financing; lastly, many farmers still need credit support, but with the advancement of rural revitalization strategy and modern agriculture, the development model of small farmers in a big country no longer fits the trend. Based on the emerging trend in rural areas, from now on, even farmers will not directly work in the fields as they traditionally did but will act as operators of farming businesses. Therefore, it is necessary to redesign the definition and evaluation method of farmers and loans for agriculture, rural areas, and farmers.
Based on the practice in recent years, driven by relevant policy and regulatory directives, all banks put more efforts into developing inclusive finance, loans for micro and small businesses, and loans for agriculture, rural areas, and farmers, meanwhile innovating products and services. However, some situations which deserve attention arise in this process:
First, major banks start to provide services for small businesses, squeezing the market that used to be dominated by small and medium-sized banks. The latter has to serve smaller businesses, raising the pressures of market expansion, cost management, and credit risk. As these pressures are the weaknesses of small and medium banks, their operations are becoming more difficult. In recent years, the regulatory authority has been working on preventing and dissolving the operational risks of existing businesses of small and medium banks, but the requirement also increases the risks of new businesses.
Second, after years of development, microloans have accounted for a large share of banks’ total loans. Particularly for major banks, the share has increased sharply. This means that a great percentage of credit resources have been put into inclusive finance, while the credit support of the banking system for other areas has been weakening (editor’s note: according to the People’s Bank of China, by the end of 2022, the balance of RMB loans for inclusive finance reached 32.14 trillion yuan, an increase of 21.2% year on year and 10.1 percentage points higher than the increase of all RMB bank loans). In areas like new infrastructure, advanced technologies, and strategic emerging industries that need massive investment, small and medium banks do not have an edge over large banks whether in terms of resource scale, systemic management, and risk assessment. Though national policy requires banks to step up support for these areas, small and medium banks are out of their depth in this matter, while large banks’ capacity is constrained.
Third, after years of loan issuance, credit funds should already have met the effective demand of inclusive finance and micro and small businesses in quantity, leaving little room for new loans that are commercially sustainable to be put into these areas. In fact, some local banks have been doing the job for the sake of accomplishing the regulatory directive and a large number of loans do not go to micro and small enterprises and farmers. In this case, highly mandatory regulatory directives should be reconsidered.
Mandatory regulatory directives should be revised or abolished to allow commercial banks to find differentiated client bases based on their own strengths in market competition and innovate different products and service models based on customer demand. In this way, different banks can foster differentiated competitive advantages and finite credit resources can be given to market entities that have effective demand. We should let the market play a decisive role in resource allocation during which financial means are the main channel. In China, competition among commercial banks is the main way of resource allocation. To build a healthy market, we should give full play to the role of commercial banks.
