Message is clear: Financial reform is back on track

BEIJING - If you want to decipher how China will press ahead with its reform of the financial market, Premier Wen Jiabao's government work report offers some useful clues.

After reading the report, which was delivered to the country's top lawmakers and political advisers in Beijing on March 5, I feel strongly that the Chinese government's willingness to move forward to reform its financial market - an endeavor that was somehow put on hold during the vortex of the financial crisis - has returned to the pre-financial crisis level.

Its pledges - including "we will further improve the mechanism for setting renminbi exchange rates" and "we will accelerate the cultivation of new rural financial institutions" and "we will continue to energetically develop financial markets and encourage financial innovation" - were almost word-for-word repetitions of last year's work report.

These are just some long-term and rather vague goals instead of short-term, specific tasks that the government is due to undertake this year. These wordings reflect the government's long-term commitment.

The real thing worth paying attention to was Wen's pledge that the government will "push forward (on) the market-based reform of interest rates". That is something he perhaps deliberately avoided mentioning in last year's report when the Chinese government was still jittery during the aftermath of the financial crisis.

Reforming interest rates actually got a mention in the 2009 report.

The reassertion of this topic was a strong signal that Chinese policymakers are ready to resume financial reform, which slowed down a bit during the financial crisis.

Indeed, Chinese policymakers are convinced that the aftermath from the financial crisis is over. Since the middle of last year, many top Chinese bankers and officials have called for market forces to play a bigger role in determining lending rates. They say this is the basis for the next steps of reforms of China's financial market.

Their calls are justifiable. If interest rates, on which most financial products and services are designed, are not orientated for the market, the marketization and reform of the financial sector will be like a building without a solid foundation.

Therefore, it is highly likely that a pilot program to allow Chinese financial institutes to get more leeway to set interest rates will be allowed this year. Interest rates are currently set by the People's Bank of China.

If China gets back to reforming interest rates, the premier's remarks on capital account reform represent a big leap.

In this year's speech, Wen vowed to "press ahead with making the renminbi convertible under capital accounts".

The internationalization of the yuan gathered pace and it was one of the few reforms that the Chinese government pushed enthusiastically during the financial crisis.

Since top leaders now believe that the financial crisis is over, we can reform the yuan to pick up again.

Giving Chinese investors larger flexibility to invest overseas using the yuan is very likely to happen. So far, investors in Wenzhou, East China's Zhejiang province, and some places in Northwest China's Xinjiang Uygur autonomous region are allowed to make outbound investments using the yuan. The policy is almost surely to be opened wider in both breadth and depth this year.

But since Chinese policymakers are fearful of hot money inflows in the fight against inflation, efforts to open up capital accounts for overseas businesses interested in investing in China may be on the back burner.

In last year's report, the most important task, Wen said, was to "keep economic growth at a relatively fast and stable level". But this year, he said, the top priority is to "keep overall price levels relatively stable".

The issue over hot money inflows was not mentioned in last year's report, but it was mentioned in this year's report. Wen said: "we will closely monitor and control cross-border capital flows and prevent the influx of hot money."

Although substantial breakthroughs to open the yuan capital account for foreign businesses may not happen anytime soon, we should not rule out the possibilities that some pilot programs will be launched.

But the launch of the international board, which allows foreign companies to become listed in China's markets and raise funds using the yuan, will perhaps move up on the government's agenda. And the effort to allow Hong Kong investors to invest in the mainland's A-share market may also get more attention.

The author, based in Shanghai, is a financial analyst with a multinational insurance company.

For China Daily

(China Daily 03/11/2011 page13)