By Nan-Hie In
China’s Third Plenum in 2013 outlined sweeping economic, legal, market and social plans to improve the quality of life for citizens of the world’s second largest economy – a goal to be achieved through continuous restructuring of a largely state-led economic system and opening up to be a more open, market-friendly economy. How China has fared three years later in delivering these promises is the question for one of the panel discussions at AmCham’s China Conference this year.
Changes are happening, and some are taking place at a faster pace than others – from inertia on State Owned Enterprises (SOE) and fiscal reforms to significant advances in the financial sector, according to the panel of experts. For instance, China has made enormous progress in the financial sector as part of its current journey of economic reform, notes Tao Wang, Chief China Economist and Co-head of Asia Economics at UBS Investment Bank.
Those, she says, include greater access to the markets of Mainland thanks to Shanghai-Hong Kong Stock Connect and the upcoming Shenzhen-Hong Kong Stock Connect; developments in the domestic financial markets such as the liberalization of interest rates last year; the internationalization of the RMB with the currency’s inclusion in the International Monetary Fund’s basket of currencies known as Special Drawing Rights.
“I’m not saying all these things are positive as there are risks associated with the [development of] these areas as well,” Wang explains. “All these changes we are seeing in China, whether it’s risks or not, such as capital outflows, provide additional opportunities for Hong Kong.” It is a shared optimism among her fellow panelists, although they have different visions of how opportunities and risks will play out for businesses in Hong Kong.
China’s financial market
One of the policy changes is the greater access to the domestic bond market. Earlier this year, the People’s Bank of China reduced the red tape for China’s interbank bond market (CIBM) by permitting a much broader spectrum of overseas financial institutions direct access to what has now become the third largest bond market in the world, valued at over US$7 trillion.
In the past, only selected categories of the investment community could participate in the Mainland’s domestic capital market through programs such as Qualified Foreign Institutional Investors (QFII) and its RMB equivalent (RQFII), and schemes are tangled with quota limits, approval requirements and other administrative requirements.
“I believe there is genuine desire from decision makers in Beijing and across the country to use capital market pressures to help drive construction [in this sector],” says Michael Falcon, CEO of Asia Pacific, Global Investment Management, JP Morgan Asset Management, calling these reforms and restructuring of the sector “impressive.”
Although it has been an encouraging development, it has not dissipated worries, particularly on the legal front with uncertainties in investor protection for scenarios such as bond default. “We need to understand the rule of law, the rule of credit, what bankruptcy means in China, and the development of structures for distressed or worse debt,” Falcon stresses, noting areas where China is less developed than other markets such as that of the US.
And it will take time to make a liquid and well-functioning market. In spite of much public concern over China’s slowing economic growth, volatilities in the market and the over-handed measures in the Chinese stock markets, many are still undeterred because China remains too large and important of a market with a GDP still growing this year. It is “almost half a trillion dollars of wealth creation in terms of economic output,” Falcon notes.
While external and internal shocks to the Chinese economic system, including global black swan events, remain probable, the demand – and hence opportunities – for asset investment and management in China are not to be taken lightly when there are demand worth “tens of billions of US dollars” from Chinese individuals and companies for outbound investment regionally and globally.
The current financial reforms in China are a balancing act: while reforms are shaping up to lead China into the next phase of economic development, strict adherence to central policy planning is factor which has contributed to the challenges China is facing. The target of maintaining 6.5 percent annual GDP growth up until 2020 in the current environment can only be achieved through debt, explains Mark Austen, CEO of ASIFMA, hence his bearish outlook in the short term (but bullish on investment and reform).
China’s mounting debt has been grabbing more headlines lately. Financial watchdog Bank for International Settlements recently released a warning that the Chinese economy could face a calamitous banking crisis in three years, citing the credit-to-GDP gap at 30.1 percent (well above the 10 percent level that signals banking risks) and debt at 255 percent of China’s GDP.
According to Morgan Stanley’s macroeconomist Ruchir Sharma, China’s “explosion of debt” is reminiscent of the peak of the US housing bubble in 2007-2008, when America generated US$3 of debt to fuel US$1 GDP growth. Today, China needs to generate US$6 of debt to create US$1 of GDP growth.
“If you look at history, any economy in this situation with this level of debt and pace of growth have all faced some kind of hard landing, the question is, what extent is that hard landing?” Austen says. He hopes China’s leader will revise the growth target to a more manageable level so that the slowdown will be a smoother transition.
Impact on Hong Kong
As China’s reforms continue, Hong Kong’s prominence as the main conduit to the development of China will likely diminish as evident in the decreasing dependence on the city as an intermediary and gateway to the global economy, says Austen. He predicts the link-up such as Shenzhen-Hong Kong Stock Connect may cease to exist in a few years as investors will by-pass these inefficient models layered with additional costs.
“I’m certain that is where China is going to end up in three, five or ten years as I think these links are temporary measures,” he says, adding that the further opening up of China’s bond market was made easier for the global investment community to access these products without having to go through Hong Kong.
As direct investment access to China broadens, Hong Kong must redefine its future role as it did from being a fishing village more than a century ago to a top global financial center today, Austen believes, suggesting Hong Kong play a stronger asset management role for China, become a key provider of dollar or euro-financial products to fulfill China’s demand to hedge against yuan risks, or transform itself into a derivatives hub the way Chicago has pioneered for decades.
“Why can’t Hong Kong be the Chicago to Shanghai’s New York?” he asks.
Wang concurs and says that investable household savings in China is around US$15 trillion, and if 10 percent of that amount is diversified overseas, that is US$1.5 trillion of foreign investment. “Hong Kong can play a big role in keeping some of the money in Hong Kong as asset managers,” she recommends.
On the status of the city’s future role, however, Wang says it all depends on how fast China will fully open its capital and financial markets, predicting that these changes will be slow due to the nation’s soaring debt problem. “[China] does not want to fully open [the markets] yet because money could quickly rush out and because you need that liquidity to help gradually resolve the debt issue and beef-up the financial system.”
The city will also enjoy its competitive edge for some time thanks to its strong legal system and protection of property rights – areas where China still needs time to develop, Wang explains.
James Quinnild, Financial Services Consulting Leader at PwC Hong Kong, believes Hong Kong still holds key advantages through its sophisticated business practices and depth of finance talent. However, as a financial technology innovations hub, he urges Hong Kong to do more to out-compete neighboring rivals.
“It was nice to see [Hong Kong Monetary Authority’s Chief Executive] Norman Chan announced the FinTech sandbox earlier that Hong Kong has to be really aggressive in adopting, encouraging and enabling financial technology so it is not just a window into China but a hub for the region,” he says.
The “sandbox” scheme permits banks to experiment new technologies without the need for regulatory compliance and is a part of the city’s effort to level competition in the area of FinTech with Singapore and other markets.
Another suggestion is to reduce barriers to doing business in the territory as Quinnild cites media reports of difficulties for companies to set up a bank account. “There’s great opportunity for Hong Kong to play a much more focal role in having a safe and secure technology-enabled financial market that has opened up from a capital market and asset management perspective.”