I. Current Financial Risks in China

 1. China’s long-term economic fundamentals remain strong with a macro environment that can prevent systemic financial risks.

As China’s economy has steped into a new stagefrom high-speed growth to high-quality development, the country is now in a crucial period of development model transformation, economic structure optimization, and growth momentum transition. The relationship amongeconomic variables such as growth, employment, prices, and environment is also changing. The Chinese economy operation shows stage characteristics andstepped into a “New Normal” stage. Looking ahead, there are many positive conditions to spur sustained economic growth, and China’s long-term economic fundamentals remain strong. China has a relatively large economic volume, In which the development in relation to the new phase of urbanization, service industries, high-end manufacturing, and consumption upgrading indicates huge potential. Economic resilience and ample space and potential for further development remains. In recent years, China has made great strides in economic reforms, supply-side structural reforms, government decentralization, the implementation of the innovation driven development strategy and reduction of excess capacity. In 2017, industrial capacity utilization in China rose to a five-year high of 77%. The level of inventories in the real estate market in real estate inventories has declined and the relationship between supply and demand has improved. Industries affected by the upgrade in consumption patterns and strategic emerging industries have developed rapidly, and the economic structure has been further optimized. Positive changes in these economic fundamentals have provided a favorable macro environment for preventing systemic financial risks.

2. Current financial risks in China are generally controllable, but the Chinese economy remains risk-sensitive. Attentions to concentration and outbreak of systemic financial risks should be paid.

In recent years, as the Chinese government continues to reduce the debt ratios in an active and steady manner and advance supply-side structural reforms, the rapid growth in leverage ratios of Chinese companies have been curbed. According to the latest data from the Bank for International Settlements (BIS)[1], China has stabilized the growth in debt-to-GDP ratio, which stood at 255.9% in the second quarter of 2017. It was the first time in six years that China’s debt-to-GDP ratio remained the same quarter-over-quarter. The leverage ratio of non-financial companies was 163.4%, which had declined or stayed the same for four quarters in a row. The leverage ratio of the financial sector has also been effectively controlled. “In addition, strengthened risk awareness and changing market expectations on implicit guarantee or moral hazard have created important psychological conditions for us to prevent and control financial risks.” [2]Overall, China has held fast to the base line of systematic risk prevention and financial risks in the country are generally controllable.

However, it must also be noted that risk-proneness is one of the broad features of the financial sector and will continue to be so over the coming period. As China’s economic transition enters into a critical period, more and more institutional and structural problems which had previously been hidden by rapid economic growth have been exposed. Drivers of endogenous economic growth are to be enhanced. The financial reform is at a critical stage, and exposure of the risks in economic and financial fields is increasing. At the same time, as a result of financial innovation, shadow banking and internet finance have grown quickly in China. While satisfying diverse financial needs, these emerging financial industries have also exposed problems such as lack of standardization, inadequate information disclosure, regulatory vacuum, and regulatory arbitrage. Potential risks have been exposed and financial vulnerabilities have increased. This is precisely why “preventing and defusing major risks” was placed at the top of the three “critical battles” agenda put forward at the Central Economic Work Conference.

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[1]  Unless otherwise specified, leverage data cited in this paper come from the BIS.

[2]  Liu He, Speech at the 48th Annual Meeting of World Economic Forum, Davos, Switzerland, January 24, 2018.