The swift liberalisation of China’s financial market could have unintended consequences for India and the world
These columns have regularly followed the ongoing liberalisation of China’s financial sector and progress in the internationalisation of the Chinese currency (see, for instance, “Translating Economic Scale into Financial Heft”, Business Standard, December 19, 2019). Several key reforms have been put in place in recent months offering greater participation to foreign entities into China’s large and expanding banking, insurance and financial services industry.
These opportunities are well-timed as China offers returns that are unavailable in the rest of the world, particularly in the post-pandemic economic environment. Among large economies, only China will register a positive growth in gross domestic product (GDP) in 2020 of about 2-3 per cent.
We are witnessing a wave of integration of China’s financial market with the West-dominated global financial system. There is swift coupling rather than decoupling here; we may be at the cusp of a massive reordering of the system with major impacts on the global economy and geopolitics.
Let us consider the scale involved. China’s financial sector is already worth $44 trillion and growing. Chinese banks handle $41 trillion in assets. The four largest banks in the world are Chinese. China’s bond market is the second largest in the world after the US, and is currently worth $14 trillion. It has been estimated that assets under wealth management projects are currently $7.4 trillion and expected to double by 2022. In terms of market capitalisation, the Shanghai and Hong Kong stock exchanges are just below $5 trillion each, while Shenzhen is at $3.5 trillion. While these market capitalisation figures are well below the New York Stock Exchange’s market capitalisation of $29 trillion, they are expanding rapidly. Access to this financial market by foreign entities has hitherto been restricted and strictly regulated. The recent reforms are offering big opportunities in this sector and attracting keen interest from US, European and Japanese firms.
Consider the opportunity. Foreign banking constitutes only 2 per cent of Chinese banking assets, while in the OECD countries it is about 10 per cent. Even a 5 per cent share would be in the region of $2.2 trillion. Similarly, foreign share of China’s bond market is only 2 per cent but under the new rules may go up to $400 billion annually. This does not include income that may be earned from wealth management instruments, ratings business and customer advisory services. Foreign insurers earn only 2 per cent of the premium income generated in China under the earlier restrictive rules, while in the OECD the figure is nearly 20 per cent.
What are the new rules instituted in 2020? There are now no limits on foreign ownership of banks, which may have wholly-owned entities or joint ventures, and there is no minimum assets limitation. Foreign banks may conduct business in Chinese and foreign currencies and such business may include trusts, leasing and consumer finance. The caps on foreign investment in Chinese securities, fund management business, futures trading, life insurance have been eliminated. Rules for exiting mainland business and transferring of assets abroad have also been simplified. In the wake of the liberalised rules, HSBC, JP Morgan, Morgan Stanley, Nomura and UBS have already taken controlling stakes in their mainland businesses. Allianz and Axes are looking to establish wholly-owned entities and engage directly in the insurance business. American Express has obtained permission to run its card and consumer finance business in the country. These are early movers and depending upon their experience others will follow.
There are other noteworthy developments. The Hong Kong-Shanghai Stock Connect and the Hong Kong Shenzhen Stock Connect, which allowed investment in China’s equity markets indirectly, has also been liberalised to include bonds. The quota limits on trading for qualified foreign institutional investors (QFIIs) and qualified domestic institutional investors (QDIIs) have been removed. A major initiative is the Northbound and Southbound Wealth Management Connect for the Greater Bay Area, including Hong Kong, Guangdong and Macao. Under the Southbound mechanism, residents of mainland can invest in eligible investment products distributed by banks in Hong Kong and Macao by opening designated investment accounts with these banks. Under the Northbound scheme, it is residents of the Greater Bay Area who may invest in wealth management products issued by banks registered in the mainland. Now these will include foreign banks. In 2020 alone, business under the Northbound scheme topped $2.7 trillion, which accounted for over 10 per cent of the total trade in Chinese A securities. The figure was 2 per cent only in 2017.
A new area of interest is China’s development of a Green Finance market. A suite of financial products are being offered, including green short- and long-term loans, green bonds, green private equity and venture capital funds and green infrastructure REITs. A range of green insurance protections are being planned to cover environmental and climate risks. With China having declared a target of peaking its carbon emissions by 2030 and achieving carbon neutrality before 2060, a huge transformation of its energy economy would be required and the plan is to use green financing to meet some of that cost, including by attracting foreign funds into these specialised instruments. China has conducted roadshows in several European capitals on them and is attracting considerable interest.
Chinese financial reforms have the obvious economic purpose of attracting large financial flows into its expanding economy but also to make its financial markets aligned with global norms and management practices. China also recognises the huge attraction that its financial markets have become for western financial firms, including US banking and securities companies. The bigger the stake they come to acquire in China, the greater the leverage China will have in the unfolding geopolitical game. Here is an emerging interdependence that could be “weaponised” in future, just as we have seen in the goods trade. See how Australia is being made an example of with punitive tariffs on its major resource exports to China.
There are important changes taking place in China’s financial sector and in its overall economic strategy. These should be the subject of careful research in order to gauge their impact on India’s economic interests. China’s use of innovative financing instruments and mechanisms may have useful lessons for us. It is a pity that one sees very little of this effort.The writer is a former foreign secretary and a senior fellow, CPR.