China’s party congress in the autumn will determine the contours of government leadership and policies for the next five years. With most reforms and policy changes on hold ahead of this pivotal event, a major financial work conference last week was a sign of the government’s economic reform and intentions.
It seemed encouraging that the top leadership understands the importance of financial industry reforms but the lack of any substantive outcomes is troubling. With financial risks increasing even as the sector becomes more important to the economy, fundamental reforms, rather than tinkering, are needed. China’s leadership seems unwilling to tackle this head on, raising the odds of dire consequences.
China saves about half of its annual output. The financial system that intermediates these resources is dominated by an inept banking system. So these resources have been misallocated to inefficient investment that features rapidly diminishing productivity, little job creation and enormous waste. Worse, the dependency on credit-financed investment to boost growth has led to mounting risks, as potential bad loans pile up.