China Shakes off Policy Paralysis With Financial Reforms

China Shakes off Policy Paralysis With Financial Reforms

BEIJING -- An emerging consensus holds that domestic price bubbles and the high degree of nonperforming loans littered throughout China's financial system represent imminent threats to China's continued economic rise. However, doomsday evocations of a Chinese crash ignore the fact that, if and when a day of reckoning arrives, China may be able to use its sovereign wealth to engineer a soft landing, thereby avoiding the more-apocalyptic scenarios often predicted. Indeed, a controlled bust may even yield benefits by moderating subsequent growth, and many analysts remain bullish on China's long-term fundamentals.

This market sentiment has been buoyed by recent evidence that China may finally be pushing ahead with the liberalization of its financial system. A recently completed comprehensive industry review by the country's top banking regulator, the China Banking Regulatory Commission (CBRC), has resulted in a raft of policy announcements. While these may not constitute the more drastic measures -- such as a sizeable yuan revaluation -- that some are calling for, they do show that, beyond the headline issues, China is creatively examining ways to expand the possibilities for capital movements in domestic financial markets.

The reforms have implications for both domestic and foreign investors. In terms of the former, Beijing launched a $9 billion state-managed fund of funds in December. Using public money, the fund will partner with domestic investment trusts to provide capital investment for projects deemed in the national interest. Other moves give increasingly cash-rich state-owned enterprises -- whose combined profits were up 37 percent in 2010 -- more scope to enter private equity (PE) markets. They also expand the range of investments open to the country's $120 billion social security fund, which has a 10 percent allocation to PE. Elsewhere, the CBRC last week mandated the country's first hedge fund, an important step in legitimizing and developing domestic institutional investment options.

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