Exclusive Insight: Background and Current Issues of China's Financial System Reform
In today's issue of the China Brief, we cover a range of topics, from China's struggle to become a soccer powerhouse to President Xi Jinping's overhaul of the country's economic policy team. The United States is also seeking allies' backing for possible China sanctions over Ukraine. At the same time, the US House Foreign Affairs Committee has voted to give President Biden the power to ban Chinese-owned TikTok citing national security concerns. In addition, the United States has approved the sale of $619m worth of missiles and related equipment to Taiwan, which Beijing has protested. Meanwhile, trade officials from China and Australia have hit a "snag" in negotiations to eliminate trade barriers, with discussions centered on tariffs related to Australian wine and barley and unofficial bans related to logs and lobsters. Finally, we discuss the upcoming National People's Congress and how Li Qiang's pro-business past and pragmatism could help tackle China's growing pains.
And here’s today’s exclusive insight:
Exclusive Insight: Background and Current Issues of China's Financial System Reform
As China prepares to undergo another round institutional reform, one important area of focus is financial system reform. I will briefly analyze some of the current issues in the financial system.
Lack of inclusivity
Chinese banks are dominated by state-owned banks that primarily serve state-owned enterprises. As a result, private enterprises have limited access to direct loans from state-owned banks and rely more on private and internet finance. This results in a narrow target audience for the banking system and a lack of inclusivity.
Multiple overlapping government bodies
The People's Bank of China and the China Banking and Insurance Regulatory Commission (CBIRC) have direct control over financial institutions. In the 1990s, state-owned banks in China were technically bankrupt and were only saved by the Ministry of Finance injecting capital. The Ministry of Finance, which is a major shareholder in many state-owned financial institutions, can also exert influence over these institutions. Additionally, the Organization Department of the Communist Party of China (CPC), responsible for evaluating the leadership of large state-owned financial institutions, also holds sway over these entities.
Lack of regulatory oversight
Financial innovation often outpaces financial regulation in most countries, but in China, the gap between innovation and regulation is particularly wide. For instance, non-bank financial institutions such as insurance companies, trust companies, securities companies, and large online tech platforms engage in banking-like activities, including fund deposit and loan businesses, without adhering to banking standards and regulations. Some of these institutions are not regulated at all. While the China Securities Regulatory Commission (CSRC) oversees securities-related businesses of securities companies, it does not regulate their deposit and loan businesses. Ideally, such businesses should be regulated by the China Banking and Insurance Regulatory Commission (CBIRC), but the CBIRC lacks the authority to regulate securities companies.
Regulator collusion and lack of fire-fighting mechanisms
Without proper checks and balances, regulators and the regulated may collude, making it difficult to enforce regulations fully. Furthermore, there are no specific departments or mechanisms to respond to financial risks when they occur. For example, when Baotou Commercial Bank faced difficulties, a temporary working group was put in place. This led to the dismissal and reappointment of its leader from the People's Bank of China and an investigation into the deputy leader from the CBIRC. Similarly, Hainan Airlines was dealt with by a working group from the Hainan Provincial Government, and it remains unclear which department is responsible for the disposal of Ant Group. While the State Council has a Financial Stability and Development Committee, it serves as a virtual coordinating and deliberative body with limited functions.
Lack of unified leadership framework for financial regulatory agencies at the highest level
China's Huarong, a problem financial institution, faced risks a few years ago, but the Ministry of Finance, the People's Bank of China as a regulatory agency, and Central Huijin Investment Ltd. as a state-owned enterprise disposal agency all refused to rescue and dispose of the risk. This highlights the lack of control over financial regulatory agencies at the highest level of power, as well as divergent interests and governance, significant risks without fire-fighting mechanisms, and personnel issues.
Interwoven fiscal and financial risks
Historically and systemically, local governments in China have accumulated significant bank debt. If the fiscal situation is unstable and local government debt defaults, the banking system will become unstable, leading to macroeconomic risks, further worsening the fiscal situation. Fiscal and financial risks are now intertwined, indicating significant changes in the fiscal framework.
While institutional reform is expected to address some of these issues, problems with commercial banks' business models may not be resolved. The systemic concerns can hardly be mitigated by personnel-level reshuffling.
(Li Weijun, a special analysis expert for “The China Brief”, authored this article.)
WSJ: China Stumbles in Pursuit of Xi Jinping’s Soccer Goals
China's efforts to transform itself into a soccer powerhouse have fallen short, with the men's national team ranking below many other countries, and some professional teams facing financial issues or collapsing altogether. A recent crackdown on graft has seen several top soccer officials detained, and a match-fixing scandal has led to widespread concern about the future of Chinese soccer. Experts suggest that China's top-down approach to soccer and sports governance is stifling the initiative and innovation needed for success, and that a ground-up approach is necessary for lasting change.
WSJ: Behind Fan Bao’s Detention—a Suspected Quid Pro Quo
Fan Bao, the founder of China Renaissance Holdings, has been detained by Chinese authorities in connection with a corruption investigation targeting a former senior executive at the investment bank he founded, Cong Lin. The investigation relates to a $200 million credit line provided to China Renaissance in 2017 by ICBC International, a division of state-owned Industrial & Commercial Bank of China, that was secured by shares in a vehicle controlled by Bao. Cong was serving as head of ICBC International at the time of the loan and joined China Renaissance in 2020, leading investigators to question whether Bao offered him a position at his bank to secure the funding.
NYT: U.S. Braces for G20 Clash Over Ukraine War
Secretary of State Antony J. Blinken has stated that there is "zero evidence" that Russian President Vladimir Putin is willing to engage in serious peace talks over the war in Ukraine. China, Russia's strategic partner, has urged the start of peace talks, but U.S. officials argue that Russia would not negotiate in good faith. Many nations are becoming increasingly concerned about the war, given its economic impact. With Russia and China sending their foreign ministers to the Group of 20 conference in India, it remains to be seen how India will steer the discussions of the war, and whether it will support a condemnation of it or encourage the combatants to enter into negotiations.
Reuters: U.S. House panel approves bill giving Biden power to ban TikTok
The US House Foreign Affairs Committee has voted 24-16 to give President Biden the power to ban Chinese-owned TikTok, citing national security concerns. The bill gives the Biden administration new powers to ban the ByteDance-owned app, as well as other apps considered security risks, and would require Biden to impose a ban on any entity that "may" transfer sensitive personal data to an entity subject to the influence of China. The fate of the measure remains uncertain and faces significant hurdles before it can become law, including approval by the full House and the Democrat-controlled US Senate.
Nikkei: Baidu's Ernie Bot garners love from investors, skepticism from experts
Chinese tech company Baidu's new AI-powered chat app, Ernie Bot, has garnered interest from investors after the company announced it would make an announcement regarding the app on March 16. The app is based on Baidu's large language model Ernie and will be embedded into Baidu's search service before being opened to the public in March. However, experts are skeptical about Ernie Bot's potential compared to OpenAI's GPT-3.5 series, which powers ChatGPT, and its effectiveness in China's online search market, where Baidu has a market share of over 75%.
Nikkei: Xi wants China's security apparatus under his direct grip
Xi Jinping is reportedly planning to strengthen the country's internal security apparatus and create a new police and state security organization under his direct command. Some insiders have raised concerns that such a move could create a suffocating police state similar to the former Soviet Union. The move follows China's "white paper" and "white hair" movements, which have led to increased concerns among the country's leadership about the threat of civil unrest. While there is a focus on what economic stimulus measures will come out of the upcoming National People's Congress, the real issue is the massive reform of party and state institutions, according to analysts.
Reuters: US seeks allies' backing for possible China sanctions over Ukraine war
The United States is consulting with close allies, especially those in the Group of 7 (G7), about the possibility of imposing new sanctions on China if it provides military support to Russia for its war in Ukraine. The consultations are in the preliminary stage and it is not clear what specific sanctions Washington will propose. The Biden administration's initial steps to counter Chinese support for Russia have included informal outreach at the staff and diplomatic levels, including the Treasury Department. The Ukraine conflict has settled into trench warfare, and with Russia running low on munitions, Ukraine and its supporters fear that supplies from China could tilt the conflict to Russia's advantage.
FT: Xi Jinping set to overhaul China’s economic policy team at watershed congress
Chinese President Xi Jinping is preparing to use the upcoming National People's Congress to overhaul the government by appointing trusted acolytes to oversee key sectors, including finance and technology. Premier Li Keqiang and his team of technocrats, credited with steering China's economy through turbulence, will be replaced. Xi is expected to pledge a “forceful” overhaul of the government, with the party exerting closer control over technology and science and more involvement in “non-public enterprises”. The reshuffle comes at a sensitive moment for China's economy, which was hamstrung by a draconian zero-Covid strategy and regulatory crackdowns on tech and property sectors that have damaged business sentiment. GDP in 2022 grew just 3%, well below the official target of 5.5%. The new team must convince skeptical investors that China is ready to tackle longstanding structural headwinds, including rising government debt, population decline, and lagging productivity.
To consolidate control over policymaking, the party has discussed a proposal to set up a super committee overseeing the central bank and other financial regulators. If adopted at the NPC, the new entity would be a more powerful party-led version of an existing body, the Financial Stability and Development Committee, supervised by the State Council. While the existing committee only coordinates financial regulation between bodies, the new committee would be empowered to quickly make decisions on cross-sector risks such as the collapse of Evergrande. The top candidates to lead the new body are He Lifeng, a Xi protégé expected to replace Liu He, and Ding Xuexiang, Xi’s powerful chief of staff.
SCMP: US approves new US$619 million sale of missiles and military equipment to Taiwan
The United States has approved the sale of $619m worth of missiles and related equipment to Taiwan, which the Taiwanese government welcomed as important in deterring potential attacks from the People’s Liberation Army. The sale comprises 100 AGM-88B high-speed anti-radiation missiles, 23 HARM training missiles, 200 AIM-120C-8 advanced medium-range air-to-air missiles, and 26 LAU-129 multipurpose launchers. It will not alter “the basic military balance in the region,” according to the Pentagon's Defence Security Cooperation Agency. China sees Taiwan as part of its territory and has not ruled out the use of force to bring it under mainland control. Beijing has repeatedly protested against arms sales to Taiwan, including during the Biden and previous administrations, warning Washington against supplying Taipei with arms and having official contact with the island. The proposed sale has further increased tensions between the US and China.
SCMP: China-Australia trade officials hit ‘snag’ as they begin meetings, with talk of wine, lobsters and logs
Trade officials from China and Australia have hit a "snag" in negotiations to eliminate trade barriers, according to sources. Discussions have centred on tariffs related to Australian wine and barley, as well as unofficial bans related to logs and lobsters. However, some insiders believe that some Australian products may be able to reclaim market share in China after a three-year absence. Nonetheless, others claim that Australian wine has already been replaced by products from Chile and Argentina.
SCMP: China’s ‘two sessions’ 2023: how will Li Qiang’s pro-business past and pragmatism help tackle China’s growing pains?
Li Qiang is expected to take on the role of premier in China, tasked with shoring up the country's economy, defusing immediate risks, tapping into long-term growth potential, and elevating the country to a high-income economy during his tenure. As a pragmatist with a strong business-oriented mindset and the most pro-business politician in President Xi Jinping’s inner circle, Li is expected to be a bold implementer of economic policies. Holding the president's trust is expected to grant Li more autonomy in economic affairs, allowing him to take bold actions to address pressing issues, such as shoring up private confidence. Li's pro-business image is vital to reviving the severely diminished private confidence. Private investment in China rose only 0.9% last year, far below the 5.1% growth in fixed-asset investments. This suggests that investors took heavy hits during the pandemic and remain concerned about the outlook.
Li's appointment would make him the first such leader in three decades to have no previous central government or west-China experience. His predecessors – Zhu Rongji, Wen Jiabao, and Li Keqiang – spent five years as executive vice-premier before being elevated to the top economic job. Li's expertise in fostering the new economy may be vital for transforming China into a digital economic power. Meanwhile, his bringing of the World Internet Conference, a Beijing-led platform on internet business and affairs, permanently to Wuzhen, Zhejiang, under Li’s leadership has bounded information technologies and the internet together with its deep-rooted private economy and turned the province into a highland of the new economy.
However, questions remain over how he might reconcile his policies with Beijing's long-term targets of self-reliance and common prosperity and how far he could push the reform of the fast-aging and debt-ridden economy to bring back sustainable growth in the face of external headwinds. The ongoing US tech decoupling, with increasing restrictions imposed on high-end chips and other hi-tech goods, may also thwart his ambitions, analysts said.
SCMP: Who are Wang Huning and Ding Xuexiang, the candidates in line to head Communist Party’s Central Leading Group on Hong Kong and Macau Affairs?
Analysts are keeping a close eye on the meetings for clues as to whether Wang Huning or Ding Xuexiang, both members of the Politburo Standing Committee, will succeed Han Zheng in heading the Central Leading Group on Hong Kong and Macau Affairs. Han is expected to relinquish his role and take on a more ceremonial role as vice-president. The decision of who will succeed Han will be one of the last steps in a five-yearly political transition that began at the Communist Party’s national congress in October. Analysts agree that political clout is necessary to navigate the complex issues that arise with managing Hong Kong and Macau affairs. Wang, who is expected to succeed Wang Yang as chairman of the Chinese People’s Political Consultative Conference, and Ding, who is a close aide of President Xi Jinping, are both capable candidates. Some analysts believe that Ding may be more likely to be appointed due to his administrative experience and his relationship with Xi. However, others suggest that Wang is the favorite due to his expected new role at the CPPCC, which has gained greater responsibilities and influence in recent years. Regardless of who is appointed, analysts agree that managing Hong Kong under “one country, two systems” and amid geopolitical tensions with the US and China will be a challenging task.
Foreign Policy: Why China Is Not a Superpower
China’s growing power is reshaping the international order and has been identified by the United States as its number one challenge. However, comparing China’s power position to the contemporary United States and the Cold War-era Soviet Union, shows that China is not yet a superpower. It is a pole in what is now a bipolar US-China system, but it is neither a regional hegemon nor a superpower. The United States is a superpower, while the Soviet Union was a superpower but did not have regional hegemony. The international system now has a distinct bipolar power structure, with China and the United States as the two poles. In terms of economic power, the current system is even more perfectly bipolar than during the Cold War, with China’s aggregated economic wealth almost equaling that of the United States. However, with regard to military power, the current international system is less perfectly bipolar than it was during the Cold War, with a larger gap in military might between Washington and Beijing now than Washington and Moscow then.
China is only a regional power, not a superpower, according to William T.R. Fox’s original definition. Superpowers have global influence and the capability to throw their armed forces into any major theater of war dictated by grand strategy. Regional powers, on the other hand, may enjoy the formal and ceremonial prestige of great power status, but their influence is great in only a single theater of power conflict. China wields global economic power and influence, but the geographic reach of its military is largely limited to the Asian and Indo-Pacific theaters. The United States and former Soviet Union had direct access to the Atlantic, Pacific, and Arctic oceans, while China only borders the Pacific Ocean and is largely hemmed in by major island chains it does not control.
China’s lack of true superpower status has two main strategic implications. In the short to medium-term perspective, the US-China rivalry will be regional and predominantly a naval contest. The other and more long-term strategic implication concerns any attempts by China to leapfrog the geopolitical constraints of its home region. The manner in which China sets about doing this, and the US’ efforts to prevent it, would then define their rivalry.
Foreign Policy: The Risks of the CHIPS Act No One’s Talking About
In an article for Foreign Policy, columnist Howard W. French cautions against the risks of the CHIPS Act, a US government initiative aimed at reshoring high-end microchip manufacturing to the country. Drawing on his experience teaching classes on the challenges faced by developing countries, French notes that despite many nations investing in manufacturing in pursuit of economic advancement, only a handful have managed to become prosperous. He highlights the tendency of many developing nations to raise barriers to protect their home markets against imports from more industrialized societies, and to provide domestic industries with non-financial support. French argues that China’s experience of industrial policy provides a cautionary tale for the US. While the country has achieved impressive economic growth, its state-led approach has resulted in addiction to investment and negative productivity growth. French is concerned that the US government risks throwing good money after bad if the CHIPS Act fails to deliver on its promise. He highlights the difficulty of cutting losses on failing ventures and subsidies that have acquired a force of their own, citing the example of US defense procurement and the continuing production of unwanted weapons systems. While French acknowledges the appeal of ensuring competitiveness in an area like microchips, he emphasizes the importance of having “utter clarity about the real economics involved” before the US government commits to the CHIPS Act.
Foreign Affairs: The Limits of the No-Limits Partnership: China and Russia Can’t Be Split, but They Can Be Thwarted
China's alignment with Russia seeks a more "fair," multipolar order that takes into account the views and interests of developing countries. Still, Beijing's association with a revanchist Russia has drawn more attention to its aggressive posture towards Taiwan. While the partnership can cause damage by shielding the likes of Russia and North Korea from punitive measures at the United Nations, conflicting priorities and Russia's generally dismal prospects limit the pair's ability to revise the existing global order in a coordinated and radical way.
Since Xi's rise to power in 2012, Russia has become one of China's key partners, with deepened economic, political, and military ties. Beijing and Moscow accuse the West of imposing their interests on others, with both pushing back on Western sanctions, despite employing economic coercion against others. In the global South, China markets itself as an apolitical champion for development, a position that Russia supports. The two have extolled the virtues of Chinese projects such as the Belt and Road Initiative and the recently announced Global Development Initiative.
Efforts to push Beijing to cut its ties with Moscow are likely to fail, so the United States and its allies should focus on preventing the partnership from veering down a more destructive path by taking advantage of Beijing's strong interest in the preservation of global stability. Additionally, Washington and its allies should recognize that China and Russia are channeling real disaffection with the existing international order in many parts of the world and work on bridging the gap between the West and the rest.
Chinese President Xi Jinping and Russian President Vladimir Putin have met 39 times since 2012, aligning their countries on measures to weaken U.S. control of the international economy, including creating alternative financial institutions and mechanisms to challenge the dollar's dominance. However, the Russian invasion of Ukraine in 2022 has raised concerns among the United States and its allies, with negative views of China increasing and the sense of urgency about Taiwan growing. Despite this, China has maintained normal trade ties with Russia and continued joint military exercises. While China and Russia share revisionist goals, they do not always agree on how to achieve them, and China is less likely to emulate or join in Russia's violent revisionism. The partnership has hurt China's image in the West, but China cannot afford to be distracted by tensions with a militarily formidable neighbor with which it shares a 2,600-mile border. The fundamental differences between their respective outlooks, along with Russia's growing limitations, will curb the alignment's appeal and its ability to revise the existing global order.
That concludes today’s issue of “The China Brief”. If you find our content helpful, please subscribe to our newsletter: