(Bloomberg Opinion) -- The easy-money addict wants to quit again.
The hint came with the reappearance of three buzzwords that had almost fallen out of the Beijing bureaucratic lexicon. In a Feb. 22 speech, President Xi Jinping resurrected “supply-side reform” in a call for restructuring of the financial sector. Six days later, the banking regulator’s chief risk officer used the phrase in elaborating on Xi’s plan. And last weekend, central bank Governor Yi Gang said the magic words could help lower the cost of borrowing for smaller, private businesses.
Beijing first used supply-side reform in 2015 to describe a drive to eliminate overcapacity by shutting factories and curbing coal-mining and steel output, as the government sought to combat deflation. This time around, the term denotes the process of weaning the economy off its dependence on bank loans by encouraging companies to raise money through the bond and stock markets.
That was the conclusion of Caixin, a respected financial news outlet, after interviews with participants at the National People’s Congress last week.
Take a look at how businesses in China are funded. As of February, the economy had 205 trillion yuan ($30 trillion) in aggregate financing outstanding, two-thirds of which was in the form of bank loans. Corporate bonds, at 20.5 trillion yuan, and stocks, at 7 trillion yuan, are tiny by comparison.
The People’s Bank of China has all but thrown in the towel in its effort to channel credit to small and private companies. In a Q&A session on Feb. 15, the bank said big lenders have become “pawn shops,” willing only to lend to state-owned enterprises and large private businesses that have sufficient physical collateral (such as real estate). Credit officers simply don’t wish to put their career at risk by approving loans to smaller businesses, a central bank spokesperson lamented.
A week later, the PBOC’s research department published a series of articles arguing that China has “capital swamps” – pockets of the economy where businesses can’t get funding no matter how low benchmark interest rates are. It’s no surprise then that Governor Yi said the room for further reserve ratio cuts is limited, even as credit growth in February tumbled. By now, it’s clear that the true cause of China’s credit crunch isn’t higher rates, but the availability of financing, as my colleague Anjani Trivedi has written.
Hence the turn in policy away from bank debt and entrusted loans toward direct financing via the public markets. Stocks, in particular, will be President Xi’s new darling. The potential is clear: U.S. stock market capitalization is equal to 154 percent of GDP; the ratio for China is only 65 percent.
This helps explains why Beijing is starting a new technology board with a faster, registration-based system for listings; why the Nasdaq-like ChiNext Index has outpaced the blue-chip Shanghai Composite Index; and why animal spirits are reviving. Investors know that for the new supply-side reform to succeed, the government needs a bull market, and is willing to stomach the leverage and retail frenzy that come with it.
For China, “supply-side reform” has been a lucky phrase. The first round pulled China Inc. out of its deflationary slump in less than two years. This time, things will be a lot tougher. China will need to consider new rules on hedge funds, electronic trading at prime brokerages, and how stocks can delist – and that’s just for starters. These questions will prove a lot more nuanced than closing a few obsolete steel mills.
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Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.
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