China's Changing Financial System: Can it Catch up with, or Even Drive Growth
52 Pages Posted: 1 Mar 2007
Date Written: February 28, 2007
China has captured the attention of the world with its unprecedented growth for such a big country during the past 28 years. At an average rate of 9.4 percent, China's GDP has grown almost three times the world average. It is now the fourth largest country in the world, behind only the United States, Japan and Germany. If such rapid growth continues, China's GDP will be larger than that of top three countries in the not too distant future. The pace of economic growth, moreover, has enabled China to double its GDP per capita three times since 1978.
China has achieved remarkable growth over the past quarter of a century despite a relatively inefficient financial system. The financial system, moreover, is imbalanced in the sense that it is dominated by the banking sector, with the bond and stock markets still relatively underdeveloped. These imbalances in the real and financial sectors are interrelated insofar as the growth in exports has resulted in current account surpluses that have led to substantial foreign currency inflows. This has contributed to rapid growth in the money supply and bank credit as the foreign currency is exchanged for domestic currency. China could allow its currency to appreciate far more than it has recently to reduce exports, but such an appreciation could seriously weaken exporting firms and thereby lead to unemployment and more NPLs for banks that had lent to these firms. A still bigger and related problem is the build-up in investment that is the number one driver in growth. There are already concerns that there is an investment boom that may soon collapse into a bust, which if it happens will reduce economic growth and create even more NPLs at banks. These issues will be explored in this paper.
Keywords: China, Banking, Exports, Foreign Exchange Rates, Financial System
JEL Classification: F30, G21, G28
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