The jolt Premier Li Keqiang delivered to China’s financial system emulates a playbook crafted by predecessor Zhu Rongji in the 1990s, inflicting short-term pain in the anticipation of long-term gain.
Li, who took office in March, sent the clearest message yet the past week that China’s new leadership team wants lenders to rein in credit expansion, depriving money markets of liquidity in the biggest squeeze in at least a decade. Next steps may include tightening that sends some smaller financial institutions into bankruptcy, according to analysts at Nomura Holdings Inc.
Zhu’s strategy of cutting the size of state enterprises with millions on the payrolls helped set the stage for years of growth in excess of 10 percent. With a focus now on a slower expansion pace that avoids asset bubbles or bad-loan crises, Li and his team face a possible backlash from indebted local governments and state banks that are among the world’s largest by market value.
“You’ve got to use a hammer to change this system,” said James McGregor, a Beijing-based former chairman of the American Chamber of Commerce in China and author of the 2012 book “No Ancient Wisdom, No Followers: The Challenges of Chinese Authoritarian Capitalism.”
“There’s no rule of law here, so you’ve got to use blunt instruments to get party members out there in the financial system to pay attention,” said McGregor, now chairman for Greater China at public-relations company APCO Worldwide Inc. “This got their attention.”
The central bank signaled this week that while it won’t let the cash squeeze further roil money markets, any liquidity support will be focused on banks that are lending to help the economy, after credit expansion outpaced economic growth this year. Li’s State Council, or Cabinet, said last week that the financial system must better support the economy, and yesterday said China will keep consistency and stability in its policies to stabilize market expectations.
“It takes pains to get through the liquidity crunch, but it also paves way for future gains,” the official Xinhua News Agency said in a commentary last night. “For the blessing of a more sustainable economy, banks are the first, but certainly not the last to suffer the hardship.”
China’s seven-day repurchase rate, a gauge of interbank funding, fell 55 basis points to 6.74 percent today after the central bank said June 25 it would use tools to safeguard stability and that tight liquidity would ease. The rate touched a record 12.45 percent on June 20.
The benchmark Shanghai Composite Index of stocks fell 0.1 percent at the close, the seventh straight decline.
Li, 57, has pledged to open the economy to more market forces and strip power from the government. This “self-imposed revolution” would “even feel like cutting one’s own wrist,” Li said at a March 17 press conference.
“Both premiers are reformers and investors are trying to find out if Li, like Zhu, has the courage and will to push for wrenching changes,” said Fred Hu, the Beijing-based founder of private-equity firm Primavera Capital Group and former Greater China chairman at Goldman Sachs Group Inc. “Zhu’s reforms, while unpopular and painful at the time, ultimately delivered tremendous benefits to the Chinese economy.”
Li’s economic team includes leaders who worked under Zhu in the 1990s such as People’s Bank of China Governor Zhou Xiaochuan, who was a deputy governor from 1996 to 1998, and Finance Minister Lou Jiwei, a vice minister from 1998 to 2007. Both played roles in economic restructuring that led to China joining the World Trade Organization in 2001.
While the PBOC’s actions this month have been “extraordinarily reckless,” Zhou is in a “very difficult position” given that he doesn’t have authority to make key decisions, said Mark Williams, a former U.K. Treasury adviser on China who is now an economist at Capital Economics Ltd. in London. “There will be a lot of angry bankers out there and a lot of state-owned industry will be questioning what went on.”
Jiang Jianqing, chairman of Industrial & Commercial Bank of China Ltd., the nation’s biggest bank, said there was no clear direction from policy makers on their goals during the money-market turmoil, Reuters reported, citing a June 25 interview. “Those few days, even for us, we were genuinely a bit tense,” Jiang said, according to Reuters.
As the economy’s steward from the early 1990s through 2003, during which he served as vice premier, central bank governor and then premier, Zhu helped slash inflation to 2.8 percent in 1997 from more than 24 percent in 1994 while slowing growth in fixed-asset investment. More than 50 million workers were laid off at state-owned enterprises under Zhu’s watch, according to Standard Chartered Plc.
Li, China’s first premier with an economics doctorate, gave his “unwavering commitment” to the 400-plus-page “China 2030” report published last year by the World Bank and the Development Research Center of China’s State Council, then-World Bank President Robert Zoellick said in February 2012.
The report lays out a framework to restructure China’s economy through market mechanisms. It recommends loosening controls over interest rates, boosting consumption, rolling back state enterprises and speeding a shift to market-set prices for everything from loans to raw materials.
Such initiatives may face opposition from entities including local governments that rely on debt to finance their budgets and state-owned enterprises in industries from banking to telecommunications that resist increased competition.
“Everybody who needs credit will be pushing back,” said Steve Tsang, director of the China Policy Institute at the University of Nottingham in England. “How are local governments going to service their huge debt?”
Zhu and Li both inherited an overhang of excess investment and both vowed to slash the role of government. Still, Zhu, now 84, became premier with a reputation as a risk taker after earning the nickname “One-Chop Zhu,” referring to the red stamps of approval for paperwork, for making it easier for foreigners to set up businesses in Shanghai when he was mayor there. Li rose to office with a lower profile and a reputation for caution.
“Both saw the need to take drastic action on the economy and they have done so in different ways,” Tsang said. “That’s probably as far as it goes. Li Keqiang doesn’t have a reputation for taking risks. He wouldn’t have done this without Xi Jinping and the rest of the Standing Committee behind him.”
The success or failure of Li’s policies will hinge on whether he follows through with “structural reforms,” Barclays Plc analysts led by Hong Kong-based Huang Yiping said in a note today.
Deposit and lending rates may become more flexible in the coming months and other initiatives, including changes to the fiscal and household-registration systems, may be detailed at a Communist Party meeting this autumn, Huang wrote.
Li inherited combined government, corporate and consumer debt at about 206 percent of gross domestic product, up from 150 percent a decade earlier, Standard Chartered estimates.
With May M2 money supply expanding 15.8 percent from a year earlier, above the year’s 13 percent target, policy will remain tight in the second half, said Zhang Zhiwei, Nomura’s chief China economist in Hong Kong.
Elsewhere in the Asia-Pacific region today, New Zealand reported a May trade surplus that was smaller than economists projected, while Vietnam’s economic growth accelerated in the second quarter. Taiwan kept borrowing costs unchanged.
Germany’s unemployment fell by 12,000 people in June, while U.S. data will probably show consumer spending rebounded in May, based on the median analyst estimate.
The sudden action by Li’s government in China contrasts with a decade of incremental policy change under former President Hu Jintao and Premier Wen Jiabao.
“What you are seeing is a re-connection with the economic management and reform mindset of the period of former President Jiang Zemin and Zhu Rongji,” said Kenneth Courtis, founder of Tokyo-based advisory company Next Capital Partners and former Asia vice chairman at Goldman Sachs. “People are starting to understand more fully that the new leadership is working to move China beyond the Hu-Wen period, when change was modest and based largely on vast reforms that had gone before.”
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