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Joseph Mariathasan: China’s financial Big Bang

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Institutions lacking a China strategy should ask themselves when they intend to develop one, Joseph Mariathasan writes

I was sitting next to a senior Scottish lawyer and his wife over lunch near Glasgow a couple of years ago, and they were moaning that their 20-year-old son had decided to be a photographer but was now staying at home, doing little to fulfil his aspirations. It was wonderful to see their expressions when I suggested the answer was quite simple: they should buy themselves return tickets to Beijing and their son a single.

I was joking, of course, but only half joking. In 1996, when I first went to Beijing, and the foreign community was small enough everyone seemed to know each other, I met quite a few people in their 20s who had done exactly that. Indeed, one person I met last year is now the COO of a major insurance company based in Asia.

China still represents a tremendous opportunity. The inclusion of the yuan renminbi in the IMF’s Special Drawing Rights marks another and significant step in China’s path towards full capital account liberalisation. A mature and functional finance industry, including functional capital markets, is a pre-requisite for successful currency and capital account liberalisation. The better financial markets work, the greater the benefits of liberalisation.

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A freely floated currency requires meaningful price signals to be reflected in a benchmark interest-rate curve, credit spreads and foreign-exchange crosses, both spot and forward, as well as in stocks and traded commodities. Of course, this all assumes mature financial-institution balance sheets, intermediation mechanisms and traded capital markets, with investors and issuers managing their balance sheets though this system.

There is still some way to go, but China’s financial Big Bang has already commenced, and its pace is accelerating. There are numerous important new sectors sporting annual growth rates from 20-30% up to 100-500% where there was no business as recently as 3-6 years ago in the absence of a licensing and regulatory framework. The scale of this development is unprecedented. What China has already accomplished in terms of its exports, urbanisation and real estate development will now occur in finance.

For the world’s investors and fund managers, China’s Big Bang will provide a cornucopia of opportunities. China’s non-SOE corporates will become the largest credit-issuer base in the world. On a purchasing-power-parity-adjusted basis, the small and medium-sized enterprise (SME) sector is larger than that of Europe or the US but underdeveloped in credit-issuance terms. The ratio of total liabilities to assets in the private SME sector is still only about 31%, and fully half currently carry no debt on their balance sheets.

Liberalisation appears self-perpetuating. The success of renminbi (RMB) liberalisation since 2009, combined with achievements in domestic finance liberalisation, together require – and would allow for – the liberalisation of the exchange rate. This can be expected to continue, in fits and starts and at varying speeds. In time, a free-floating RMB and global activities of China’s larger financial institutions will require significant opening of the capital account. The flow of China’s domestic retail savings into overseas assets has barely begun, but it will become a major source of capital, particularly into higher-yielding assets. The US Federal Reserve’s rate rise and the potential for the US dollar to strengthen on the back of further increases will act as added stimulus for those flows.

The historical impact of China’s financial Big Bang is often lost in the rhetoric of speculation and hysteria about short-term market moves. Yet these are of little consequence and to be expected in any developing economy. The financial centres of the world are already competing to establish themselves as offshore centres for Chinese finance. It also is another reason why investors and financial institutions should consider looking at China as a separate investment proposition, as opposed to merely a component in a heterogeneous emerging market asset class.

The opportunities are vast, the changes are swift, but the experience of many institutions in China is still low or non-existent. As we enter 2016, those institutions that haven’t yet developed a China strategy should certainly start asking themselves when they intend to develop one.

Joseph Mariathasan is a contributing editor at IPE

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