China Herald: Next, the state has to let the banks go

Liberalization of the interest rates is a first important step in financial reforms, but it is not enough, tells financial analyst Sara Hsu in the EastAsiaForum. Next the state needs to let the state banks go.

Sara Hsu:

It is also worth noting that interest rate liberalisation will happen just as the exchange rate is being liberalised and the slow, partial capital account liberalisation takes place. As financial markets become more competitive, exchange rate liberalisation can help financial participants control for risk and ensure price stability, while capital account liberalisation will, over time, allow investors to diversify their assets.

The order and pace of financial liberalisation is crucial to its success, and China’s gradual approach to liberalisation is likely to prevent the financial crises that so many developing countries experienced when they liberalised suddenly, throwing open their banking sectors and their capital accounts at once. Destabilising forces, particularly rapid capital inflows and outflows, are likely to be controlled in China for some time. The actual impact of financial liberalisation will probably be what the authorities are hoping for: that is, financial deepening.

Managing the financial market requires caution. Authorities should closely monitor and control for risk. So far, regulators have been conscientious in attempting to ferret out excess risk, and this is expected to continue. It is hoped that China can liberalise interest rates while sharply reducing the presence of the state in implicitly directing funds from banks to less efficient SOEs. If this complexly choreographed process is carried out properly, then financial markets will metamorphose into more sophisticated structures, and participants will reap the rewards of new market opportunities.

More in the EastAsiaForum.

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