China’s Financial Sector: Contributions to Growth and Downside Risks

Abstract

China has a two-part financial system with a competitive market-based component and a public, government-directed component. Both have reformed rapidly since China's reforms began in 1978. The market-based component is immature and subject to numerous systemic weaknesses, while the government-directed component, which also suffers shortcomings, performs essential funding for infrastructure and other underpinnings of China's sustained rapid growth. Critics claim that China's financial system is inefficient, with banks considered technically insolvent. But a realistic evaluation of the system's resources and accomplishments, including investment rates of return and efficiency in generating sustained growth, can only conclude that China's financial system is performing well and is likely to continue to do so. China's newly articulated strategy for financial reforms going forward clearly intends to pursue gradual commercialization of the whole system—a process that can be expected to last 20 or 30 years. In the meantime, ongoing improvements in government-directed credit will continue to ensure adequate investments in the necessary substructures for competitive for-profit economic expansion.

This paper was prepared for “China′s Changing Financial System: Can It Catch Up With, Or Even Drive, Growth?,” a conference sponsored by Networks Financial Institute at Indiana State University and held in Indianapolis on January 25, 2007.