Reform of China's Capital Market to Support Sustainable Economic Growth

It will be critical for China to more efficiently allocate capital and resources if it is to achieve sustainable economic growth in the next few years, according to Moody's Investors Service.

"In this context, capital market development will play an important role in allocating resources within the real economy and supporting economic re-balancing," says Jenny Shi, Moody's Country Manager for China. "Here, the ultimate purpose of economic re-balancing is to ensure sustained economic growth."

Shi identifies four key areas necessary for the development of China's capital market: securitization; reform in local government debt; the internationalization of the RMB market; and the formation of global connections.

"China's securitization market -- which is still at a developmental stage -- is playing a key role in deepening the country's credit market, but the diversity of the investor base needs to broaden to truly shift risks away from the domestic banks," says Shi.

At a time of tighter bank lending in China, securitization is providing an alternative funding source for larger corporates as well SMEs. It is also helping banks revitalize their own balance sheets.

In addition, securitization acts as an important funding source for lenders of consumer loans, who will, as a consequence, lend more money to consumers. Securitization thereby assists in China's push to make domestic consumption a bigger driver of economic growth.

With reform of local government debt, the new guidelines announced by China's State Council in October, together with earlier reform measures, will enhance the creditworthiness of Chinese regional and local governments (RLGs) as they will further pave the way for these entities to borrow in their own names rather than through intermediaries.

Moreover, despite uncertainty over the timeframe for full implementation, the guidelines are another milestone in the development of a Chinese local government bond market and in China's broader policy goal of economic rebalancing.

So far for 2014, the internationalization of the RMB bond market has progressed significantly and new issuance continues to grow despite the softening in the RMB. For January-September 2014, total dim sum bond issuance -- which is offshore RMB denominated -- totaled RMB451 billion.

Such a high level of issuance is a strong indicator of the offshore RMB market's successful transition from pure currency play into an international fixed-income asset class.

Finally, global connections are important, and opening up China's capital markets to foreign investors will directly increase the capital pool available to the efforts on economic re-balancing.

China's steps towards financial liberalization, such as the Renminbi Qualified Foreign Institutional Investor program (RQFII), are providing new opportunities for foreign investors and intermediaries.

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