China’s leaders at the National People’s Congress (NPC) promised to increase the amount of risk in their financial markets. Leaders are not talking about allowing companies and investors to make riskier bets, however, they are talking about cutting down on bailouts and assistance so that investors are at a high risk of losing money if they make bad bets.
During the 2008 financial crisis, Lehman Brothers was allowed to collapse. The collapse sent shockwaves throughout the financial system and may have precipitated the system wide meltdown that nearly destroyed the global financial system. Treasure Secretary Henry Paulson had decided that it was time to restore the so-called moral imperative to markets.
The moral imperative refers to the threat of collapse should a business make poor business decisions. When businesses are likely to be bailed out by a government or other organization, they are more likely to engage in risky behavior, believing that if they should fail, the government will bail them out. This results in high levels of risk being taken by companies, and markets prone to failure.
Central government may not be willing to bail out local governments
China’s government has been working hard to prop up an ailing financial sector. During the 2008 Financial Crisis and resulting recession, China launched a large-scale stimulus package to keep the economy going. On the national level, the stimulus plan appeared to have worked and the country maintained strong growth.
Part of the stimulus package included allowing local governments to take out loans, which could then be invested in development projects. Unfortunately, many local governments wasted money from the stimulus loans on ill-conceived projects that never paid off, or else squandered the money on low priority projects.
Other financial reforms announced
Increasing risk in the financial system was not the only reform announced at the NPC. Other reforms include creating bank deposit insurance, allowing local governments to issue bonds, and accelerating the interest rate liberalization of the yuan. These measures will spearhead the government’s efforts to modernize China’s economy and financial sector.
The Chinese government does not appear to be ready to increase measures to slow down the country’s booming credit sector. Companies and individuals have been taking on high levels of debt in a build up reminiscent to the debt levels accrued before the United States and European Union nearly collapsed.
China appears unwilling to crack down on lending, because doing so will almost certainly slow down growth. The government has set its growth target at 7.5% this year, but has already admitted that achieving such high growth will be difficult.