local government debt, considerable leverage inthe shadow banking system, and weaker-than-expected manuacturing activity. Manuacturingweakness stems rom weakness in export markets.In addition, rising wages in China are havingan adverse impact on export competitiveness,thereby leading to an exodus o manuacturingcapacity. Tus, even growth in the range o 7–8percent cannot be guaranteed.
Financial market reorms
One area o reorm in which the governmenthas begun to take action involves the nancial sys-tem. Indeed, China appears to be on the verge o implementing signicant reorms. A report romthe central bank says that there is consensus thatnow is the time to introduce deposit insurance tothe banking system. Analysts say that this bodeswell or introducing liberalization o interest rates.Free movement o interest rates would eliminatethe automatic nature o bank protability thatnow exists under interest rate controls, which putsbank capital, and consequently deposits, at risk—hence the need or deposit insurance.Freer interest-rate movement will be critical toeliminating some o the imbalances in the Chineseeconomy. Government-controlled interest ratesmean that unds are not necessarily channeled tothe most protable uses. As such, currently thereis oen excessive and ineective investment, notto mention incentives or excessive risk takingthat puts the entire system at risk. Low interestrates have probably contributed to the property price bubble in China as well. Freer interest ratesalso would help reduce the demand or shadow banking services, which also create risks to theeconomy. Indeed, the central bank report calledor greater supervision o such activities. Why isthis so important?China’s shadow banking system could pose asystemic risk to China’s nancial system. In China,ormal banks ace interest rate regulations, bothon deposits and loans. Tis restricts the supply o credit and channels most such credit to state-run companies. However, tens o thousands o non-bank entities have been established in orderto operate outside interest rate controls. Somesuch entities, part o the shadow banking system,are operated o-balance-sheet by banks. Tey areunded not by deposits but by the wholesale mar-ket. Tey oer high-interest loans to businesses,households, and local governments. Teir mas-sive activity is unregulated, unsupervised, and nottransparent. Part o the problem is that, althoughthe ormal banking system has a non-perormingloan (NPL) ratio o only 1 percent, this numberlacks meaning when an estimated 36 percent o credit is extended by non-banks—and their NPLratio is unknown. Te risk is that ormal banks,which have provided wholesale unding or theshadow banking system, could ace big losses.Already there have been some deaults. Ultimately,it would be more eective or interest rate controlsto be abandoned. Tis would eliminate the needor shadow banks and lead to a more ecientsystem o nancial intermediation.Based on what many government ocials havesaid, there is much to do on the nancial ront.Implementation o deposit insurance would cer-tainly be an important rst step.
Premier Li Keqiang, in a recent speech in Germany, saidthat growth or the remainder o the decade will averagean even lower 7.0 percent per year.
Aa Pacfc Ecmc olk—Je 2013