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Beating the Trap of Financial Repression in China
By David D. Li
Introduction
What is the future of China's financial sector? Will it continue to be stable? Will it be more efficient? In addressing those questions, we need to review China's financial system of the reform era (1978 to the present). I argue that the key feature of that system has been a mild financial repression that has helped China maintain the financial stability needed for reform. But the repression has been inflicting increasing costs in terms of lowering economic efficiency. Moreover, having been implemented by various policies in the reform era, China's financial repression tends to be self-propelling and selfsustaining, creating a low-efficiency trap that prevents financial sector liberalization. In order to beat the trap, I argue that the ongoing financial reform must aim at breaking up the dominant state banks into smaller, manageable independent banks. Alternative reform strategies aimed at restructuring state banks are likely to be futile. To achieve the objective of breaking up the largest state banks, two preconditions must be satisfied and should be the focus of the current reform. The first precondition is to restructure the central government's public finances, and the second is to properly deal with the nonperforming loans of the state banks.
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