At a State Council executive meeting chaired by Premier Wen Jiabao on March 28, the Chinese government approved the establishment of a comprehensive financial reform pilot zone in Wenzhou, a strong policy signal aimed at promoting financial reform and building diversified financial systems in China. The Reform Program involves a number of relatively revolutionary polices, as far as China is concerned, including the development of private financing, reform of financial institutions, innovation of financial service products, and easing of restrictions on individual foreign direct investment. Most striking are the changes being made that allow for private citizens to invest abroad, and those allowing private capital to set up financial institutions and provide loans.
So why Wenzhou?
From a geographical point of view, Wenzhou is prominently located in the Economic Zone of the Yangtze River Delta, and has close ties with Shanghai, giving it a strong influence on China’s southeastern coast and hinterland. If the experiment in Wenzhou proves to be successful, it can easily be extended to Zhejiang, Shanghai, and other coastal areas. From an economic standpoint, Wenzhou has the most developed private economy in China. Known as the birthplace of China’s private economy, Wenzhou boasts the most abundant reserves of private capital and the most active private finance sector in China. From a demographic point of view, the people of Wenzhou have a reputation for being skilled entrepreneurs, emigrating all over the world and opening successful businesses in their new home countries.
Wenzhou is not just a good candidate for the pilot project; it is also in urgent need of reforms to better develop its private economy, which until recently has been at odds with official Chinese economic policy.
There are more than 400,000 small and medium enterprises in Wenzhou, but only 29 commercial banks to serve them. These few banks are hardly enough to meet demand and foster the development of so many growing companies. There is, however, abundant private capital ready to be invested, but under current rules these funds are not officially available for the financing of small and medium enterprises. Wenzhou’s vast private wealth has left indelible marks throughout the history of China’s economic reform; from traditional manufacturing to the stock market, from real estate to antiques, agricultural commodities, equity investment, even usury. Private capital in China has created huge profits, along with dramatic volatility, pushing the limits of the traditional regulatory mechanism again and again. Wenzhou’s private sector has been flush with active financial trading and underground financing for many years without the permission of official policy. Effectively guiding these reserves of private capital to ensure China’s long-term prosperity and stability has become a problem in need of a prompt solution, and the recently proposed financial reforms will provide the opportunity for Wenzhou’s private investors to emerge from a grey area and into light of the sun. The new rules are clearly targeted at legalizing, standardizing, and internationalizing the private assets of Wenzhou into a more market-oriented economy.
Although the new rules only apply to Wenzhou, the unprecedented concession of the Chinese government in allowing private capital to set up banks and other financial institutions is a significant policy breakthrough. The reform brings the underground money back into legitimate use and entitles Wenzhou’s private investors the right to operate their financial businesses legally. When an illegitimate lending institution defaults, the lack of legal protection leaves creditors without the means to seek compensation through proper litigation channels, leading to the fragility of Wenzhou’s private credit system and the risk of damaging chain reactions.
The new policy allows the government to incorporate these underground lenders into the existing central financial system, making them much easier to regulate and observe. Moreover, through the guidance and training received from government, these private financial institutions can significantly improve their ability to identify and control potential risks.
The multi-level financial system established by the new policy reforms in Wenzhou will be a major boon to the local economy, as it has historically been very difficult for small and medium-sized private enterprises to get loans from the traditional commercial banks in China. The small size relative to risk, lack of mortgage assets, and low value loans have made SMEs unattractive to the large banks. On the other hand, the new financial institutions set up by private capital can cater directly to the needs of small and medium businesses, since their orientation in the grey market has been to provide small short-term flexible loans. The advent of legitimate private lenders will be an effective supplement to the traditional financial system, allowing financial resources to be appropriately allocated and improving the efficiency of the financial market as a whole.
Another important breakthrough made by the new guidelines is the lowering of barriers to private foreign direct investment, and Wenzhou’s world-travelling businessmen will be the first to reap the rewards. In terms of monetary reform, the new policy will provide deeper involvement of private capital in overseas investment and an increase in cross-border flotation of the renminbi. This will not only push local financial institutions and regulatory authorities to achieve higher professional competence, but also play a significant role in the internationalization of the renminbi and reform of the exchange and interest rate system in China.
The pilot program is an important experiment for China’s financial reform and economic development, and will certainly help Wenzhou to upgrade its financial system and build a much healthier economic foundation. Wenzhou was at the forefront of economic development in China thirty years ago, and today it stands again on the crest of China’s financial reform. What happens now in the comprehensive financial reform pilot zone in Wenzhou will probably be the future of China’s financial development path. The announcement of the program mentioned that it would take five years to reach its goal, but China may not need five years to surprise the world once again.