Although it is unlikely to see system-wide financial risks in China in the near future, there are however six possible risk areas that may significantly work on the Chinese economy, if not properly addressed.
High inflation
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Annualised consumer price index (Cpi) released in April had reached 8.5%, which is at an uncomfortable level. There are any reasons for the rapidly rising prices in China.
Rmb appreciation has only minute impact on the rising price of commodity imports. The rising food and metals prices in the world have directly contributed upward pressure to China's Cpi, and the rising power prices globally are expanding difficulties on Chinese government's domestic price control measures.
The ability of downstream industries to digest price pressures from upstream materials suppliers has come to be minimal. Back in 2007, although the Chinese economy was also growing rapidly, the Cpi could nevertheless stay around 4%. This was because there had been a capacity surplus built up in downstream industries and the competition was intense.
But due to the rising Rmb and price adjustments in environmental protection, labour and land last year, profit margins in downstream industries have been suppressed. Therefore upstream price rises are now being passed onto consumers.
Price controls may be hard to maintain. The government's price control measures can unquestionably be productive to keep down price hikes in the short term, but it has been proven that the "control - subsidy" mechanism may not be sustainable. Take the example of refined oil products in China. The breakeven price for Chinese petrol refiners is about Us per barrel, but in the first quarter of this year, international oil prices had been around 0-110. So even though there are lots of fiscal subsidies to refiners, shortage of refined oil products are still occurring in some markets.
Foreign exchange risks
Due to Us dollar depreciation, Us Federal Reserve's rate cuts and People's Bank of China (Pbc)'s rate increases, Pbc's foreign currency hold briefcase is showing widening losses arising from foreign currency (mainly Us dollar) asset depreciation and hedging costs.
According Pbc's balance sheet released in February, it had equity of 21.975 billion yuan (Rmb:Usd = 7:1), equivalent to an equity/asset ratio of merely 0.12%. Course makers should now forestall the Pbc from assuming dual responsibilities of monetary Course and exchange rate policy, and let the government take over some of Pbc's quasi-fiscal deficit. If such deficits are left to be self-digested within the financial system, they may eventually bring risks to China's monetary Course independence and even to Pbc's credibility.
Sharemarket volatility
The Chinese sharemarket's price to earning ratio reached a improbable 67 times in 2007, while it has gone down nearly 50% since 2008. Such volatility may lead the following impacts on the economy.
Social wealth will be additional concentrated towards a small group of people. But due to the rapid ups and downs, a lot of the paper wealth hasn't been converted into real consumption, hence minute safe bet impacts on the consumer market.
The sharemarket's capital raising capacity has been severely impacted. The depressed sharemarket and the excess interrogate for capital have prompted the authority to place restrictions on Ipo and refinancing activities, so that shop integrity can be maintained.
On the other hand, in the farranging context of excess liquidity in China, surplus capital may flow to other asset markets such as asset market, resulting in new asset bubbles.
The declining sharemarket has also increased the difficulties of macro Course implementation and monitoring measures by the regulator, such as "market bailout" interrogate and how to control liquidity while not additional hammering the market.
Mortgage crisis
China's real estate question is largely a financial problem. By the end of 2007, real estate mortgage balance of China was 4.8 trillion yuan, accounting for 17.3% of total lending balance. And real estate mortgage balance increase accounted for 28.9% of total lending increase in 2007.
Amid the tightening monetary policy, some real estate fellowships that heavily depend on bank reputation are now facing the risk of funding deficiency, and the ability of existing loans in some real estate fellowships may also deteriorate.
Reduced home affordability among home buyers may increase the risk of default. Loan reimbursement ability characterize on borrowers by Chinese banks is still relatively loose, and the reputation theory is still unsophisticated. Bank interest rates have cumulatively increased 1.44 percentage points in the middle of April 2006 and Dec 2007, additional expanding the risk of default by less affordable home buyers.
The severe correction in China's real estate shop may lead to substantial negative equity among asset owners. For properties purchased within a year, if their prices go down 30%, many mortgages may come to be a negative equity for their buyers, or buyers may be forced to give up their asset ownership.
Banking sector risk
Since the banking business reform, the proportion of non-performing assets in Chinese banks has substantially reduced, but future operational risks still remain.
Bank profits are still relying on original company liens and non-marketised interest rate differentials. Although China's banking business has seen improved proportion of intermediary company income in 2007, such increase was heavily depending on wealth supervision businesses. As the sharemarket continues to decline, income from wealth supervision businesses is improbable to shrink significantly in 2008.
Bank balance sheet supervision and liquidity supervision need to be adjusted. In January 2008, long term lending accounted for 50% of total lent assets in China's financial institutions, up 13% from the 2001 level. But on the other hand, short term deposits amounted to 40.3% of total deposit base, with no corresponding decline from 2001.
Bank credits are still chasing heated industries. Loans from industrial banks have generally concentrated in industries such as real estate, transportation, public utilities and manufacturing. Amid the tightening monetary environment, if banks suddenly cut their lending to those overheated industries, it may lead to severe funding breakdown in some highly-leveraged companies, hence loan ability deterioration.
International currency crisis
The current international currency theory possesses safe bet deficiencies, but a dramatic adjustment to this theory will not be beneficial to most economies, either. It will still be difficult for China's financial theory and financial business to adapt to the complex international currency environment.
Firstly, China's international trading activities are primarily located in Usd, hence heavy dependence on the Usd in terms of foreign exchange rate setting and hamlet system. Secondly, as a country with huge trade surplus, both the Chinese government and the inexpressive sector have accumulated substantial Usd asset, therefore any Usd depreciation will cause substantial losses to China's foreign exchange asset. Thirdly, even though the Usd's international currency status is declining, Rmb regionalisation is still at an early stage, not capable of filling up the requirement of a regional currency in Asia. Lastly, if any change in Usd's status affects the Hong Kong Dollar, which is pegged to the Usd, mainland China may have to bear some kind of ramification responsibilities.
Beware of Six Financial Risks in China
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