By Susan Krause
USINFO Staff Writer

Washington - China is on the right track in implementing economic reforms, but must speed the pace of development and modernization in its financial markets, U.S. Treasury Secretary Henry Paulson said in a speech in Shanghai, China, March 8.

"Time is of the essence," Paulson said in remarks prepared for delivery at the Shanghai Futures Exchange. "China's underdeveloped financial markets place the nation in a challenging position, trying to balance between a centrally administered and a market-driven economy."

Paulson urged China to capitalize on its current economic strength to move quickly and confidently toward greater transparency and liquidity in its financial markets, cautioning that delay would increase political risks at home.

"The longer China waits, the more difficult it will be to create robust capital markets and reach your goal of more balanced, harmonious, and innovation-based growth," he said.  "Some industries that may seek protection from competition will grow more politically powerful as they grow more economically powerful."

Calling strong capital markets (financial markets that trade in stocks and bonds) the "backbone of stable and balanced growth," Paulson said efficiency and competition in the financial sector are important in allocating a society's economic resources to the most productive uses.

"China's growth is increasingly imbalanced - among regions, households, and sectors," he said, adding that these imbalances are creating economic challenges for China that it has not dealt with before.

EFFICIENT CAPITAL MARKETS ESSENTIAL TO GROWTH

Paulson said that China's leaders recognize the need for economic diversification and movement away from overdependence on the production of low-cost manufactured goods for export. 

"China's most recent five-year plan acknowledges the need to achieve better balance ... by increasing the role of the services sector, increasing the quality of inputs - not just their quantity - and developing a more innovative and technologically sophisticated economy," he said.  

The country's underdeveloped financial sector is a drag on growth and development, limiting returns on investment and reducing the rewards of saving, Paulson said.  The Chinese people suffer as a result, he said, with reduced job creation, lower incomes, and less money for education, health care and retirement security.

"Efficient, developed capital markets will allocate resources more effectively and efficiently, allowing China to continue growing at a healthy pace, while spreading prosperity throughout the economy and giving Chinese citizens a better return on their savings and investments," he said.

STRUCTURAL CHALLENGES REMAIN

China has made "substantial progress" in the banking, securities and insurance sectors over the last 10 years, Paulson said.  But important structural challenges remain in the country's financial sector, he cautioned.

Capital markets remain underdeveloped, both in private stocks and in government and corporate bonds, the secretary said.  In addition, he said, an institutional market for mutual fund and asset managers is essentially nonexistent.

"Institutional investors are the most rigorous in their analysis, and innovative in developing new securities and investment strategies," Paulson said.   

Despite progress in the banking sector, modernization and more professional management are needed in areas such as risk management, supervision and reporting, he said.

Finally, Paulson said, China's central government continues to play an intrusive and inefficient role in investment decisions that should be left to the market. 

"Government has a responsibility to set corporate governance rules and enforce them," he said.  "But today, these rules are unclear and adherence to them is weak." 

Paulson said the lack of a predictable, transparent regulatory regime might inhibit innovation.

"Addressing these challenges is vital to China's long-term economic growth," he said.

GREATER OPENNESS TO FOREIGN COMPETITION

Allowing greater foreign participation in these areas would speed up the pace of reform, Paulson said, leading to increased stability and prosperity.

"I don't know of a single country in the world with a successful and sustainable well-balanced economy that doesn't have a strong capital market in place," he said.  "And I cannot think of any such country that isn't open to competition - both domestically and from abroad."  

Greater foreign participation and competition in China's financial markets also would offer the benefits of new technology and products, domestic skill development, alternate sources of financing, and improved market practices, Paulson said.

"Opening to international competition does not mean compromising your own rules and identity," he said, noting that Japan has accepted large foreign investment banks but these mostly are staffed and managed by Japanese.  "The wealth that is generated in Japan stays in Japan," he said. 

Paulson said he was pleased with the early results of the bilateral Strategic Economic Dialogue, a senior-level initiative established by President Bush and Chinese President Hu Jintao in September 2006.  An inaugural meeting took place in Beijing in December 2006, and another meeting is scheduled for May in Washington.  (See related article.)

"China has come a long way in developing its capital markets, but the journey is not complete," Paulson concluded.  "At the end of the road lie benefits for all the Chinese people.  With visionary leadership and steady progress, these benefits are within reach."

The full text of Paulson's remarks, as prepared for delivery, is available on the Web site of the Treasury Department.

For additional information, see The United States and China.