How prepared are Chinese leaders for reform?

Speculation about China’s much-needed reforms is intensifying as the country’s 18th Communist Party Congress kicks off, but the new leaders’ reformist credentials are still far from clear.

Optimise is the order of the day at HSBC, which issued a 60-page report featuring very encouraging predictions about how China’s new leaders are ready to revolutionise the country’s financial system.

The British bank claims that conditions are ripe for the renminbi to become fully convertible in five years — and that the bond market will double in size under the new leadership’s transition to market-based interest rates.

These changes would not only make capital allocation more efficient, boosting the private sector, but also provide the middle class with more options about where to put their money so they can earn a higher return and spend more, it said.

Many critics have urged the new leaders to address urgent issues, such as abandoning the hukou (household registration) system; narrowing the wealth gap; and balancing the distribution of resources between state-owned and private enterprises.

No doubt all party officials and critics would agree on the need for reform. But how serious and committed are the authorities?

Some commentators would like the new cadres to signal their intentions by declaring more information about their wealth. As long as the assets owned by high-ranking officials and their relatives remain secret, it will be difficult for the incomers to win back the people’s trust.

Transparency is long overdue. The government ordered officials and their families to declare their assets years ago, but all of the information has been kept secret, if it exists at all.

On the face of it, the timing looks good for a move to convertibility. China’s trade balance is back on an even keel, with the current account-to-GDP ratio falling to below 3%. The renminbi is now close to its market equilibrium rate; and domestic financial reforms have already made progress — and will likely gain momentum in the coming years.

Moreover, the role of the renminbi in cross-border trade and investment should continue to expand quickly in coming years, HSBC said.

A fully convertible renminbi would be a huge milestone for China — and a key step in pushing its use as a reserve currency. China has also tried to expand the use of the renminbi for trade settlement to curb its reliance on the US dollar.

Even China’s top central banker, Zhou Xiaochuan, and other government officials have said that the renminbi will be fully convertible soon.

However, in an economy as complex as China’s, the currency won’t be freely convertible without a sequence of drastic reforms in other areas. And the political decisions to unblock the capital account are unlikely to be made quickly.

China must strengthen its domestic banking system, liberalise interest rates and develop a functioning bond market before making the renminbi convertible. But it is likely to adopt a gradual approach in these areas.

The pace of interest rate liberalisation shows how hesitant the policymakers can be. China’s central bank widened the floating band of both deposit and lending rates earlier this year. Economists say that move had been agreed many years ago, but the reform was delayed by worries that financial institutions were far from ready.

There are clear signs that China’s new leaders will make speeding up reform top of their policy agenda in the coming years, HSBC argued in the report.