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General Principles and Policy Suggestions for Winning the Battle against Major Risks

Feb 15,2018

By Wang Yiming

Research Report Vol.20 No.1, 2018

I. General Principles for Winning the Battle against Major Risks

Considering the changes in the stage of economic development and the frequent risks during the period of economic transformation, we should figure out how risks are caused and spread in this period and think systematically and strategically while bearing in mind the bottom line. Following the general principles of “proactive prevention, systematic countermeasures, addressing both symptoms and root causes, and holding the bottom line”, we should effectively forestall and resolve all possible risks and make sure major systemic risks will not occur.

1. Proactive prevention

Risks in economic and social development undergo a process from emergence to accumulation and to final release. If we can find the right time window of risk resolution in the accumulation stage and take effective and proactive measures, we will considerably reduce the negative impacts caused by the risks on economic and social development. Gray Rhino refers to highly probable potential risks that have tremendous impact. According to the Gray Rhino theory, risks break out not because the previous signs are too covert, but because of people’s negligence and poor response and their unwillingness to take proactive and preventive actions.

“Gray Rhino” is scarier than “Black Swan” because people usually miss the best timing for risk disposal out of habit and numbness.

Proactive prevention means strengthening the top-level design, systematic plan and steady promotion of risk prevention. We should combine “focusing on major tasks” with “market mechanism and efficiency”, intensify the evaluation of various risks, establish the risk pre-warning mechanism, work out systematic plans for preventing and resolving risks, and specify the focus of risk management in each stage. Unlike the passive responses to risks, proactive risk prevention and resolution is a complex and systematic project that requires overall strategic planning. For instance, when dealing with the high leverage ratio, an overall strategic plan for deleveraging must be formulated, from controlling the leverage growth, stabilizing the leverage ratio, adjusting the leverage structure to lowering the leverage level in the end.

2. Systematic countermeasures

In the market economy system, risks are transmitted and diffused much faster among different sectors, and the risk transmission mechanism is more complicated and diverse. Especially given the context of globalized and open economy, the rapid information flow in the Internet age, and the quick changes in market expectations, the spillover effect among different risks is more obvious, and the effect of their cross-contagion and feedback magnification is more prominent. Against such a background, we must be mindful that risks come along with economic transformation and are inseparable from substantial economic structural imbalance. The risks in each sector are not isolated, so we cannot deal with them with fragmented local measures but should prevent and deal with them with systematic thinking and from a network perspective.

To systematically deal with risks, we should make systematic strategic plan and turn risk prevention and resolution into a systematic project, in which the work in each stage is carefully designed. We should intensify the judgment and prevention of risks in the early stage, reinforce risk handling and disposal in the process, and improve the ability of risk immunity and management afterwards. In the meantime, we must work out the plan and implementing path for risk prevention and resolution from a systematic perspective, including advancing the strategic adjustment of economic structure, comprehensively rectifying the substantial economic structural imbalance, improving the financial regulatory framework, recovering the balance sheet, establishing a new model of risk management system, and enhancing risk management capability.

3. Addressing both symptoms and causes

Risk prevention mainly targets pressing issues and the measures taken areusually temporary, but they only address the symptoms. To resolve risks at source, we need to resolutely deepen the reform in all respects. Risk accumulation is usually the external expression of economic imbalance and resource mismatch, and the fundamental causes are the structural reform lagging behind and twisted institutions and mechanisms, which can only be addressed through structural reform. According to international experience, the two crises in 1998 and 2008 both broke out in the financial sector, but essentially, they largely reflected the structural imbalance in the real economy, which resulted in the resource mismatch and concentrated release of risks in the financial sector and eventually amounted to the outburst of financial crisis. After the financial crisis, leading Western economies implemented the policy of quantitative easing, which stimulated the real economy in the short term. However, the structural imbalance was not solved thoroughly, so there were many uncertainties regarding the sustainability of economic recovery.

To address both symptoms and causes, we need to center on letting the market play the decisive role in resource allocation and letting the government better play its role. Around that, we should deepen the reform of basic areas and key aspects, such as the reform of SOEs and of the fiscal, tax, financial, social security and macroeconomic management systems, establish and improve the internal restriction and external supervision mechanisms necessary for economic operation, and promote the betterment and innovation of the socialist market economy system on a higher level, thus enhancing our institutional advantages. In view of the pressing task of economic transformation and the not-well-developed market economy system, we should adhere to the market-oriented reform, give up the expectation that the government will bear all the risks and be the final defense line, “pay to establish mechanisms”, and give full play to the market’s role in risk management, disposal and sharing.

4. Holding the bottom line

The process of economic transformation is usually the process of balance sheet reconfiguration and risk accumulation and release. If we are not vigilant enough for risk accumulation and do not have the awareness to prevent them, they will keep gathering till they reach a certain level and break out in concentration, causing systemic risks and economic and financial crisis. According to international experience, Eastern Asian countries, Eastern European countries that used to be part of the Soviet Union, and Latin American countries all encountered serious financial crisis during economic transformation. The transformation would be obstructed if the crisis was not properly handled and those countries would fall into the middle-income trap.

To hold the bottom line, we should be problem-oriented, always keep the bottom line in mind, forestall risks before they emerge, and fully estimate the worst scenario. Once we envision the worst situation, we will be able to solve the problems and turn crisis into opportunity. While we bravely face up to risks and assume responsibilities, we should also keep a clear mind, calmly and objectively analyze and evaluate the risks, and deal with them properly, so as to make sure the worst situation will not appear and hold the bottom line of forestalling systemic risks.

II. Arrangements for Preventing and Resolving risks in Stages

To effectively prevent and resolve risks in the period of economic transformation, we have to clarify the short-term, medium-term and long-term focus and main tasks according to the features of risk accumulation in different stages.

1. Dealing with financial and real estate risks in the short term

In the short term, financial risks and real estate risks are the most prominent ones at the moment, as reflected in the excessively high macro leverage ratio, mismatch of financial resources and real estate bubbles. When these risks accumulate to a certain level or encounter abrupt external impact, the risks may be magnified and quickly transmitted to real-economy sectors, and further trigger systemic risks. We should deepen the financial reform, put in place market- and law-based default handling mechanisms, improve the financial regulatory system, and make up for regulatory shortcomings and fill in the regulatory blanks. We will adopt measures to tackle a batch of risky points and control the financial increment while actively disposing of the stock, in order to prohibit the gathering of financial stock risks and consequently forestall liquidity risks. At the same time, we should move faster in the research and establishment of a basic system and long-term mechanism for the real estate industry that suits the national conditions and adapts to market laws, and adopt measures to curb the real estate bubbles, in the attempt to avoid drastic fluctuations in the real estate market and prevent systemic risks.

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