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Is Xi worried about Pyongyang-triggered financial crisis?

Beijing bolsters financial crackdown for better resiliance

BEIJING -- Chinese President Xi Jinping is stepping up his crackdown on corruption and regulatory infractions in the financial sector, a move seen as reflecting Beijing's worries about another financial crisis -- perhaps one triggered by an emergency in North Korea.

Risk prevention took center stage at the National Financial Work Conference held recently. The twice-a-decade meeting determines the direction financial policy will take over the next five years. "Take note of problems early, and sound the alarm," Xi told officials at the meeting. "Root them out and solve them at an early stage." According to the president, China's ruling Communist Party intends to strengthen its control of the financial system as a whole.

In fact, the party has been engaged in a wide-ranging crackdown since January. Famed Hong Kong investor Xiao Jianhua was abducted by Chinese authorities that month and hauled to the mainland for questioning. "Xiao has connections to many in the upper echelons of the party. He knew secrets about how they managed their money," said an acquaintance of the tycoon in the financial sector. With such a valuable source of sensitive information close at hand, "Xi has a powerful card to play against rival party factions" ahead of the party's twice-a-decade National Congress this fall, the source said.

And it seems the president has played it. A series of financial-sector giants have fallen this year: Xiang Junbo, chairman of the China Insurance Regulatory Commission, and Yang Jiacai, assistant chairman of the China Banking Regulatory Commission, are both being investigated on serious graft allegations, while Wu Xiaohui, chief of the powerful Anbang Insurance Group, was detained by authorities in June. Documents provided by Xiao or his associates illustrating ties among major financial institutions and party officials or their families are thought to have spurred these and other probes.

The party's over

Finance, rather than manufacturing, is increasingly seen as China's primary growth sector. The government has been slow to loosen its hold on the interest rates that banks charge, allowing institutions to accumulate hefty profits. The financial sector accounted for 8% of China's gross domestic product in 2016, up from 4% in 2005 and higher than the equivalent figures for countries such as the U.S. and U.K. Manufacturing's contribution to GDP dropped from 42% to 33% over the same period.

Party officials and their families have displayed their familiar knack for colonizing industries where money is to be made. Managing investment funds in Beijing or Shanghai is a favorite pastime of the children of ranking cadres. For Xi to take the scalpel to the financial sector is thus an act of political warfare -- one that could help him ahead of the all-important party congress, where new top leadership is to be chosen.

Moves toward tighter monetary policy since the beginning of the year could help instill some discipline in this freewheeling industry. While the People's Bank of China has left its policy rate untouched, open-market operations have been used to guide short-term rates higher, and the PBOC is charging more interest on short-term loans to banks. The one-year Shanghai Interbank Offered Rate is now 4.4%, a full percentage point higher than at the end of 2016.

Meanwhile, regulators have issued directive after directive to China's banks and tightened their grip on financial market trading. The PBOC has toughened restrictions on sending yuan overseas, and has even adjusted the way it governs each day's trading in the currency to give authorities greater leeway to guide exchange rates.

Learning from history

But while political control is certainly a factor in the crackdown, Xi seems also to be concerned about something greater: preparing for a potential financial crisis. "Financial security is national security," the president told party leaders in April.

Consider the life cycle of the Chinese presidency. Leaders can serve for 10 years total. The first five are given over to consolidating authority, and during the last one or two, the president is often rendered a lame duck. "The two or three years after the National Congress in a president's fifth year are effectively the only time a leader can disregard objectors to ram through reforms," according to a researcher at a government think tank.

But in recent decades, presidents in this phase of their careers have had their ambitions crippled by financial crises -- first the Asian currency crisis of 1997, and then the subprime mortgage crisis 10 years later. It is only natural that Xi should fear a repeat.

Given the current strength of China's economy, the inciting factor for any crisis would most likely "come from abroad -- an emergency in North Korea, for example," said a financial analyst in Beijing. If a military contingency on the Korean Peninsula were to send Asian asset prices plunging, China's fragile and overleveraged financial system could feel the pain.

The timing of Xi's "financial security" remark is notable, coming shortly after he met with U.S. President Donald Trump in April. Since then, tensions in the region have only grown, with Pyongyang claiming to have successfully launched an intercontinental ballistic missile. As the situation heats up, China's president may be working to ensure this country avoids severe burns if things boil over.

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