China’s “Triangle of Woes” and Its Impact on Financial Stability

The purpose of this paper is to apply Dean’s (2001) model of the ‘Asian governance triangle’ to assess the symbiosis relationships among the Chinese government finance, state-owned enterprises (SOEs) and the banking system in China. According to Dean, the relationship as a whole is fragile and unhealthy. This is because crises of such character are interdependent and contagious in that crisis in any one corner could readily lead to crises in the others. However, China has so far managed to avoid a financial crisis, which according to Dean (2001), is due to three reasons. Firstly, China remains willing to pour public funds into its SOEs and banks. Partly, as a result, hundreds of millions of ordinary Chinese people keep adding to their bank deposits, which enable the banks to sustain their flow of non-repayable loans to the SOEs. Secondly, China remains shielded from the crisis by its holding of massive foreign exchange reserves. Finally, the financial system is well protected by its exchange and capital controls. However, over the years, a series of reforms of its SOEs and banking system has severed the symbiosis relationships through the introduction of banking and corporate governance in the system. Any disruption of the gradual approach towards the reforms by hastily adopting a f lexible exchange rate and free capital flows would do more harm than benefit China in the long run.