China should step up innovation in the financial sector to guard against risks from increasing economic inequality as the country shifts to a market economy, experts said on Saturday.

Such risks arise from both high non-performing loans (NPL) in the banking system and inequality in income distribution and livelihood for the rural population as well as retirees and laid-off employees from state-owned enterprises (SOEs).

Inequality is unavoidable during the economic transition, but the Chinese economy could face unstable periods and risks if such issues are not addressed properly and in a timely manner, they said.

Avoiding inequality would require a new and solid social security system, revived taxation, wage subsidies and insurance for disadvantaged people and a better regulatory and legal environment, said Robert Shiller, a renowned Yale economist, at a financial forum jointly held by the Renmin University of China and Peking University on Saturday in Beijing,

Shiller made some bold suggestions to help China fend off potential economic risks during the transition. He said that China should build an effective and progressive tax system to redistribute the income of the rich and improve wage subsidy systems to aid low-income households. If necessary, the authorities could even implement negative income taxes to help the poor and establish special insurance for the disadvantaged.

His opinion was echoed by Wu Jinglian, a renowned economist also at the forum.

"We need financial innovation at a higher level," said Wu. He was referring to the idea that the authorities need to ensure the long-term stability of the Chinese economy, which has been expanding rapidly over the past few years, but has also encountered many challenges to sustained growth.

China is undergoing a drastic transition from an agriculture-based and planned economy to an industry-based and urbanized market economy, he said.

"If the resources used to be controlled by the few with power, it should no longer be so," said Wu. The market mechanism should start to function well on the basis of an improved legal and regulatory environment and fair and upright implementation of the law.

But China still has much catching up to do, as medical insurance and social security schemes have not yet been established and necessary financial policy innovation is insufficient, Wu said.

Such issues are of common concern for both economists and government officials. Apart from labor and social security issues, banking reform is another top priority for China.

To solve the high NPL ratio at banks, the Chinese authorities have tried many measures including reducing NPL to professional asset management companies, seeking private investors for the banks and infusing them with fresh capital.

But as China further opens up, such risks will increase, said Lin Yifu, director of the China Center for Economic Research of Peking University.

Banking reform should be more thorough, with the banks themselves becoming more efficient and relying less on government support. And listed companies should also improve quality and give investors more returns, he said.

Xie Ping, director of the Financial Stability Bureau of the People's Bank of China, the nation's central bank, also admitted that financial risks in the banking sector should be better monitored and guarded.

At this time, there still remains a big regional gap in terms of financial risks. Some provinces, for example, reported high risks in lending, which is reflected in a high NPL ratio that may reach 30 to 40 percent, while some only recorded a 5 percent NPL rate, he said.

The regulatory environment, including transparency and credit culture, also differs among the regions. That has led to imbalanced investment and lending structures. China should design the necessary financial tools to control the risks and give investors in more risky areas subsidies to protect their interest, said Xie.

(China Daily March 8, 2004)