China pessimists are claiming vindication as growth slows in the world’s second-largest economy. Optimists point out that Beijing has fiscal room to respond but there are risks to any short-term policy measures. A surge in bank-financed investment, for example, could boost growth but it would likely also increase the stock of non-performing loans in the banking system and set back the goal of rebalancing growth by promoting private consumption. An ageing population and a rocky leadership transition strengthen the bears’ case.

However, there are grounds for hope. Recent political turmoil, including the Bo Xilai affair, put reactionary forces in the Communist Party of China on the defensive. Meanwhile, reform-minded officials pushed through some modest but significant financial market reforms.

The government has long recognised that reforming the financial sector is needed to improve the balance and sustainability of growth. Why has it not acted more forcefully before? The present system works well – for some. State-owned banks provide cheap financing for state enterprises, which are key fiefdoms of political patronage. Banks also provide financing to powerful provincial officials through shell corporations that bankroll pet investment projects. This is financed by paying Chinese households low or negative inflation-adjusted returns on their voluminous bank deposits.