IMF deputy managing director warns a misshaped industry will send development down wrong track

Financial reform in China should place a priority on meeting the needs of the real economy, or the part of the economy pertaining to goods and services, Zhu Min, deputy managing director of the International Monetary Fund, said on Tuesday.

History, including the recent global financial crisis, has proved that overly inward-looking financial industries do not generate sustainable growth and long-term prosperity, Zhu said.

China should reform its financial sector in a way that can best accommodate the real economy, he said.

"A misshaped financial industry won't stimulate the development of the real economy and will send development down the wrong track by creating asset bubbles," Zhu said in a speech at the annual Asia Financial Forum in Hong Kong.

Zhu made the comments amid widespread calls for China to reduce State control of the economy and liberalize financial markets.

Reform advocates say the backward state of the country's financial industry gives rise to price distortion, hinders efforts to use financial resources efficiently and stymies growth. Opponents fear that mistakes could result in financial turmoil and cause the financial industry to be even more inefficient.

Proponents of reform now expect to see larger steps taken, especially after financial regulators made some groundbreaking changes last year.

Among those were decisions to widen the yuan's daily trading band - which controls how much the currency's value against the US dollar can change in a single day - and to allow lenders to fine-tune their deposit and lending rates in accordance with the central bank's benchmark rate.

Moreover, a 12-point plan for Wenzhou, in Zhejiang province, is aimed at bringing legitimacy to the city's shadow banking system, which is made up of non-bank lenders of private capital and is estimated to have a value of 17 trillion yuan ($2.73 trillion).

Many top government officials, including Premier Wen Jiabao, have publicly spoken in favor of further reforming the system.

Zhu didn't propose specific reforms but said agricultural and small service companies should receive special attention when regulators plan the next stage of reforms. The changes should also be designed to accommodate the country's ongoing urbanization and aging population.

Xiao Geng, an honorary professor at the University of Hong Kong, said regulators should place their top priority on liberalizing interest rates.

He said the country's artificially low interest rates hurt depositors and make capital cheap, leading to the formation of real estate bubbles.

"The current interest rate system actually levies a tax on depositors," Xiao said. "It's like using migrant workers' deposits to subsidize real estate developers."

Wang Jianxi, executive vice-president of China Investment Corp, said he wants to see more changes take place in the capital markets. He urged regulators to improve the stock market's infrastructure and strengthen the corporate governance of public companies.

Many public companies in China have corporate governance structures that fail to protect the interests of investors, Wang said.

"Regulators did a lot about the stock market last year," Wang said. "They should pay more attention to the problem of corporate governance, which is at the root of the problem of China's stock market."

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