DOUBLING the threshold at which income tax kicks in, launching a system of market-makers for currency trading and scrapping the farm tax that has been your main source of revenue for more than 2,000 years would keep most finance ministries busy for a while.

Yet China is cramming all three reforms into the first week of the year, keeping up a cracking pace of change as it seeks to modernise its economy and financial markets to sustain the 9 per cent-plus growth rates that it has enjoyed for more than a quarter of a century.

A raft of innovations last year that largely passed under the West’s radar screen included the launch of a highly successful commercial paper market; China’s first asset-backed and mortgage-backed securities; approval for banks to trade currency swaps and forwards; the establishment of the country’s first money broker; the first “panda bonds” — denominated in yuan and sold in China by international borrowers; and, last but not least, the scrapping in July of the yuan’s 11-year-old peg against the dollar and its replacement by a managed float.

What links all these changes is the recognition by a new generation of Western- educated policymakers that China’s financial system urgently needs upgrading if it is to deliver the high-quality growth that is the new guiding economic principle of the ruling Communist Party.

More than 80 per cent of the financing for China’s economy comes through government-run banks, where political needs, not profit, traditionally have determined where the country’s $1.7 trillion (£987 billion) in household savings are channelled. The result has been a massive misallocation of capital that has saddled the banking system, even after radical surgery, with $200 billion in non-performing loans, some 10 per cent of total loans.

This is where the financial reforms come in: modern capital markets ought to steer more money to profitable projects, not white elephants, and keep the banks on their toes.

Central to this drive in 2006 will be efforts to complete a plan to offload more than $250 billion in untradeable shares that various government bodies own in state companies.

The overhang has depressed the Shanghai and Shenzhen stock markets — more casinos than bourses — for the past five years, reducing their combined capitalisation to less than that of Toyota.

If the plan works, the Government will be able to reopen the domestic initial public offering (IPO) market, closed since April to help the digestion of the newly tradeable shares, and so provide a made-in-China alternative to listing in Hong Kong.

That was the route taken in October by China Construction Bank, which raised $9.2 billion, and is likely to be followed this quarter by Bank of China, another of China’s Big Four state-owned banks.

In line with the push in the financial sector to give greater play to market forces, Beijing is widely expected to loosen price controls in 2006 on water, gas, electricity and oil products. Consumers had to bear only about a third of last year’s surge in crude oil prices.

Yet as Gordon Brown, the Chancellor, knows, no one likes to pay more at the pump. Expect China to proceed warily. Caution will be the watchword, too, on the currency front. Beijing has let the yuan creep up just 0.5 per cent against the dollar since July, and most economists expect only a slightly faster rate of climb in 2006.

Statisticians may have just discovered that China’s economy is a sixth bigger than previously thought, but the central bank will not take risks with the strong, export-led growth that underpins the Communist Party’s political authority by acceding to American demands for a sharp revaluation.

Qu Hongbin, an economist with HSBC in Hong Kong, said that introducing market- makers to trade the yuan, also known as the renminbi, showed that the central bank was serious about giving the currency more leeway to float. Yet he expects it to rise by less than 3 per cent in 2006 to 7.85 per dollar from 8.07 now. “We believe that the key word for new measures is flexibility rather than appreciation,” he said.

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