'China must focus more on soft assets'

Driving down from Haikou, capital city of South China's Hainan province, to Boao, the venue of an annual pan-Asia forum, one can see several residential properties along the road that are empty or unfinished, he said. "They are all examples of bad investments," he said.

"If you have too much investment that does not generate good returns, debt is bound to pile up and lead to more non-performing loans. If you have too many bad loans, then everybody's attention, including that of the newly-elected Chinese leaders, would be on the debt problem and not on growth any longer," he said.

Parallel to the two kinds of investment, there are also two kinds of innovation at the corporate level - one that creates real market value and the other that does not, said Dassen and DeWoskin.

The first kind of innovation lies in leveraging technology and business model innovation to be responsive to, or generate, market demand in the real economy. Examples include Google, Tencent, or Starbucks. There is also the type of innovation that primarily focuses on avoiding regulatory or policy based burdens.

There are other Chinese companies that claim to be innovative but are actually innovative only in getting around government regulations, DeWoskin said, arguing that the government can play a role in promoting the right business conduct by creating a supportive environment for innovation.

The first task for such a journey would be to step up the reform of State-owned enterprises. "We have several big State-owned enterprises in China. They have great access to the capital market and talent. But currently what has made these companies global players is their sheer size. Most of them are really not global players on a competitive basis, although I think that is what they can and should aspire to," said Dassen.

These SOEs need continuing reforms to lift their management and competitiveness to a higher level, he said.

Both Dassen and DeWoskin concur that Deloitte China has been playing an active role in SOE reform. Many Chinese private companies and SOEs are now teaming up with global consultancy firms such as Deloitte for professional advisory services.

"They want to be more efficient and use capital more efficiently. Financial management and capital efficiency are big topics in our discussions with SOEs," DeWoskin said.

A slow progress in SOE reform will affect the overall health of the Chinese economy, they said, pointing to a surge in State-sponsored investment, very fast growth in credit and money supply and extremely fast appreciation of real estate assets.

Taking reference from previous crises, Dassen said the sustained and rapid appreciation of assets, especially real estate assets, is always a precursor to the destructive adjustment of asset prices.

Related signs of such a phenomenon are the higher level of short-term borrowings at unusually high interest rates, rapid diversification of large and small financial players, most of which is outside the purview of regulators.

Dassen also said that the rapid introduction and spread of wealth management products is another area of concern. Most of these products are poorly regulated and not well understood by the companies and individuals investing in them.