Finance
in relation to industry has continued to remain as
a state subject in China, even after the launch of
the wide-ranging reforms which began in 1979. Reforms
in China have thus followed a gradualist path, retaining
much of the earlier control and jurisdictions, especially
as these concern finance, both domestic as well as
of foreign origin As is common in mature capitalist
economies, dominance of finance has gone in with state
authority, in a bid to avoid systemic risks and crises
as can erupt otherwise. In the process the state so
far has been effective in restraining the advances
of speculatory finance in China while steering the
flows of capital along productive channels. The outcome
is one which is to the mutual interest of industrial
as well as finance capital, both domestic and of foreign
origin, with speculatory capital having less to do
than could be expected in the otherwise booming Chinese
economy. Currently China provides an unique example
amongst the transition economies, with effective financial
management in a state of 'guided financial market'.
China has been subject to some challenges to the above
pattern of an effective financial management. This
has been the case with FDI inflows on a scale hitherto
unforeseen for a developing country and especially,
with China's access to the WTO in 2001 with related
commitments in the sphere of external trade and finance.
China's entry to WTO has raised doubts regarding the
continuity of the prevailing regulations, especially
on overseas capital. It has become a matter of debate,
for those who pay attention to the Chinese economy,
as to whether the country will be able to continue
with its regulations in its financial sector, and
what kind of a turn the changes, if any, would generate
in the economy.
The much-waited revaluation of the RMB by a small
margin, which came about as a response to the continuing
US demand for a steeper rise in RMB, is one more example
of China's demonstrated ability to maneuver its own
finance which include the exchange rate policy.
China Watch has of late assumed a great degree of
significance, not just with its entry to the WTO but
more with its new mantle of being a major trading
and financial partner in the world economy. With China's
growth since 1978 at around 9% on average and the
country as world's 2nd largest oil and aluminium and
lead consumer, 3rd largest consumer of nickel and
the largest consumer of steel as well as a variety
of mineral based products, receiving a steady inflow
of FDI, the rest of the world has a genuine concern
for the economic performances in China.
It is, however, another matter whether the country
is ready to follow a path of egalitarianism as is
expected under a Communist regime. While much of the
directives as emanate from its State Committee originate
from the supreme command of the Communist Party, issues
concerning the divide between the rich and poor as
well as the urban and the rural economy has failed
to be addressed in post-reform China. Rising prosperity
has contributed to greater degrees of inequality,
of a scale which compares with many other developing
countries.
We deal, in this paper, with the financial sector
reforms in China and their future in the context of
its entry to global finance. Section I provides a
brief account of the institutional set up relating
to the financial sector and the regulatory bodies.
A familiarity with the institutions enables us to
judge the implications of the recent changes in the
financial scene as have been introduced in recent
past, especially with China's accession to the WTO.
It also helps us to analyse the current financial
status of China including its exchange rate policy
which is analysed in Section II. Section III provides
the conclusion, with a commentary on China's path
to 'development' as distinct from its 'growth performance'.
Section I: The Financial Regime in China:
The Institutions
Financial institutions in China have been subject
to a closely guarded regulatory regime which continues
to be supreme even after the implementation of the
economic reforms since 1979. This has been rather
unique in the face of the rapid integration of the
Chinese economy to the world economy over the last
few decades. Thus during 2002 the value of China's
total merchandise trade and FDI inflows have respectively
been at $607bn and $49.3bn, registering increases
which have been considerable compared to what had
been in 1982 at $397bn and 4.3bn 2.
There has been, in particular, a strong link between
trade and FDI flows. The explanations of above include
the spectacular growth performance of the economy
and the rather limited space for speculatory investments
as are left within the country in terms of the regulatory
regime. The rest of this section provides an account
of the financial institutions in China, which include
banks, stock exchanges, the FDI channels as well as
the regulatory bodies.
Banks in China have remained the main conduit of financial
intermediation. These handle, even today, 80% or more
of financial flows in the country, with four major
State controlled Banks (SoBs) controlling 70% of deposits
and advances in the banking industry. A high concentration
of banks exists in urban areas with Shanghai as the
major money center. As for bank incomes, most of these
are generated from traditional operations with spreads
between lending and deposit rates providing 90% of
the former. Thus unlike the pattern in countries which
have implemented financial reforms, China's banking
industry earns very little as non-banking sources
of income. This reflects the state of the security
sector which is still at a nascent state in China.
As for banks, only a few can float equities in the
stock exchanges while no Chinese bank is permitted
to invest in securities. The State controlled Enterprises,
(SoEs) which have access to the market for securities
also use banks rather than the stock market for finance.
Thus in 2001 the SOEs raised only $14bn by floating
shares while borrowing more than $157bn from banks
3.
As for the Foreign controlled Banks (FoBs) these are
subject to a large number of restrictions including
a ban on their RMB operations, which seek to prevent
the unwarranted speculatory transactions of Chinese
currency by foreign financial institutions. These
banks first started operation in China in the year
1984 and have been allowed, since 1990, to function
all over the economy. However these banks are concentrated
in big cities with the branches in Shanghai controlling
50% of the total of $270bn assets held by the 60 odd
FoBs operating in China. Currently these banks are
putting up stiff competition to domestic banks, with
product innovations which include credit cards, as
reported by some bank managers of domestic banks
4.
All banks in China have been closely guided by the
State Council, not only in terms of handling the balance
sheet but also with the direction provided in the
allocation of credit. Credit advanced by banks is
subject to monitoring, if not control, by the state,
in terms of the ''guide book'' provided by the State
Committee which specifies the desired directions (not
volume) of credit to what the state considers as the
Emerging Industries. Decisions of banks regarding
advances are also sometimes done in consultation with
local Municipal bodies. On the whole there is thus
a clear link up between the state, industry and banks
in the allocation of investible resources.
SoBs in China recently got a very special preferential
treatment from the state in terms of the cancellation
of the ''bad loans'' held by these banks. These include
an injection of $45bn to Bank of China and the Construction
Bank of China in December 2003, out of funds provided
from fiscal sources and the official exchange reserves.
NPAs against the bad loans were auctioned by specially
created Asset Management Companies, to State controlled
Enterprises (SoEs). Since 1997 the People's Bank of
China (PboC), the country's central bank, has spent
700 billion yuan ($85 billion USD) to refinance loans
owed by various Chinese financial institutions
5.
Reforms of China's financial institutions accommodated,
as mentioned above, the state initiative in the handling
and cancellation of doubtful assets held by the SoBs.
The measures targeted a stronger financial footing
or these banks so as to enable these to float equities
and to conform to the Basle Adequacy norms. Limits
to lending were placed on loans which exceeded 10%
of total advances of an individual bank, but subject
to relaxation when the project against the loan was
considered important by the State Committee. Reforms
of banks also aimed at improving the disclosure norms
and transparency, along with corporate governance,
especially relating to the joint stock banks.
The urban-rural divide in the country is reflected
in the limited role of rural banks which are located
in the country-side. The biggest of these, the Agricultural
Bank of China, a SoB, offers only 10% as small loans
and is mostly engaged in lending to large borrowers.
The rural credit co-operatives seem to be least saddled
with bad loans, with only 10% of loans advanced classified
as NPAs. The reason lies in their limited operation,
with advances which are small as compared to the average
for other banks located in urban areas.
A major function of the financial institutions include
the management of the exchange rate and external payments.
This is done by the PoBC, the country's central bank
which also remains responsible for the country's monetary
policy. Tendencies as are prevalent at the moment
for upward movements in the exchange rate of the RMB
are counteracted by the PoBC which regularly purchases
a large part of the foreign exchange inflows. The
possible expansionary impact of the rising official
reserves on money supply is neutralized by the PoBC
with open market sales of short term Treasury bills.
These bills, which are of 3-6 month duration, carry
a low to moderate return, and are held by SoBs as
well as other banks in the country, often on an obligatory
basis. Exchange reserves in turn are invested, on
behalf of the PoBC, by the Foreign Exchange Reserve
Board, in US Treasury Bills.
As for the security market, it maintains a low-key
performance as an alternate source of finance in China
as is reflected in the hesitant flows of portfolio
finance. Opening of the stock market in the two cities
of China (Shanghai and Shenzen) in 1990 has not as
yet led to a rise in market capitalization. Stock
market capitalization in China, net of non-tradeable
shares, has been at 17% of GDP which is rather low
as compared to the ratio in similarly situated developing
countries like Korea (52%), Malaysia (136%) and Singapore(136%).
Stock markets provided only 5% of official corporate
financing in 2002 as a whole 6.
Stocks sold in the market are separated by the currency
denomination (RMB and dollar denominated shares) and
also with the restrictions imposed on the tradeability
of nearly 2/3rd of shares in the market. (See the
Appendix for details).The limited operation of the
stock market in China is thus related to the segregated
nature of the security market, as mentioned later
in this section.
As for FDI flows, China has demonstrated the ability
to attract massive flows, the major part of which
is contributed by the non-resident Chinese entrepreneurs
in South-East and East Asia. The FDI flows to a large
extent are contributed by the favourable conditions
for investment in China which include cheap labour,
infrastructural facilities, the stability of the RMB
in terms of dollar at a rate considered as undervalued
by US, and finally, the official patronage to FDI
in China in terms of tax incentives, low interest
rates, in-house organization with the setting up of
Special industrial zones (e.g, Tianjin Industrial
Development Area near Beijing). The rapid increase
in the annual inflows of FDI which today exceeds $50
bn reflect a flying-geese syndrome; with China, the
second largest destination of FDI, bypassing all earlier
records of such flows to East and SE Asia.
In contrast to FDIs, flow of equities to the country
have been rather modest. This reflects the rather
primitive state of the security sector and the stock
market in the country. Stock exchanges, initiated
in Shanghai and Shengen in December 1990 have a bifurcated
structure in terms of distinct share categories, the
A shares denominated in RMBs and the B shares in dollar.
Moreover, not all shares are tradeable in the exchanges,
and only 1/3rd held by individuals and institutions
(IP shares) can be exchanged in the market. As for
the players in the market, foreign firms can register
in the market only as joint ventures and can own upto
20% of shares in a company. Similarly, only 5 banks
are listed in the security market and their shares
can only be bought by the Chinese and some Qualified
FIIs, 12 in number. These FIIs are approved by the
China Security Regulatory Commission (CSRC) and can
deal only in B shares. Domestic banks in China can
not invest in securities but can float securities
to borrow from the market. At present five shareholding
(joint stock) banks are listed in the two stock exchanges
of the country. Stock markets are much less important
in China as compared to banks as sources of finance
to industry and as channels of investment.
Reforms of the financial institutions in China have
led to a complete segregation of functions relating
to supervision of banking, security market and insurance
since April 2003. Accordingly the PoBC is no longer
responsible for the respective roles for supervision
as are entrusted to the China Banking Regulatory Commission
(CBRC), China Securities Regulatory Commission (CSRC)
and China Insurance Regulatory Commission. In terms
of China's commitments to the WTO since the country's
membership in December 2001, foreign banks are expected
to have a level playing field in the country and for
the domestic banks there is a need to go through ownership
reform with disclosure of informations. The CBRC provides
for the banks a comprehensive risk assessment for
loans which in turn are classified into five categories
in terms of their perceived risks. With bad loans
of the SoBs reduced considerably with the help of
active state involvement towards restructuring of
these banks, the capital adequacy ratio for most banks
is expected to be sustained at the current levels
of 8% or above. The risk-adjusted returns on capital
(RARoC) of most banks is also already above 6% , a
level which is considered moderate if not high.
While banks, and in particular, the four SoBs play
a major role in financial intermediation in the country,
much of their operations are still under the surveillance
of the state. The SoEs remain the major clients of
the SoBs, a fact which, according to observers, have
led to the piling up of the bad loans in the past.
There are attempts, on part of the official agencies,
to upgrade the functioning of the SoEs as well, especially
in view of their close relation to the SoBs. The guidelines
for credit disbursements provided by the State Committee
to banks provide a supplementary role in forwarding
finance to directions considered desirable in terms
of their industrial potential. The SoBs are regularly
inspected by the state auditing bureau.
Section II. The Current Financial Scenario
Banks, as mentioned above, are the main financial
intermediaries in China. Thus the four SoBs, as mentioned
earlier, are still the main custodians of the financial
system, handling more than 60% of deposits and advances.
Deposits with financial institutions as a whole include
a major share from enterprises (36.1%) and households
(23.4%). As for advances, medium and long term loans
constitute 40.4% and short term loans around 52%.
Most of these are directed to the industrial sector
as can be seen from the small share of the agricultural
sector receiving only 5.79% of total advances from
the financial institutions 7.
[1] The
paper reflects my impressions of the Chinese financial
system which I gathered as a member of a Research
Team sponsored by the Mushashi University of Japan.
We met a large number of financial experts in China's
financial institutions in course of our study during
September 2004.. Sources for the facts documented
in the present paper include official publications
, websites as well as the interview material collected
during the tour. The author gratefully acknowledges
the financial assistance and the initiative of Mushashi
University Open Research Project and in particular,
to Professor Tetsuji Kawamura of Mushashi University
and to Professor Gary Dymski of Riverside Campus,
University of California, for their active contribution
in this research.. I would also like to thnk the Chinese
Academy of Social Sciences which invited me in September
2005 to present this paper in an International Conference
at Tianjin University.
[2] IMF, Balance of Payments Yearbook
2004.
[3] Stephen Green, '' China's Stock
Market: Eight Myths and Some Reasons to be Optimistic''
A report from the China project The Royal Institute
of International Asffairs Asia Programme February
2003.
[4] Interview with the Shnaghai-Pudong
Development Bank, Shanghai and the Industrial and
Credit Bank of China (ICBC) in Beijing, the largest
commercial bank in the country.
[5] Tapei Archives, February 2004
[6] Stephan Green, op.cit
[7] www.pbc.gov.cn
