Chinas Financial Development

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Chinas Financial Development By C.A.E.
Goodhart A. Some History After 1949, typical
Communist mono-bank (Peoples Bank of China, PBC)
system, plus international import/export bank,
Bank of China (BOC). Allocation of resources
done by centralised Plan, State Planning
Committee. PBC largely plays role of
accountant. Following the death of Mao, and
the break with Russia , attempt to combine
continuing Communist control with decentralised
market system. Main mechanism was provincial
competition. Co-responsibility system in
agriculture, (incentives, but now ownership
problems).
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• B. Banking
• Break-up of mono-bank into four main specialised
  State Owned Banks-
• Industrial and Commercial Bank of China (ICBC)
• Bank of China (BOC)
• Construction Bank of China (CCB)
• Agricultural Bank of China (ABC)
• Plus a few others, e.g.
• Bank of Communications
• These four main State Owned Banks (SOBs)
  dominated system. Huge, far flung web of
  branches.
• Their main clients were the manufacturing and
  infra-structure (e.g. utilities) State Owned
  Enterprises (SOEs). As was typical under
  Communism, SOEs provided urban social services,
  health, education, housing, pensions. Under the
  mono-planning system, wages/prices fixed so as to
  provide profits to companies and taxes to
  government.

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Competition, amongst SOEs, and between SOEs and
other forms of enterprises. (1) initially
TVEs (2) then Joint Ventures (3) some Private
enterprises led to reduction of profits of SOEs,
and sharp fall in tax revenues as of
GDP. SOEs could not, in the main, be allowed to
fail because- (1) too economically
important (2) too socially important (3) too
politically important But government could not
bail them out directly, so, in effect, turned to
SOBs, a quasi-fiscal role. Similarly
development in urban banks, urban and rural
co-ops. Inter-action of politics, banking and
business. Soft Budgets everywhere.
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C. Soft Budget Problems (1) Non-Performing
Loans NPLs rose to staggering levels. 35 of
SOB financial assets (NB SOB deposits 120 of
GDP). Effectively insolvent. Problem of
incentives, risk management for SOBs, also on a
soft budget. Answers in order of
formation. (a) Policy Banks, e.g. China
Development Bank, to take on Planning proposals
that could not be justified on straight profit
basis. (b) Asset Management Companies, to which
NPLs were reallocated. But partly financed by
bond issues taken up by SOBs. (c) Recapitalisatio
n by Government (d) Minority stake-holding by
main foreign banks. (e) IPO of minority stake in
BOC, CCB ICBC to come ABC still technically
insolvent. Also Bank of Communications,
Everbright, etc.
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(2) Monetary Policy Cannot easily use interest
rates as monetary policy instrument under
soft-budget system- (a) Worsens allocation of
resources (b) Worsens SOE loss-making (c) Refuse
d by State Council. PBC is subservient to
politicians (3) The Problem of SOEs It is
always possible to clear up existing stock of
NPLs (n.b. loss already sustained) by
recapitalisation, (n.b. deposits implicitly
guaranteed) Problem is how to stop it recurring.
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(a) Grow out of problem. SOEs a declining
proportion of GDP and of bank loans, but still
huge. (b) Reform. SASAC for SOEs. Huijin SAFE
investment company for SOBs. Divide SOEs/SOBs
into two groups. Too big to fail and the rest.
Put the rest under hard-budget, but problems of
politics/bankruptcy laws. Transfer most social
services back to government, but problem of
expense, (tax revenue reviving, but not fast
enough). Being done slowly. Re-nationalise
Too-big-to-fail. Remove quasi-fiscal role from
banks. Banks should have ability to put new
lending request of SOE to government. My own
suggestion, not being done. (c) What role for
foreign banks under WTO? Will they be perceived
as safer? Can they learn the modus operandi?
Why are they taking minority shares? Conflict of
interest?
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(4) Other Channels of Finance All Chinese
enterprises require political licence and
support. Connections enterprise/
politics/banking. But much easier to get licence
if finance supplied from outside. Role of
Chinese diaspora, Taiwan (Suchou and Shanghai),
Hong Kong (Guandong), Singapore, etc. FDI has
been a substitute for a dysfunctional internal
banking system. (NB the capital market is even
worse).
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D. The Capital Market Equity markets started
some 15 years ago in Shanghai/Shenzhen.
Allocation of slots for new issues determined
politically regarded as a source of fresh money
for politically-supported (and often loss-making)
SOEs. Publically available shares always a
smallish minority. Majority owned by State, and
legal persons, (lower-tier government, other
SOEs). Minority share holders have no residual
rights of control. No ability to force dividend
pay-out. Why should SOE management pay
dividends? Consequence. While PRC grows by 9
in real terms, stock markets decline steadily.
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• Corporate bond market similar. No covenants.
  No right to control/close company if payment not
  met.
• An embarrassment to Government, and distorts
  pattern of saving. QDII not allowed to invest
  abroad. (NB Could offset capital inflows at a
  stroke.)
• Steps are already being taken.
• Announced for promulgation in 5 year program.
• PBC initiative in short-term company paper
  market.

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E. Macro-economic Issues (1) Development of
Markets A Socialist Market economy needs
more/better markets. A reason for gradual
increase in exchange rate flexibility was lack of
associated markets for fx dealing, (forwards,
futures, swaps, options, etc.), now being
established. Need for improvement in capital
markets, and ability of banks/OFIs to control and
hedge risks. Such markets largely absent, along
with a shortage of skilled professionals, but do
not underestimate Chinas ability to grow,
(Pudong as national centre).
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(2) Savings Ratio 50 and greater than
investment ratio. Hence current account surplus.
Need is greater Domestic demand. Why so high
4 ? 2 ? 1, demography. Partial solution, State
pension, to be paid for by higher
taxes. Under-developed Mortgage Market, so
saving for down-payment. Also property
development slanted to high-end
properties. Mortgage market only really started
about 5/6 years ago, but bank mortgages growing
at well over 20 p.a. But remains a major
problem.
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3. Demand Management (a) Fiscal Policy The
numbers are unreliable since much of the
expenditure (e.g. defence) and also revenues are
off-budget, and not fully recorded. Even so tax
revenues to Central Government fell as of GDP
to about 12 about five years ago. Now recovered
to around 18, but needs to be considerably
higher, in order to finance- (i) social
security (ii) loss-making SOEs (iii) infra-struc
ture in West water in North Reduction of
pollution. (b) Monetary Policy Needs
eventually to shift from direct controls to
market policies. Need to improve markets.
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(c) Exchange Rate Policies Need to move away
from exchange controls. Until that is done, and
markets improved, no great benefit to greater
exchange rate flexibility. Appreciation would
shift income distribution towards (richer) urban
dwellers away from (poorer) Northern farmers. An
unwelcome switch. 4. Politics The
extraordinary feature of China is that it can
continue to grow so fast with most ownership and
all key decisions concentrated in the Communist
Party. A lot of misallocation of resources and
corruption exists, but yet it drives forward
economically. And also despite dysfunctional
financial system.
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Queries- (a) If market/financial system
improved, could China grow even faster? (b)
Does Chinese example suggest that all the work
relating growth to secure property rights/legal
structure is mistaken? (c) How will economic
growth affect the political structure? Can a
Communist party survive when it becomes based on
the maintenance of power, not ideology?