Advantages and Disadvantages of Chinese Interventions - Essay Example

Finance (China) Contents Contents 2 Introduction 3 Discussion 4 Advantages and Disadvantages of Chinese interventions 4 Intervention of Chinese Government in financial system 6 Critical Analysis of Chinese Interventions 8 Suggestions for further reforming the Chinese financial system 10 Conclusion 12 References 13 Introduction The emergence of China as a global economic power represents the effectiveness of state capitalism model under which it has governed for so many years. One of the important features of state capitalism in China is the main role of state-owned enterprises which are considered as the organs of national government. These firms dominate major industries in China and are becoming an active player in the global markets. In state capitalism, the government offers support to national champions and helps them get listed on stock market and subjects them to global competition. In China the model has achieved remarkable success and it has achieved a growth rate of almost 10% for the past 30 years. China Telecom, a state-capitalist company have come from nowhere to become mighty global companies. Similarly tens of thousands of state-owned enterprises (SOE) dominate half of the economic output of China and the Chinese government protects them by providing subsidizes to them. Any Foreign companies which try to threaten them are restricted by stringent government rules and are forced to share their technical expertise with the SEOs through joint venture and are also denied of any lucrative government business. Chinese government has made intervention in the entire financial system of China (the stock market, bond market and banking sector). But State capitalism has some flaws associated with it. Such a model will work until cheap resources are available. The economic growth of China is built on the back of cheap labour. Again state capitalist companies are less efficient and their private competitors. It is argued that state capitalism slowly but surely degenerates into crony capitalism as powerful political parties tries to extend their control over the economy. This report will discuss about the role of Chinese government in state capitalism and what were the interventions adopted by the Chinese government and how the Chinese financial systems responded to overcome the problem. Discussion Advantages and Disadvantages of Chinese interventions There are many advantages which China has incurred due to state interventions. For example in 2007, China faced shortage of polycrystalline silicon which is an important raw material for solar panels were creating problems for rising solar energy industry. Thus the prices of polysilicon soared and hit tenfold price in 2008. But Chinese government responded quickly by developing a domestic polysilicon suppliers (Dean, Browne and Oster, 2010, p. 1). Huge amounts of money were invested by banks and stationed enterprises. The local governments expedited approvals of such plants. Again the cheap currency policy of Beijing had angered many Western powers. The national economic strategy of China is multifaceted and detailed and hence it is challenging UK, US and other powers. The hero in achieving such a feat is the state owned firms who obtain huge capital, subsidies and advanced technology from the government. The leaders of China don’t assume that market is preeminent and instead they consider state power is crucial for maintaining growth and stability. Such policies have resulted in accumulation of record $ 3.66 trillion (Silk, 2013, p. 1). This has resulted in high appreciation of Yen as compared to other currencies. Such focus on indigenous innovation has resulted in rapid rise of home grown technologies like high-speed trains of China which are based on technology which are introduced to China by French, Japanese and German makers. This has helped Chinese to acquire the ability of killing a model developed in another country and taking away the profits. Many believe that such kind of rise of state capitalism will erode the competitiveness edge of US. Some of the most powerful companies of China like Sinopec, China Mobile and PetroChina have huge government ownership. Many advocates that state capitalism combines the best of both worlds, the stability gained from government backing with the entrepreneurial spirit of private sector. In 1978 Deng Xiaoping started the growth of China by freeing up the foreign investment and trace and allowing the private enterprises to enter into the country. But Deng never entirely surrendered the power to the private sector and only two-thirds of economic activity of China was in private hands after decades of gradual privatization. The central theme of Chinese business was private out and state in. Thus Chinese entrepreneurs were not able to compete with state-sponsored giants at home and hence they were forced to venture outside thus costing China a vital source of innovation and energy (Tisdell, 2009, pp. 271-279). The money invested into such large state-owned enterprises is not able to generate adequate returns in comparison with large private companies and it would be even lower without government subsidies. Again the stated owned companies tend to overcharge due to lack of competition. After the end of Cold War, the world leaders have started to agree that it is better to let the market completion shape the economic outcomes than government planning. China has started to understand the importance of opening up the market. Though Chinese government had always played a vital role in their economy but most of the reforms which took place started in the late 1970s. Thus the reforms retreated as state owned collective enterprises were dismantled. The state industrial enterprise which was inefficient was closed. In 2001, China became part of WTO (BBC, 2001, p. 1) and the leaders were forced to liberalize the financial markets. But as vast amounts of industry was still under the control of state companies and the state was tightly restricted for foreign companies the pace of liberalization was slow. Due to heavy involvement of government in sectors from coal mining to the Internet has made the companies unable to face tough competition. Organisation for Economic Cooperation and Development prepared a report and mentioned that the economy of China had the least competition among 29 economies total surveyed. Such kind of state capitalism has unhealthy implications for market competition. The State owned enterprises are exempted from anti-trust enforcement. The Chinese government enforces rules selectively and try to keep the private sector rivals in their place. With such huge control, the shareholders have no say in the corporate affairs and they cannot go to courts. Again Lack of transparency is easy to hide as there is corporate mis-governance. Intervention of Chinese Government in financial system The Chinese government has been intervening in the stock market by buying shares in the four big banks of the country. For example Central Huijin Investment bought shares in Industrial and Commercial Bank of China, Agricultural Bank of China, China Construction Bank and Bank of China. This was done to boost the confidence in the benchmark Shanghai stock index. But structural changes and tight liquidity conditions in economy of China and uncertain economic outlook have downgraded the growth forecast in recent weeks. But even after such interventions the Chinese banks are facing difficulties as the government are trying to liberalize the interest rates in the country. This means that the profits of the banks are getting squeezed. The state decided the interest rates and put investment caps for both foreign investors and domestic investors. There was ceiling on deposit rates offered by local banks (Bloomberg News, 2013, p. 1). The Government intervened in the normal foreign exchange market and decided the foreign exchange rates. This is in contrary to law of demand and supply where the interest rates and foreign exchange rates are determined by the principles of demand and supply. With increase in demand for Renminbi, the foreign exchange rate of Renminbi with respect to other country will depreciate. (Source: Research Institute of Economy, Trade & Industry, 2012, p. 1) Chinese government also intervened in the bond market. The Chinese government experimented with the underwriting system for the bond issuance and they created primary dealer system. The secondary bond market included three markets namely the inter-bank market, the exchange market and the over the counter market. In 1977, Chinese government pulled the banks out of the exchange market and began started their trading in the interbank market. The Chinese government made a number of changes between 1998 and 2001, in the financial markets. They authorized the interbank market participation of the fund management companies, agricultural credit companies, finance companies, securities firms, leasing companies and insurance companies. The government established a market maker system in 2001 so as to increase the liquidity in the market. From 2001, the investors were allowed to participate in multiple markets (Lin and Milhaupt, 2013, p. 11). Critical Analysis of Chinese Interventions Until 1997, China used the four big state banks as instruments of government policy and directed the banks to give loans for state projects like expansion of state owned industries and infrastructure projects. But in many cases as the loans were not subject to careful processing a large amount of those loans turned out to be non-performing in nature. But as the non-performing loans started accumulating, it undermined the solvency of bank. Then central government recapitalized the banks and categorized the non-performing loans as special purpose entities to keep them under the rug. In 1997-98 Asian financial crisis made Chinese government make significant effort towards financial reform in China. With rapid rise of China in the global context, the rise of such kind of state capitalism is challenging the organisations and rules which govern the global trade as well as the business strategy and plans of enterprises all around the globe. But during the same time, the limits of such kind of capitalism are becoming increasingly evident in China where there is substantial increase of corruption and the State Owned Enterprises are consuming and enjoying the fruits of reform and hence the economic engine is running low of gas. The birth of state capitalism in China began in 1950s when ten thousand Soviet advisers helped them to organize central planning in the state owned enterprises. This led to such state owned enterprises becoming bloated extensions of state’s power and patronage. After 2001, China became part of World Trade Organisation and thus they had access to global markets. But for over the next decade China started reversing its course and filled the state owned enterprises with state cash and thus protected them from many foreign competitors by array of industrial policies. Following the process China became disconnected with rest of global business. By hiding the funds of the subsidies China violated the international restrictions. The big four state owned banks primarily made the financial system of China inefficient by guiding ht cash to money losing companies and in effect undercutting the competitors. Again the judges of China re Part appointed and they lack the authority to gather compelling evidence and thus making it impossible for foreign companies to fight against them in trade cases. Because of heavy subsidies the foreign competitors were forced to lose the battles the SOEs. In many cases the bosses of these SOEs were not directed to make profit for the companies, instead the state government encourages them to pursue other goals like resource acquisition, technology transfer and foreign policies regardless of cost. But he less obvious factor is that such kind of policies is harming China. By nurturing such large unaccountable companies China is draining their resource which could have been put to good use if investment were done in efficient private players. According to a study conducted by National University of Singapore the new forms were more productive and efficient than the incumbents though it was possible than they would fail more often and the entire blame was put on institutional barriers. According to a study by Fathom China it was found that small and medium sized private firms were deprived of capital in China. Such kind of distortions of subsidies breeds overcapacity and indiscipline. For example an effort to sponsor clean energy champions led to bankruptcy of Suntech in China. China delayed for many years in joining WTO which would now restrict the country from discriminating products of foreign companies. Slowly as the state enterprises grew the share of world trade of China rose to 10% and along with that corruption also flourished. But Chinese state capitalism was not only devilish in nature. It is argued that it was the state capitalism which unleashed the driving forces in markets for over 30 years. It led to private sector growth and globalization. The key to China’s spectacular growth are the state owned enterprises. The state capitalist in some sense indicates a co-operation between private and state capital and it provided capital to the companies whenever necessary and possible. Further the importance of Capitalism in China was derived from the fact that during global recession China achieved a healthy rate of GDP compared to other developed countries. The stimulus spending of Beijing was larger than that of US and it was effective in overcoming the slowdown and directed its fund towards infrastructural tracks for further economic expansion. Between 1985 and 2005, China spent more than $300 billion on their biggest state owned enterprises (Haley and Haley, 2013, p. 1). This helped in the formation of underpriced inputs and cheap capital which are unavailable to their international rivals. For example the glass industry got soda ash at low cost. Subsidies worth $ 28 billion were put in auto business from 2001 to 2011 in the form of steel, technology and glass. Further the government promised to put additional $ 10.9 billion by 2020. Suggestions for further reforming the Chinese financial system China must undertake key financial sector reforms to address the increased state capitalism. China works under a bank-centric model with bank credit accounting for around 90 percent of the total funds raised by corporate sector. Again the equity and bond market of China are small but have imbalances. When comparing the financial system of China with that of other more developed market, it is observed that china has small size of outstanding debt securities and no presence of securitized loans. China must try allowing major banks to securitize credit assets which will help develop the economy. China should aim at increasing the proportion of direct financing as percent of total social financing. It is way of including items like trust loans, entrusted loans, bankers and acceptance bill as par to f regular bank loan. According to a study by People’s Bank of China in 2012 the equity and bond fundraising accounted for only 16.1 percent of total social financing. Due to presence of large State owned enterprises the equity markets of China do not reflect the broader economy. All the major banks in China are listed in the stock exchange and thus the banking sector is overrepresented. But the sectors associated with consumer economy are underrepresented. Hence it is important that in the equity market all the major sectors should be reflected. China should aim at making the securities sector more stringent. The Chinese regulators should try to reduce the entry barriers for foreign investors to the domestic capital markets. Thus gradual lowering of the entry barriers will support the market development due to increase presence of longer term investors and increase of competition. The Chinese government should aim to allowing foreign hedge funds to enter into the market. Chinese policymakers should aim at developing a well functioning bond market with a lager base for both investors and issuers. Presently in China the commercial banks are the largest investors in the bond market and thus the bond market needs to be more streamlined to spur development of the corporate bond market so that high demand can be generated for high-yield bonds. Also more viable channel should be opened for private firms to raise funds. China should try to evolve the bond market by increasing the issuance of RMB bond in the offshore market like Hong Kong (J.P. Morgan, 2013, p. 1). China should aim at liberalizing the bank deposit rates. It is a risky and critical step which will have profound impact on China’s financial system. This will push the rates up and it will allow savers to earn higher returns which will drive China a consumption driven economy. As of February 2014, the inflation of China is running at 2 percent making the Chinese households earn meagre amount on bank deposits (Roberts, 2014, p. 1). Chinese government must launch private banks which will introduce greater competition in China will is still a state-run financial system. Conclusion China is a state capitalist country and it had tried to inject substantial money in the form of subsidies to the state sponsored enterprises. China has for a period of time promoted such enterprises so that they can become the best of the world. China was successful in their strategy because such enterprises contribute heavily to the Chinese economy during global financial crisis. The Chinese government bought shares of major Banks of China to inject sense of confidence in the index. The State government also intervened in the bond market. This made the Chinese debt market less developed with major imbalances in it. Again the equity market of China didn’t reflect the broader economy. There are a number of steps mentioned above which China needs to implement to strengthen its economy. China should to address the structural imbalances within the financial system by giving more priority to small and medium sized enterprises. Chinese government should try to reduce the cost of funding for such enterprises and encourage the informal lending companies to develop township banks and legitimate villages. References BBC. 2001. China joins the WTO - at last. Available at: http://news.bbc.co.uk/2/hi/business/1702241.stm. [Accessed on: 19 March. 2014] Bloomberg News. 2013. PBOC Will ‘Basically’ End Normal Yuan Intervention: Zhou. Available at: http://www.bloomberg.com/news/2013-11-19/pboc-will-basically-exit-normal-yuan-intervention-zhou-says.html. [Accessed on: 19 March. 2014] Dean, J., Browne, A. and Oster, S. 2010. Chinas State Capitalism Sparks a Global Backlash. Available at: http://online.wsj.com/news/articles/SB10001424052748703514904575602731006315198. [Accessed on: 19 March. 2014] Haley, U. and Haley, G. 2013. Perverse advantage. Available at: http://www.economist.com/news/finance-and-economics/21576680-new-book-lays-out-scale-chinas-industrial-subsidies-perverse-advantage. [Accessed on: 19 March. 2014] J.P. Morgan. 2013. Perspectives on China’s Financial System Reforms. Available at: https://www.jpmorgan.com/pages/jpmorgan/is/thought/magazine/1Q2013/China_Reforms. [Accessed on: 19 March. 2014] Lin, L.W. and Milhaupt, C.J. 2013. We are the (National) Champions: Understanding the Mechanisms of State Capitalism in China. Available at: http://www.jura.uni-freiburg.de/institute/izpr1/downloads-1/gastprofessorenprogramm-sose-2013/Kraakman/27.06.2013/7. [Accessed on: 19 March. 2014] Research Institute of Economy, Trade & Industry. 2012. Renminbi Exchange Rate Close to Equilibrium Level. Available at: http://www.rieti.go.jp/en/china/12050201.html. [Accessed on: 19 March. 2014] Roberts, D. 2014. Expect China Deposit Rate Liberalization Within Two Years, Says Central Bank Head. Available at: http://www.businessweek.com/articles/2014-03-11/china-deposit-rate-liberalization-within-two-years-says-head-of-chinas-central-bank. [Accessed on: 19 March. 2014] Silk, R. 2013. China’s Foreign Exchange Reserves Jump Again. Available at: http://blogs.wsj.com/economics/2013/10/15/chinas-foreign-exchange-reserves-jump-again/. [Accessed on: 19 March. 2014] Tisdell, C. 2009. “Economic Reform and Openness in China: China’s Development Policies in the Last 30 Years”, Economic Analysis & Policy. Vol. 39(2), pp. 271-279. 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