Chinas Financial Reforms - Essay Example

China’s Financial Reforms Introduction Due to the global financial crisis in 1988 and 2008, the ities in China took a range of reforms to internationalize the Chinese currency usage, the renminbi. The reforms included currency swap lines establishment with foreign central banks, Chinese exporters and importers encouragement to settle their renminbi trade transactions. In addition, the authorities expanded the corporation’s ability to maintain renminbi deposits along issuing renminbi bonds in the Hong Kong’s offshore renminbi market. China financial reforms and policies by the government’s regulation get mainly evidenced in the interest rate and capital allocation intervention. The economic theory argues that the financial repression minimize the increase and efficiency risk. Thus, this report provides interpretations for reforms experiences understanding on economy and industry and the financial industry. Though, the financial systems have not yet get completed. It is because, even though the free markets now determine the product prices, the production market factors get heavily distorted. In this case, the Chinese financial liberalization is important in the financial reforms even in many other developing countries. The reform period has experienced a rapid financial activity growth. Thirty years ago, the industry of finance was close to non-existence (Huang 384). Now, China has wide financial institutions range, from security companies to banks. The useful measure that determines the financial progress is the money supply proportion to GDP. Researchers argue that the financial systems affect the economic development of a country. Thus, theoretically, the financial sector has a basic relationship with economic development. For this reason, the financial reforms that get carried out in China aims to improve the economic development in China and its economic relationship with other countries. Economists have argued that the main role of the financial sector in the economic development is to stimulate the economic growth through providing various important functions like setting and clearing of payments. Levine summarized the five main financial systems (Levine 105). They include; exerting corporate governance and monitoring investment; to control trading; to pool and, mobilize savings; management of risk and easing the goods and services exchange. Given that the sector of finance gives such basic services important for economic growth sustainability, many economists says that the financial reforms have a significant role economy. Thus, due to the significance, it is important to have financial reforms. The financial reforms are used to regulate the interest rates, allocating resources and setting great bank deposits reserve requirements. The reforms aim to improve the economic development. Financial Reforms in China Many economists argue that the financial sector of China remains significantly unreformed (Huang 387). In particular, China’s central government continues practicing considerable control over its financial sector. The reforms can primarily get seen through two facts that get stylized. Firstly, the state-owned commercial bank activities changed slowly; thus, most of their lending is directed to the state sector. Secondly, the state-owned commercial banks interest rates levy on loans and deposits offer are still managed by the public-owned commercial banks. In the prior few decades, the China People’s Bank has practiced the powers and functions of central bank and handling commercial and industrial savings and credits business. Though, since reforms began in 1978, China has performed a number of significant reforms in the banking system. It has also strengthened its opening globally. Thus, the Chinese economic development is consequently increasing with changes in the finance industry. At the end of 2004, the foreign and domestic currency savings balance deposits stood at 25 billion Yuan and the foreign currency loans, and home balance came to 18 billion Yuan. China has now created a financial system under a supervision, control and regulation of the central bank and its state bank as its mainstay (Demetriades & Luintel 467). It features the policy-related finance separation and commercial finance, various financial institutions the cooperation’s with mutually complementary functions. In 2013, the main topic on reforms was the financial and IT industries product, Yu’E Bao, offered by Alipay. It is an online payment service that permits the holders of Alipay account to invest their cash balances in the money market funds. Although, the average fund investment money market per account is less, the total invested amount has grown since June 2013. The reform is an example of liberalized interest-rate product turning to more accessible. In addition, the shadow banking is a circumventive finance form (CBRC 1). Thus, in order to circumvent regulations, banks utilize the off-balance-sheet accounts. At the same time, the shadow banking of China is another example of deposit rates market-led liberalization. It is because of its comprise to the wealth management product sale that offer interest rates that are not unregulated to retail customers of the bank. China’s financial reforms in the banking sector include insurance and leasing introduction, and operational boundaries are being eroded slowly. It aims to promote customers competition who are permitted to hold accounts in more than one bank and choose banks. Banking reforms got initiated to strengthen the central banks roles and allow the establishment of private banks. China set up stock exchanges in Shenzhen and Shanghai in 1990 and 1991. In prior decades, the stock market has finished a journey that many countries have taken over a century to complete. The stock market in China, today has capital about 3 billion Yuan, 72.1 million and 1,377 listed companies. The stock market in China has promoted government-owned corporations reforms and their systems changes and enable an appropriate transition between the systems. Due to the stock market reform, many great state-owned enterprises have discovered system change (Ang & McKibbin 221). The change also has encouraged small-sized and medium state-owned enterprise to embrace the shareholding system; thus, solving system problem during the transition starting from planned to the market economy. The stock trading methods are constantly being reformed. For instance, today, the securities exchange network system and account settlement have been created, with the Shenzhen and Shanghai as the powerhouse that radiates countrywide. In 2004, China issued 23 rights shares, 123 A Share kinds and collected 83.6 billion Yuan. It also issued 28 H and B shares kinds, collecting 67.5 billion Yuan. The capital markets reforms also improved the financial system of the Chinese (Demetriades & Luintel 471). The capital markets open up, the Hong Kong-Shanghai stock connect scheme, increases both outward and inward investment quotas. The reform also relaxes the foreign shareholders limits that get listed in companies that liquidate into the A-share market of local China. It gets believed that the great foreign investor’s participation can change dynamics and behaviors of the market and company governance level. The repressive financial reforms policies are also among the financial reforms. It includes; controls over exchange rates, interest rates, capital mobility and credit allocation. These are the significant factors for market distortions. The Chinese financial repression degree is higher than the world average and also higher than the average for the low-income countries. Amazingly, the financial market policy distortions do not prevent rapid growth of the economy. The Mutual Benefits from Financial China’s Reforms The streamline of the bank license application process leads to increasing the rate of foreign banks investment in China willingly. The reform also increases the opportunity for Chinese regulators and banks to access the first-hand knowledge of financial market (Maswana 100). The Chinese banks would increase their international standards understanding on derivative products that can impact their international expansion objectives positively. Thus, the Chinese financial institutions can benefit from customer satisfaction and as well as providing great flexibility for the customers when deciding on financial services and products. The increase in tax regimes uniformity across the Chinese regions will encourage investments through foreign-funded bank in different locations (Ang & McKibbin 219). The reform also maximizes Chinese banking sector operational cost effectiveness; thus, enhancing additional foreign participants to join the financial services market of China. The direct access provision to China National Advance Payments System will benefit the customers of the Chinese through obtaining good settlement price without market disadvantage and at the right time. As a result, it will increase efficiency and contribute to a further equitable, balanced financial system (Ito 318). There is also open up to the funds management sector to Chinese state-owned institution, and Qualified Foreign Institutional Investors and other Qualified Foreign Institutional Investors equal participation level. Thus, resulting in more liquid, competitive and high-growth sector with the added flow-on impact benefit to the entire Chinese financial sector. Achievements and Risks According to China’s macroeconomic performance during the reform period, the financial reform of China is greatly successful. According to research, the financial liberalization reduced the financial repression degree by over 40% during that period. The Change resulted in addition of 1.5% to growth of GDP. Thus, financial liberalization significantly influenced the growth of China’s economic. The liberalization forces like free markets open up contributed to strong economic growth. For instance, China successfully averted the financial chaos during global and Asian financial crises, even though, most of its neighbors got affected. Thus, China has been able to grow since its reforms development and implementation (Ang & McKibbin 227). The Chinese financials system is also very stable. In the prior years, Chinese had isolated bank cases. The depositors trusted the banks in spite of the “technical insolvent”. For instance, the stock prices sometimes were volatile. As a result, the new reforms on free banking have increased the stability of banks. In terms of risks, the competition on interest rates can easily distort the banking sector stability. Thus, the authorities are to maintain the repressive financial policies. In addition, the capital account control should be used to shelter the domestic economy from experiencing external shocks in case of the financial institution weakness. In general, the repressive policies were favorable for sustaining macroeconomic stability during the reform period of the Chinese. As a result, the remarkable financial and economic performance can be attributable towards good luck and careful policy reform design. It also reflects the overall capability of the government, including the administrative power and fiscal power (Li 83). Since the reforms had no blueprint, the financial reforms began with an objective of creating financial intermediaries institution outside the central plans. The policy on exchange rate reforms creates both abroad and home currency appreciation (CBRC 2). As a result, China can reduce trade conflict risks and diminish distortions. The reform also assisted in growing financials system risk. Firstly, the financial institution corporate governance is at risk. Even though the Chinese financial system seems to be modern and big, most of it gets effectively subjected to government intervention or managed by the government. The other risk is in relation to capital allocation efficiency by the systems of finance. Currently, the China’s SOE account for not over 1/3 of the company. Though, they still get over half of the money raised by both direct and indirect financing channels. In the fact that the medium and small-sized private companies have become the main Chinese growth force, such financial pattern challenges both asset quality and growth sustainability. The third risk involves the exchange rates and interest rates distortions. These distortions reduce the efficiency of economic directly. They significantly pose a great threat to stability of macroeconomic. For instance, the real negative rates of deposit were behind the speculative assets activities in 2010, when housing and stock potentials prices diminished. In addition, the undervalued currency has resulted in great ‘hot money’ inflows. Hence, adding the necessary liquidity to the domestic system though, it undermined the monetary policy independence (Ito 317). Lastly, the final risk is related to weakening and the likely consequences of capital account controls. Even though authorities maintain strict controls on capital flows in a range of areas, observations argue that the controls have got weakened, for instance, the “Hot money’. For this reason, sudden restrictions fading on capital outflows can result in devastating exchange rates and banks changes. Other Financial Reforms that China Needs to do In spite of thirty financial reforms years, the financial industry of China has to do a significant and wide-ranging transformation. Firstly, China should try to accelerate its liberalization capital account controls. The capital account controls assist the Chinese economy with protection against external shocks (Li 86). But the economy is very open already, thus it is difficult to sustain such control. In addition, such control creates economic efficiency costs. As a result, with a significant increase in domestic financial institutions, China should have restrictions on direct investments and debt financing. Secondly, China should have an independent central bank. The PBOC is always a State Council integral party having all the monetary policies being made by the State’s Council Executive Council. This method worked in previous years where most of the economy got managed by the government but now the product market is almost getting liberalized. Additionally, the private sector is already contributing over 2/3 of the economy. For this reason, ideally having an independent PBOC is important to safeguard financial and monetary sustainability. Thirdly, China should improve its exchange rate flexibility quickly. Since 1994, it adopted a managed exchange rate float through its flexibility gets limited (Ito 315). Despite rapid economic growth, the limited appreciation has caused domestic economy problems like monetary policy independence loss and excessive foreign exchange reserves accumulation. Most importantly, recently, the exchange rate policy has turned out to be the key conflict source between China and other countries. As a result, there is need to implement the managed float due to the increase of market forces roles so as to reduce external conflict risks and improve the efficiency of the domestic economy. Fifthly, the government should give up its credit allocation intervention completely. It is because, the interventions affect the ability of the financial institutions to control financial risks and optimize fund use. This issue becomes more serious in times of economic difficulty than in normal times (CBRC 1). Thus, it is crucial that the government to gives up the interventions because the private enterprises are already the main engines of the China’s economic growth. Sixthly, China should have more balanced financed structures between stocks, bonds, and banks. The financial industry of the Chinese is dominated by the industry of banks. While bank industry is important for economic growth, direct financing has a direct role on the risk and return sharing between the investors and the borrowers. Thus, it is important to have the balanced structure through corporate bond markets rapid development. Lastly, the capital market should get improved significantly. In particular, the stock markets still exhibit the strong immature markets symptoms (Maswana 94). Investors show very herding behavior and remain highly speculative. Thus, the regulators have a significant role to diversify the investor groups. As a result, the regulators should reduce insider trading, market and rumor manipulation and incorrect information to improve the capital market. Conclusion From the discussion, since the global financial crisis in 1988, the Chinese government and other authorities have been implementing reforms to secure its economy from external shocks. The reforms included currency swap lines establishment with foreign central banks, Chinese exporters and importers encouragement to settle their renminbi trade transactions. The main reform was of liberalization of the capital account controls. The reforms had some achievement though at the same time posing risks to the economy. The financial liberalization reduced the financial repression degree and increased GDP, and free markets open up contributed to strong economic growth. The risks that the economy had get related to; financial institution corporate governance risk, capital allocation efficiency by the systems of finance and exchange rates and interest rates distortions. For this reason, China is supposed to perform the recommended reforms to reduce the risks Works Cited Ang, J. B. and McKibbin W.J. ‘Financial Liberalization, Financial Sector Development and Growth: Evidence from Malaysia’. Journal of Development Economics, 2007, 84: 215-233. China Banking Regulatory Commission, “Report on China’s Banking Sector Opening-up”, (2007) Retrieved from http://www.cbrc.gov.cn/03/22/2007 Date of Access 12 February 2015 Demetriades, P.O. and Luintel K. B. ‘Financial Restraints in the South Korean Miracle’. Journal of Development Economics, 2001, 64: 459–479. Huang Yiping. ‘Is Meltdown of the Chinese Banks Inevitable?’ China Economic Review, 13(4, December), 2002 pp. 382-387. Ito, H. “Financial Development and Financial Liberalization in Asia: Thresholds, Institutions and the Sequences of Liberalization”, The North American Journal of Economics and Finance, 17(3): 2006. Pp.303-327. Levine, R. “Finance and Growth: Theory, Mechanisms and evidence,” in Aghion, P. and S. N. Durlauf (eds.) Handbook of Economic Growth, Elsevier. 2005. Li, D., 2001, ‘Beating the trap of financial repression in China’, Cato Journal, 21(1): 77-90. Maswana, J. “China’s Financial Development and Economic Growth: Exploring the Contradictions”. International Research Journal of Finance and Economics, 19(2008): 89-101. 2008. Read More