© 1996 International Monetary Fund

Library of Congress Cataloging-in-Publication Data

Monetary and exchange system reforms in China : an experiment in gradualism / Hassanali Mehran … [et al.]. —

p. cm. — (Occasional Paper ; 141)

Includes bibliographical references.

ISBN 1-55775-562-0

1. Finance — China. 2. Monetary policy — China. 3. Banks and banking — China. 4. China — Economic policy — 1976- I. Mehran, Hassanali. II. Series: Occasional paper (International Monetary Fund) ;

no.141.

HG187.C3M66 1996

332.1 ’0951—dc20 96-34203

CIP

Price: US$15.00

(US$12.00 to full-time faculty members and students at universities and colleges)

Please send orders to:

International Monetary Fund, Publication Services

700 19th Street, N.W., Washington, D.C. 20431, U.S.A.

Tel.: (202) 623-7430 Telefax: (202) 623-7201

Internet: publications@imf.org

recycled paper

Contents

• Preface

• Glossary Of Abbreviations

• I Introduction

• II China’s Financial Reforms Since 1978:An Overview

  • Three Components of Financial Sector Development

    • Institutions

    • Instruments

    • Markets

  • Characteristics of the Overall Reform Process

    • Laboratory Approach and Selectivity

    • Intermediate Control Mechanisms

• III Financial Sector Development

  • The Role of Banks and Banking Before Economic Reform

  • Re-Establishment of Banking System (1978–84)

  • Diversification and Innovation (1984–88)

  • Rectification and Recentralization (1988–91)

  • Commercialization and Expansion (1992-Present)

  • Present Characteristics

• IV Legal Underpinning for a Market-Based Financial System

  • Establishment of a Legal Framework for the Central Bank

    • Autonomy of the Central Bank

    • The Central Bank as Legal Entity

    • Primary Objective of the Central Bank

    • Responsibility for Formulating and Implementing Monetary Policy

    • Functions of the Central Bank

    • Instruments of Monetary Policy

    • Regional Participation in Monetary Policy

    • Summary: How Much Autonomy for the PBC?

  • The Commercial Bank Law

    • A Two-Tier Commercial Banking System

    • Reinforcement of the PBC’s Authority

    • Separation of Banking and Nonbanking Activities

    • Enhancing Financial Discipline

    • Summary

• V Development of Money and Capital Markets

  • Money Markets

  • Primary Securities Markets

    • Government Securities

    • Nongovernment Securities

  • Secondary Markets for Securities and Equity

    • Initial Developments

    • Building the Infrastructure

• VI Payments, Clearing, and Settlement System

  • Payments System

  • Clearing and Settlement System

• VII Instruments of Monetary Policy and Monetary Developments

  • The Operating Framework

    • The Credit Plan

    • PBC Lending Facilities

    • Reserve Requirements

    • Interest Rates

    • Open Market Operations

  • Monetary Developments

    • The First Cycle (1979–82)

    • The Second Cycle (1984-Early 1986)

    • The Third Cycle (Mid-1986-Late 1989)

    • The Fourth Cycle (1992-Present)

  • Overview: Monetary Developments Versus the Instrument Framework

• VIII Developments in the Exchange System

  • Early Stages: Regulated Exchange Rates and the Foreign Exchange Plan

  • Swap Centers and Retention Quotas: First Step Toward Market-Determined Rates

    • Settlement Procedures

    • Regulation of Swap Center Trading

  • Reform Plans and Reforms Since 1993

    • Reform Plans

    • Implementation

  • The Present Exchange System

    • Domestic and Foreign-Funded Enterprises (FFEs)

    • Domestic and Foreign Banks

    • Interventions by the PBC

    • Prudential Regulation

• IX The Agenda for Developing a Market-Based Monetary and Exchange System

  • Assessment of Achievements and Directions for Future Reform

    • Assessment

    • Some General Principles

    • Directions for the Future

  • Interest Rate Liberalization

    • Reasons for Liberalizing Interest Rates

    • Structural Impediments

    • Plans for Interest Rate Liberalization

  • The Shift to Indirect Monetary Policy

    • The Target-Instrument Framework

    • The Supporting Infrastructure

  • Next Steps in Foreign Exchange Reform

    • Alternatives for Developing Exchange Markets

    • Supervising and Regulating Banks’ Foreign Exchange Operations

    • Financial Institutions’ Operational and Managerial Capabilities

    • Forward Operations

    • Leveling the Playing Field and Strengthening the Environment for Competition

• X Assessment and Conclusions

  • Main Characteristics of Financial Sector Development

    • Diversification of Financial Sector

    • Accessibility of Financial Sector

    • Interplay of Government Plans and Market Forces

    • Capital Markets and Money Markets

    • Role of the PBC and Underlying Legal Framework

    • Transition to Indirect Monetary Policy Instruments

    • Interest Rate Liberalization

    • Exchange System

  • The Challenges Ahead

    • Commercialization of State Banks and Level Playing Field

    • Foreign Exchange Market Development

    • Coordination of Monetary and Exchange Rate Policy

    • Real Sector Reform

• Appendix Chronology of Financial and Exchange System Reforms

• Bibliography

• Boxes Section

• I 1. Decision of the Third Plenum on Financial Development

• II 2. China and the Northeast and Southeast Asian “Miracles”: Common and Uncommon Features in Financial Sector Development

• III 3. Policy Lending and Policy Lending Banks

• V 4. Price Convergence in Secondary Government Securities Markets: The 1990–91 Episode

• VI 5. The Cash Plan

• VII 6. The Credit Plan

• VIII 7. The Retention Quota System

• 8. Trading Arrangements in Swap Centers

• IX 9. Interest Rate Liberalization and Regional Disparities in China

• 10. Phases in the Formulation of Monetary Policy in Selected Countries

• 11. Monetary Policy Framework Models that Focus on Interest Rates as the Operational Target

• 12. Interbank Market and Financial Reforms

• Tables Section

• II 1. China and the Northeast and Southeast Asian “Miracles”: Financial Sector Policies and Development

• V 2. Structure of the Financial System

• 3. Domestic Government Debt: Total Amounts Issued by Maturity Type and Interest Rate

• 4. Clearing and Settlement Procedures of Selected Exchange and Trading Systems

• VII 5. Selected Interest Rates on Loans

• 6. Interest on Deposits, PBC Operations, and Interbank Market

• 7. Margins on Selected Maturities

• Box

• 10 Monetary Targeting by the Group of Seven Industrial Countries

• Charts Section

• III 1. Structure of Financial Sector in 1978–84

• 2. Structure of Financial Sector in 1984–88

• 3. Structure of Financial Sector in 1994

• 4. Deposit Money Banks, 1985:IV-1994:III

• V 5. Composition of Outstanding Debt Issues

• 6. Transactions in Debt Securities

• VII 7. Interest Rate Developments

• 8. Money, Credit, and Price Developments, 1985:IV-1994:III

• 9. Indicators of PBC Control on Banks’ Reserves, 1985:IV-1994:IV

• 10. Factors Contributing to Changes in Banks’ Reserves

• 11. Sources of Banks’ Reserves, 1985:IV-1994:IV

• VIII 12. Foreign Exchange Rates

• IX 13. Achievements in Financial Sector Development (Institutions, Markets, and Instruments) and Agenda for the Future

• Box

• 4 Trade Volumes and Bond Quotations in Secondary Government Securities Markets

Preface

This IMF Occasional Paper traces the monetary, exchange, and financial sector developments in China since 1978, when the country embarked upon a far-reaching reform of its economic system. The paper reflects the continuous involvement of its authors, as well as of a number of other IMF staff and outside consultants on China, going back to 1991. The staff advisory work in the areas covered by this paper initially focused on central banking and commercial banking legislation, with contributions by Tobias Asser (Assistant General Counsel, Legal Department), and with the participation of Manuel Guitián and Justin Zulu (Directors, Monetary and Exchange Affairs Department (MAE)), William Holder (Deputy General Counsel), Leonard Gleske (member of the Board, Bundesbank), Didier Bruneel (Secretary General, Bank of France), Akira Nambara (Executive Director, Bank of Japan), and J. De Beaufort Wijnholds (Executive Director, IMF), as well as Hassanali Mehran and Marc Quintyn. Bernard Laurens integrated the material into the section dealing with legal issues in this paper.

The development of the exchange markets reflects a series of missions and parallel workshops organized for this purpose. Masaru Tanaka, Yoshihiko Noguchi, and Shuzo Sakata (Bank of Japan), David Strachan (Bank of England), Christopher McCurdy and Dino Kos (Federal Reserve Bank of New York), Thanasak Chantarovas (Bank of Thailand), and Igor Kniazev (Central Bank of the Russian Federation) participated at various times and contributed to the process. Tom Nordman, who headed these missions, put together the section on the development of the exchange system. R. Barry Johnston, Arto Kovanen, and Bernard Laurens also participated and contributed at various stages.

The sections on financial sector, money and capital market development, and instruments of monetary policy are the product of a series of missions, seminars, and workshops that were organized in China and in which, in addition to Hassanali Mehran, Marc Quintyn, and Bernard Laurens, a number of experts from the cooperating central banks participated. They were Ian Clunie (Bank of Canada), Leonard Fernelius (formerly Federal Reserve Bank of Minneapolis), Giorgio Gobbi (Bank of Italy), Jae-Chun Kim (Bank of Korea), Suchada Kirakul (Bank of Thailand), Werner Nimmerrichter (Bundesbank), Irwin Sandberg (formerly Federal Reserve Bank of New York), Rüsdü Saraçoglu (formerly Governor, Central Bank of the Republic of Turkey), Hiroki Tanaka (Bank of Japan), and Abdul Ghani Zamani (Bank Negara Malaysia). Professor Maxwell Fry also conducted seminars on money demand estimates and reserve money programming. Payments, clearing, and settlement systems were the subject of one workshop in which Leonard Fernelius participated. The theme of one mission in which Eung-Jin Kim (Bank of Korea) participated was currency issue and management. Marc Quintyn integrated these sections, as well as the paper as a whole. The statistical work has been coordinated by Bernard Laurens, while tables and charts have been prepared by Kiran Sastry (Research Assistant, MAE). Charmion O’Connor (Administrative Assistant, MAE) prepared the manuscript, and Thomas Walter (External Relations Department) skillfully edited the text and coordinated its production and publication.

Throughout the work of various missions and in the final stage of preparing this paper, Douglas Scott, the IMF Resident Representative in China, worked closely with the staff and contributed greatly to the policy discussions with the authorities. He also extensively commented on all sections of the paper.

The staff of the People’s Bank of China and of the State Administration for Exchange Control cooperated closely with the IMF teams during their work in China. The Chinese officials maintained frank and open discussions, presenting to the IMF staff the policy options for China in the area of financial sector reform. To them, who are too numerous to name here, the special thanks of the authors are due. Our special thanks are also due to Governor Dai Xianglong and Deputy Governor Chen Yuan, who coordinated the work of the missions’ counterpart teams.

The authors are also grateful to their colleagues in several IMF departments who provided useful comments and suggestions on earlier drafts of this paper. They are particularly grateful to their MAE colleagues Ales Bulir, Peter Dattels, Anne-Marie Guide, Kyung Mo Huh, V. Sundararajan, and Peter J. Winglee for their helpful suggestions and insights.

The views expressed in this Occasional Paper, as well as any remaining errors, are the sole responsibility of the authors and do not necessarily reflect the opinions of the Chinese Government, the Executive Directors of the IMF, or any other members of the IMF staff.

Glossary of Abbreviations