In 1978, China embarked on a gradual but far-reaching reform of its economic system. In December 1978, the Third Plenum of the Eleventh Central Committee of the Communist Party identified the principal contradiction in China’s social, political, and economic system as the backwardness of the economy in responding to the needs of the people. Therefore, the principal task was to reform those aspects of the economic system that had impeded the development of the economy.1
In the decade and a half that has elapsed since the start of the reform process, China’s economy has been significantly modernized and opened to the rest of the world. In addition, the concept of reform itself has evolved. The most dramatic change in it took place in 1992, when the Communist Party formally embraced the view that the market system was not incompatible with the ideals of socialism and proclaimed the idea of establishing a “socialist market economy.” The concept of a socialist market economy implies an economy in which the market mechanism governs economic interactions but ownership over the most important means of production remains in the hands of the public sector or the collectivity, thus preserving the socialist character of the society.
In October 1992, the Fourteenth Party Congress adopted this idea as China’s official line for the future. In the wake of this decision, the Third Plenum of the Fourteenth Central Committee (November 1993) outlined and approved a comprehensive reform strategy aimed at achieving a breakthrough in China’s efforts to transform its economy into a market-based system.2 More than in preceding reforms, this reform program derives much of its significance from its definition of clear objectives and adoption of a comprehensive and consistent package of reform measures to realize the framework of the socialist market economy by the year 2000.
The contrast with previous reform goals is perhaps clearest in the financial sector. The November 1993 program explicitly mentioned financial reform as a key element to ensure the creation of efficient financial markets in order to strengthen the capability for macroeconomic management through indirect instruments. Box 1 provides a summary overview of the decision of the Third Plenum regarding the financial sector. Implicitly, this statement recognized that the financial sector, if not reformed, could become a bottleneck for further reforms in other parts of the Chinese economy.
This paper takes a closer look at the process of reforming China’s monetary and foreign exchange system, describing the achievements so far and analyzing the task ahead to achieve the goals set for 2000. Section II provides an overview of the main achievements thus far and places financial reform within the general reform framework. Sections III through VIII give a detailed account of the reform process in, respectively, the financial sector, the legal framework for financial transactions, financial markets, the payments system, and the monetary policy and foreign exchange system. Section IX discusses the outlook for further reform, and the main conclusions of this paper are presented in Section X.
Decision of the Third Plenum On Financial Development
Guided by the theory of building “socialism with Chinese characteristics,” great changes occurred in China’s economic structure in the period 1978–92, as the role of the market in the distribution of resources rapidly expanded. The decision of the Third Plenary Session of the 14th Central Committee of the Communist Party of China of November 14, 1993, however, meant a break with past reforms, as for the first time a blueprint was presented to guide future reforms. The decision of the Plenary Session explicitly laid down the goals of establishing a socialist market economy by the end of the century, thereby allowing the market to play the decisive role in resource allocation under macroeconomic control by the state. The decision of the Third Plenum is thus a milestone in China’s economic reform process.
To achieve the goal of establishing a structure conducive to the operation of a socialist market economy and to accelerate the pace of transformation, a number of areas in which further reforms were deemed necessary were specifically indicated, including reform of the state-owned enterprises; transformation of government functions; establishment of a sound macroeconomic control system and of a rural system of income distribution and social security; deepening of the rural economic structural reforms; further revamping of the educational system; and tightening of the legal framework.
The contrast with previous reforms is perhaps clearest in the financial sector. The decision explicitly mentions that “the present cultivation of the market system should focus on the development of markets for finance ….” Both capital and money markets are mentioned: “Capital markets should actively but steadily expand financing activities in the form of bonds and stocks”; and “the money market should develop standard interbank lending and bill discount.” This was an implicit recognition that the financial sector, if not reformed, could become a bottleneck for further reforms in other parts of the Chinese economy.
The decision of the Third Plenum explicitly mentions that the establishment of a “sound macroeconomic control system” requires the establishment of a “central bank whose primary objective is to stabilize currency value, regulate the aggregate money supply, and maintain balance of international payments.” Accelerating reform of the financial system requires that “the central bank, the People’s Bank of China, under the leadership of the State Council, should implement monetary policies independently.” Moreover, “the power of the central bank and local authorities over economic administration should be rationally delineated,” and “powers of macroeconomic control, which include power over the issuance of currency, the determination of benchmark interest rates, regulation of the exchange rate …, must be concentrated in the hands of the central government.” One practical consequence is that “the branches of the People’s Bank of China are certified as agencies of its head office.”
On the conduct of monetary policy, the decision provides detailed guidelines. The central bank “should control the money supply and stabilize currency value by changing from relying mainly on the control over the scale of credit to using such means as reserve ratio on deposits, the central bank’s lending rates, and open market operations.” Moreover, “in light of the changes in the monetary supply and demand, the central bank should make timely readjustments of the benchmark interest rate and allow the deposit and loan interest rates of commercial banks to float freely within a specified range.” These provisions underline the determination of the authorities to shift resolutely from direct to indirect monetary management. On the foreign exchange system, the goal is “to set up a market-based, managed floating system, and an integrated and standardized foreign exchange market,” with the renminbi (the currency of China) “becoming gradually a convertible currency.”
With respect to the coordination of monetary and fiscal policies, the decision mentions that “the fiscal deficit of the central authorities should be met by issuing long- and short-term government bonds rather than by overdrafts from the central bank.” Also, “the government’s domestic and external debts should be centrally managed.” These provisions, which pave the way for active domestic debt management through the issuance of government securities, are consistent with the decision to develop open market operations.
Regarding the banking sector, policy lending banks should be established in order “to separate policy lending banking from commercial banking.” The decision mentions the establishment of the National Development Bank and of the Import and Export Credit Bank, as well as the reorganization of the Agricultural Bank of China, to handle strictly policy-related business. New commercial banks should be established and “the existing specialized banks should gradually transform into commercial banks.” Moreover, “the commercial banks should engage in the management of the proportions of assets and liabilities and in the management of risks.” These provisions aim at enhancing the commercialization of the banking system. The provisions that nonbank financial institutions (NBFIs) should be standardized and developed underline the desire to better monitor the activities of the NBFIs. Finally, “banking business and securities business should be managed along separate lines.”