Abstract

Despite 16 years of economic reforms, the Chinese economy is still largely cash based. Furthermore, the share of cash payments in total payments has increased since the beginning of the reform. In the period between 1950 and the beginning of the reforms in 1978, the share of cash transactions in total financial transactions fluctuated around 5 percent, mainly because the volume of household transactions was low and payments between enterprises were effected through bookkeeping entries. Since the beginning of the 1980s, the share of cash transactions has gone up to close to 20 percent for the nation as a whole (and as high as 80 percent in some provinces), mainly owing to greater consumption activity by households, the high degree of reliance on cash by the newly emerging township and village enterprises (TVEs), and the switch to cash payments on the part of the state-owned enterprises (SOEs). The total volume of cash payments has grown tenfold since the beginning of the 1980s and now amounts to several hundred billion yuan.

Despite 16 years of economic reforms, the Chinese economy is still largely cash based. Furthermore, the share of cash payments in total payments has increased since the beginning of the reform. In the period between 1950 and the beginning of the reforms in 1978, the share of cash transactions in total financial transactions fluctuated around 5 percent, mainly because the volume of household transactions was low and payments between enterprises were effected through bookkeeping entries. Since the beginning of the 1980s, the share of cash transactions has gone up to close to 20 percent for the nation as a whole (and as high as 80 percent in some provinces), mainly owing to greater consumption activity by households, the high degree of reliance on cash by the newly emerging township and village enterprises (TVEs), and the switch to cash payments on the part of the state-owned enterprises (SOEs). The total volume of cash payments has grown tenfold since the beginning of the 1980s and now amounts to several hundred billion yuan.

Payments System

The growing reliance on cash, in combination with the growth of the economy and periods of inflation, has dramatically increased the demand for currency since the beginning of the reform. In the 1980s, the People’s Bank of China (PBC) issued on average ¥ 10 billion per year. By 1994, this amount had risen to ¥ 150 billion. Currency in circulation increased from ¥ 39.6 billion in 1981 to ¥ 728.8 billion in 1994, representing an average growth of 25.1 percent per year (compared with an average GDP growth of 10.1 percent and an average inflation rate of 8.2 percent in the same period). As a result, the velocity of currency in circulation declined from 12 in 1981 to 6 in 1994. During the same period, the share of currency in M1 increased from 24.2 percent to 35.4 percent.

Even though the latter percentage is not excessively high according to international standards, changes in the level of currency in circulation are important because of their political sensitivity: cash is still seen as the engine of the economy. This political attention is also the main reason that the cash plan still plays an important part in the formulation of the country’s financial policies. However, the cash plan, which used to be mandatory, has lately been treated as more indicative than prescriptive (Box 5).

The increasing reliance on cash since the start of the reforms—and, more particularly, since the beginning of the 1990s—has put the demand for currency and the cash plan even more in the spotlight than before. The PBC’s ability to control liquidity in the economy is hampered because the cash part of money demand is controlled by the State Council and subject to a host of political influences. This situation tends to generate friction between the PBC and other government agencies as their respective objectives are often at odds. The increasing reliance on cash in China mainly stems from a combination of factors, such as the lack of generally accessible alternative payments instruments in the economy, the lack of confidence in those alternative payments instruments that do exist (until 1995, there was no legal framework underpinning the use of negotiable payments instruments), the lack of confidence of the banking system in the collective enterprise sector, and the inefficiencies and imperfections of the payments, clearing, and settlement system.

A considerable part of bank credit, notably but not only to the agricultural sector, is still in the form of cash. The transactions of the TVE sector—a sector that is now larger than the SOE sector in terms of output—are still mainly cash based because of the difficulties that those enterprises experience in getting access to the traditional banking sector. The buildup in recent years of interenterprise arrears among SOEs is another reason for this sector’s increasing reliance on cash. Wages are generally paid in cash. Experiments in selected cities and sectors have been undertaken to pay wages in savings deposits, but, owing to the lack of such alternative payments instruments as checks, workers almost immediately withdraw the funds from their accounts. In general, only a small portion of households have current accounts and the use of checks is very limited. (For a long time, individuals could not hold checking accounts with banks for administrative reasons.)

The Cash Plan

The cash plan is prepared by the People’s Bank of China (PBC) at the end of each year, based on estimates received from the municipal and prefecture level. The expected demand for currency is calculated using (i) the real growth rate of the economy, (ii) expectations with respect to inflation, (iii) the growth of fixed-asset investment, (iv) the growth of the consumption fund,1 and (v) requirements for agricultural production. This bottom-up procedure in itself introduces an expansionary bias into the plan.

Final approval of the cash plan is in the hands of the State Council, following input from different ministries and the State Planning Commission, a process that tends to increase the expansionary bias. The cash plan is broken down by provinces, based on the growth rate of industry and agriculture in each province, the planned volume of investments per province, and the regional inflation rates. The PBC is in charge of implementing the plan during the year. The cash plan is usually revised in the middle of the year, based on recent economic developments and forecasts. The PBC has almost no control over the factors affecting currency in circulation, and its role is essentially to monitor cash flows and alert the authorities when deviations from the cash plan have occurred.

1 This item relates to wages, salaries, and pensions payable by enterprises and state administrative units, plus an estimate of other administrative expenses.

At the end of 1993, vault cash of enterprises amounted to ¥ 132.4 billion, or 22.6 percent of total currency in circulation. The farming sector held another 46.5 percent, urban households 20.1 percent, and the remaining 10.8 percent was in the hands of the so-called floating population (People’s Bank of China (1994a)).

Efforts have been undertaken in some provinces to stimulate both the development of new payments instruments and confidence in their use. For instance, the introduction since 1989 of promissory notes, checks, and commercial paper in Jiangsu Province reduced the proportion of cash payments from 7 percent in 1990 to 3.3 percent in 1994. Debit cards have been sold by banks since 1989 in selected cities.38 Recently, banks in some cities have also started selling credit cards. Thus far, such experiments have remained the exception rather than the rule. On the contrary, the share of cash payments in total payments is still increasing in many parts of the country. In some southern provinces, the practice of placing a premium on the use of cash has been gaining importance. In addition, the growth in interenterprise arrears and increased drug trafficking, as well as smuggling and tax evasion, are further stimulating the use of cash.

Clearing and Settlement System

China’s payments, clearing, and settlement system was established in the 1950s, partly based on the Soviet model. Noncash payments are mainly done through checks, mail transfers, and bank drafts. Intracity, business-related payments are done by check or credit transfers and cleared locally. Out-of-town payments are conducted through mail transfers, bank drafts, or telegraphic transfers, as checks are not accepted outside the town or city clearing region. Other instruments used in business-related payments include promissory notes, bank drafts, and trade bills of exchange. Reflecting the administrative structure of the banking system, each bank branch within the same clearing zone clears both intrabank and inter-bank as if it were an autonomous bank, because each branch has a clearing account with the local PBC branch.

The rapid development of China’s financial system since the middle of the 1980s put considerably more pressure on the operational capacity of the existing payments system. In 1986, in an effort to cope with these problems, the PBC undertook many initiatives to improve the payments system, including the development of an electronic payments system; the expansion of the number and geographic coverage of local clearinghouses; the use of microcomputers; the introduction of automated check-processing equipment; and the initiation of some standardization and coding systems.

While all these improvements were significant, the most important one was the development of an electronic payments system, the satellite-based Electronic Interbank System (EIS), by a wholly owned PBC subsidiary. The EIS became operational in November 1991. It is managed under the leadership of the PBC and was designed as a system for large-value transfers (payments exceeding ¥ 100,000) between the PBC branches on a gross basis. The system is primarily designed to deal with credit transfers (payment orders) but can also handle a small number of debit payments. The EIS links PBC branches in 416 cities using the X.25 Protocol. Of those 416 cities, 300 are actively using the system for large-value transfers.39 Connected PBC branches also use the system to transmit statistical, accounting, and banking supervision data to PBC headquarters in Beijing. While transactions are reported to move rapidly point to point (in seven seconds), settlement is on a next-day basis. Perhaps this lag is attributable to the need for manual intervention to net total daily activity and post entries to the 3,500 connected PBC branch accounts. Even though the EIS marked a major improvement over the previous system, it is still not equipped to deal with the large-value payments common to an active money market. This is also one of the main reasons for the delay in the development of nationally integrated money and capital markets.

In the late 1980s, work started on a completely new payments and clearing system, China’s National Automated Payments System. The new system is planned to be implemented throughout the entire country by the year 2000 (pilot projects in parts of the country will start as early as 1997). The system will rely on a common information carrier based on the X.25 Protocol, which will link all PBC branches (2,500 at present) throughout the country and provide direct access to financial institutions. The carrier will provide communications services between specialized bank branches via the local PBC branches, with a capacity to carry approximately 50 million payment transactions per day. The system will comprise a bulk electronic system for retail payments (featuring multilateral net settlement), a large-value transfer system (the settlement system of which has yet to be determined), and a book-entry system (at this stage, available for government securities only).

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