China-Path-to-price-liberalization

MANAGEMENT OF AGGREGATE DEMAND

The shift to financing investment through bank loans rather than state grants, and the emergence of security markets, raise the possibility of using market controls on money supply, rather than imposed prices, to manage the overall price level of the economy China's central bankers were led to the conviction that inflation could be managed through control of overall money supply even during a process of price decontrol.

However, the 1980's wave of reform was aborted temporarily by excessive inflation. In China, price liberalization, low interest rates, excessive credit, excessive investment and explosion of consumer demand caused the inflation, and central authorities tried ineffectively to restrain it through price control. But China's bankers and planners now believe that controlling money supply through interest rates and fiscal policy can stabilize the overall level of prices during a new wave of decontrol of individual prices.

Foreign exchange markets in China

Prior to the mid-1980's, China did not participate in international bond markets. In 1986 it began to issue bonds in the Tokyo market. After the incident in TIanAnMen Square on 4th of June 1989, China was briefly shut out of foreign bond market, but it re-entered yen markets on a large scale in 1991 and dollar market in 1992. Another form of participation came through management of country's massive foreign exchange reserve (over $40 billion by the end of 1991, earned by running trade surpluses). Most of the foreign exchange reserves were invested in foreign government bonds. This made China a significant player in international bonds markets.

As China development accelerated, direct borrowing increased, and by the end of 1992 foreign debt had reached US$ 69 billions. To keep this debt under control, China needed to encourage exports and discourage imports. But an overloaded renminbi did the opposite. Managing this through direct controls on imports ended up blocking many needed imports or creating lengthy delay in getting them approved. It also encouraged vast corruption and caused trade conflicts with Western countries, most notably the United States, which in 1992 threatened multibillion dollar sanctions unless China reduced the use of administrative measures to block imports.

In this situation, China began to learn the same lessons that other East Asian countries had learned in the previous 3 decades: to encourage development, one needs to promote and discourage imports through a cheaper currency. Hence, in 1989 and early 1990, China devalued the renminbi by over 20% each time, moving it much closer to the market rate. Afterwards, it moved to a system of mini-devaluation deigned to move the currency in the direction of its market rate. In 1992, to its own success in exporting and accumulating foreign reserves and responding to US trade pressure, China greately liberalized its imports.

The ensuing surge of imports raised demand for foreign currencies and depressed the value of the renminbi so that the official and market rates come to diverge by 25%.

China began allowing enterprises to retain a portion of their own foreign exchange earnings instead of turning all of them to over the government. In 1986 it introduced small foreign exchange markets that were completely free to find their own levels. This market allowed ventures with surplus foreign exchange to trade with ventures that needed additional foreign exchange. China banks began accepting deposits in foreign currency. The Hong Kong dollar plays a much larger role in Guangdong than the US dollar played in Argentina or Poland, but unlike the authority in Argentina and Poland for most recently history, China's managers have accommodated the phenomenon and have tried to adjust to the market rather than fighting it.

China Stock Markets

China has two small but fully functioning formal stock market, in Shanghai and Shenzhen, and a third one in Beijing, along with informal markets throughout the country.

The Chinese central government in Beijing intended Shanghai to open first and become the dominant market, but Shenzhen opened unofficially on the 1 December 1990, just before Shanghai opened officially on 19 December. Shenzhen's status was formalized the following July. Chinese officials intended those two markets to operate in identical fashion, but they have diverged. Shanghai initially traded mainly in bonds, but used its bond business as a cover to get a real stock market going. From the beginning, Shenzhen focused more on stocks. Subsequently, Shanghai became the market for China's blue chips, mainly large state enterprises, which remained heavily dependent on government orders. Shenzhen became exchange for smaller, entrepreneurial companies which were largely dependent on the free market and on export competitiveness. In addition, because its proximity to Hong Kong, Shenzhen was quicker to understand the importance of modern settlement systems and other techniques to protect investors.

In March 1993, the total value of Shares traded on stock market.

Tokyo is about 10 times Hong Kong's size, New York 17, 5 times, London 5 times.

Indonesia              9  billion US dollars

Philippines          20

China                   22

Singapore           50

Taiwan               102

Hong Kong        198

From the beginning Chinese officials were faced with public demand for shares that vastly exceeded any foreseeable supply. By late 1990 Shenzhen had only five listed companies but sixteen brokers and 900 million renminbi on deposit for future share purchases. About One million people from all over China gathered in Shenzhen 8 August 1992 to purchase applications. Police used electric cattle prods to keep the crowds under control. Key official could not resist the opportunity to make profit by manipulating the application process, and a major riot ensued between the 8 and 11 August. The share index plummeted 20% and the government briefly closed the stock exchange. In December several officials were convicted of corruption.

It is probably rational to limit the number of stock exchanges in the long run, but in the short run the practical difficulties of communication will make it difficult for people in Sichuan to trade on the shanghai Exchange. By 1992 thousands of China's state enterprises had issued shares, but most were not allowed to sell their shares to individuals.

Chinese regulators made a distinction between "natural person" or "real people" and "legal person", which were mostly government agencies and state enterprises. (Western law treats a limited corporation as a legal person). They then confined most legal enterprises to selling their shares only to legal persons. (They needed a system for trading the share but they didn't want ordinary people to be able to buy up the shares of state enterprise). In July 1992 Beijing began listing companies on a new Beijing stock market. Beijing traded legal person shares whereas Shanghai and Shenzhen traded natural person shares. China decided to move more quickly than Taiwan and South Korea to open its stock market to foreigners; after all, it is particularly useful for enterprises to be able to acquire foreign exchange for their shares. But, like other emerging markets, China wanted to ensure that foreigners were unable to come in and buy up all of the country's most successful enterprises. (Korea, Thailand, Taiwan, Indonesia and the Philippines among others put special restrictions on foreign ownership of listed enterprises.) Following the example of Thailand, China created a special group of shares for foreigners, called B shares, and limited them to a minority stake. In February 1992 both Shanghai and Shenzhen listed their B shares. These B shares issued require special approval from the central bank, and no investor is allowed to acquire more than 5% of a company without approval. Prices are quoted and purchases settled in US dollars or, more commonly in Shenzhen, in Hong Kong dollars.

At a meeting in World Economic Forum in Beijing, in October 1992, Chen Yuan spoke of the need for international accounting standards. At the time there were fewer than 50 accountants of international standards in China. In early 1993 the Chinese Ministry of Finance hired a major Western accounting firm, Deloitte Touche Tohmatsu, to design accounting standards and to create a training programme for Western-style accountants.

For comparison, Indonesia's stock market has a much longer-history but show far less willingness to conform to international standards. The Indonesian authorities have talked for years about imposing international accounting standards, but have delayed year after year because of the opposition of the local accounting profession.

(China, incidentally, has a much larger local accounting profession with much more to fear from international competition, since Chinese accounting diverges far more from international practices than Indonesia's). In the meantime, a promising Indonesian stock market takeoff in the late 1980s was aborted in part by scandals over wildly exaggerated profit forecasts that were certified by local accountants.

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