Financial Reforms in Modern China

I have been working at the Department of Monetary Policy in China’s Central Bank since 1996, designing and conducting with my colleagues the reforms of the money market, interbank bond market, and foreign exchange market of China, as well as taking note of the development of the stock market. From a frontbencher’s perspective, I have been pondering on the theoretic framework and the path to take concerning China’s financial reforms. A number of papers were produced during the time. Financial Reforms in Modern China: A Frontbencher’s Perspective is a collection of 22 papers that represents my major points about the reforms.

A money market generally refers to a market for short-term financing of less than one year and consists of interbank lending market, repo, short-term bond market, market of jumbo certificates of deposits, commercial paper market, and other submarkets. Money market, an important venue for financial institutions to adjust positions and the platform on which the central bank conducts monetary policy, plays an important role in the healthy development of the economy and the normal operation of the financial system. In 1998, amid the continued spread of financial crisis in Asia and persistent fluctuations of the international financial market, the stable operation of China’s money market played a positive role in managing financial risks and safeguarding the smooth implementation of monetary policy and fiscal policy.

The national interbank bond market founded by the PBC in June 1997 is a key and characteristic component of the current bond market of China. Therefore, thorough understanding of China’s bond market cannot be acquired without observation of the whole institutional change process of China’s bond market. We may make a case study of the establishment of China’s interbank bond market to discuss the topic. This requires answers to several questions: first, why was China’s bond market first built upon the exchange market; second, what caused the institutional change from the former exchange-based market to the interbank market, and why did the central bank promote an over-the-counter (OTC) bond market; and third, what drives the rapid and steady development of China’s interbank bond market? So to speak, China’s bond market, in its set-up and development, becomes a genuine embodiment of the characteristics of China’s market-oriented reforms. In particular, China’s interbank bond market turns into a successful case of a government-built market, which is rare in the history of China’s economic restructuring. It is worth analyzing its differences from the institutional innovation and reforms in other economic fields and exploring what have made it successful. However, to understand the limitation of such a development pattern is also required.

In 1994, China decided to undertake fundamental reform in its foreign exchange management system to unify the dual exchange rates, adopt the managed floating exchange rate regime of RMB, implement the compulsory settlement system of foreign exchange, and establish an interbank foreign exchange market. At the same time, China’s central bank started its foreign exchange open market operations and has achieved some initial success.

The existing IPO process has three steps: (1) to set the price at a designated PE ratio of 15 (or below) that is obviously lower than the average PE ratio in the secondary market; (2) to freeze the funds of investors according to how much IPO stocks they would like to bid for; and (3) to require the investors to transfer their funds to appointed accounts. This issuance method has adversely affected the development of the stock market and the economic growth. Therefore it must be reformed.