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China's Economy Forum

The Reform-Driven Financial Sector Development In China
Dai Xianglong - Governor, People's Bank of China

Nanjing, China - 19 September 2001

Ladies and Gentlemen,
Friends,

It is a pleasure to attend this Convention. I wish to express my sincere appreciation for the important contribution you have made to the economic growth in China over the years. Let me share with you my views on the recent development and prospect of China's financial sector, a sector that is undergoing reform and opening up.

I. The Progress in Financial Reform

Since the initiation of reform and opening-up policy, China's rapid and sustained economic growth has greatly enhanced the aggregate strength of the nation. With its GDP reaching one trillion US dollars, it has become the 7th largest economy in the world. People's living standard has improved markedly with political and social stability consolidated. In this process, the financial sector has moved ahead in a stable manner. After more than a decade's hard work, we have by and large put into place an organizational system, market system and supervision and regulation system consistent with a socialist market economy.

First of all, we now have a full-fledged legal framework for the financial system with such key laws as Law on People's Bank of China, the Commercial Banking Law, the Securities Law and the Insurance Law governing the business and supervisory activities in the financial sector.

Secondly, a financial institution system has been set up with commercial banks as the mainstay and the coordination of all kinds of financial institutions. In 1994, four state-owned commercial banks and 3 state policy banks were created on the basis of the 4 state specialized banks. At the moment, there are more than 110 joint-equity commercial banks, 100 securities and 30 insurance companies.

Third, a unified and open financial market system has been in place to encourage orderly competition and balanced development. An interbank money market with such investments as interbank borrowing, debt securities and commercial papers has grown to a fairly reasonable size. Money market interest rates have been liberalized. A unified nation-wide foreign exchange market has been in operation, with bank purchase and sale of foreign exchange reaching US$305.8 billion. Capital market is expanding rapidly. At the end of June, there were 1,137 listed companies with an aggregate market value of 5.4 trillion yuan, of which 1.9 trillion were publicly traded.

Fourth, there has been a shift of reliance from direct to indirect instruments for macroeconomic management. Credit quota was abolished and the floating band of interest rates has been widened. The PBC uses indirect tools such as interest rates, open market operation, central bank lending, rediscount and reserve requirement, in a flexible manner to influence money supply and maintain the value of currency, contributing effectively to economic growth.

Fifth, a new system has been adopted for the segregation of banking, securities and insurance industries and their respective supervisory authorities. In 1998, the PBC, and the newly established China Securities Regulatory Commission and China Insurance Regulatory Commission became respective supervisory authorities of the banking, securities and insurance industries. Over the past several years, special state bonds have been issued to recapitalize the state-owned commercial banks. Asset management companies have been established to take over and dispose of non-performing assets from state banks. Small and medium-sized financial institutions have been rectified, and the insolvent ones closed. The long-accumulated financial risks have been thus gradually dissolved for the benefit of smooth operation of the financial system.

Sixth, the balance of payments position has been strengthened and the RMB exchange rate has stayed stable. In 1994, a single, managed floating rate regime based on market supply and demand replaced the dual exchange rate regime. Since then, the exchange rate has been stable. Current account RMB convertibility was introduced in December 1996. The balance of payments position has become stronger with foreign exchange reserves growing to US$190 billion by the end of August.

This new and open financial system has served to promote the stable performance of the whole sector, contributing to the good performance of the economy and the reform progress. At end-June, total assets of the financial sector reached 21.4 trillion yuan, among which 19.7 trillion, or 94.8%, was owned by financial institutions under PBC's supervision. The remaining 3.4% and 1.8% were held by securities and insurance sectors respectively. Between 1991 and 2000, broad money grew by an average of 21.7% per annum, lending by financial institutions by almost one trillion every year, or 16.5%. A total of 650 billion yuan was raised in the securities market. Insurance premium income grew by 23.1%, or over 14 billion yuan on average every year.

II. Opportunities and Challenges in the new Century
Political multi-polarization and economic gloalization have ecome two major trends int eh 21st century. Financial globalization, as a result of economic globalization, further deepnes the degree of economic and financial globalizatoin. Financial and economic globalization is a double-edged sword that brings about rapid economic and wealth growth, but widens the gap between rich and poor at the same time. The developing countries benefit from the globalization in terms of fund inflow and technology transfer, but are faced wiht great risks of economic imbalance and financial turbulence.

As the largest developing country, China has made persistent efforts in opening up and gradually integrated itself into the globalization process. We have adopted a gradual approach to liberalization. This is not only for ensuring a sound economic development in China but also for reducing the risks for foreign investors and safeguarding their interests.

The financial sector has opened wider and wider. At the moment, the geographical restrictions on foreign banking establishments have been lifted . Experiments have been made to allow foreign banks to engage in local currency business in Shanghai and Shenzhen. At end-June this year, there were 190 foreign-funded financial institutions operating in China, including 158 foreign bank branches, which had total assets of US$41.04 billion and a foreign currency loan balance of US$14.32 billion, accounting for 17.2% of the total foreign currency loan balance of all the resident financial institutions. Altogether, 31 foreign bank branches handle local currency business, their RMB deposit and loan balances reaching 7.8 billion and 33.88 billion yuan respectively. Foreign insurance companies have set up 14 branches and 8 joint venture companies with their Chinese partners. Foreign-funded financial institutions have become an important component of China's financial sector.

We will soon join the WTO. As a result, the financial sector will be further openend up. According to our agreement with the United States and EU, foreign banks will handle full scope of foreign currency business in the year of our accession. Within five years of accession, they will get local currency deposit taking and lending business for households. In terms of geographical access, four more cities will be opened for RMB business every year after the WTO accession. Five years after the WTO accession, the geographical limit on RMB business will be abolished completely. The central bank shall examine and grant approval in a prudent manner on the branch and subsidiary applications.

Four years after accession, foreign insurance companies will be allowed to provide the full range of non-life insurance to foreign and Chinese clients. For joint-venture life-insurance companies, the foreign partner is allowed up to 50% of the total investment. Foreign investors are allowed to participate in fund management companies, joint-venture securities companies will be allowed to set up.

After China becomes a WTO member, foreign financial institutions will take a greater part in China's economic and financial development. This will increase the inflow of international financial capital, modern banking management expertise and new products and help further standardize financial activities. However, with more foreign institutions coming in, they will compete with the Chinese counterparts for quality clients and good professionals, and in introducing new technology and providing new services. Given the weak self-discipline and self-development mechanism, the weak infrastructure, and the heavy historical burden, the domestic institutions are not in an advantageous position. Therefore, WTO accession will bring new pressures and challenges to these institutions and supervisory authorities. China will further speed up market-based restructuring of domestic financial institutions, foster and improve financial market, improve financial legislation, put in place a highly-efficient supervision system, train financial management personnel, upgrade the technology of management in order to rise up to the challenges and opportunities.

III. The Priorities of Financial Sector Reforms during the Tenth Five-year Plan Period

China's GDP is projected to double and exceed US$2 trillion by the year of 2010. To achieve this goal, financial sector reforms and development need to be accelerated during the Tenth Five-Year Plan period.

Improving the quality of decision-making and implementation of monetary policay and creating a better macroeconomic environment.

The objective of China's monetary policy is to maintain the stability of the value of the RMB, thereby promoting economic growth. Starting in the second half of 1993, China implemented a moderately tight monetary policy and succeeded in controlling inflation. Since 1998, China has carried out a sound monetary policy focusing on credit structure adjustment and efectively prevented the deflationary trend. Over the recent years, the ratio of broad money M2 to GDP have been on the rist, registering 1.31, 1.46 and 1.52 for the years of 1998 to 2000, respectively. Such a ratio is comparatively higher than that in such countries as India and Japan, implying that there has been a high growth in China's broad money. The debt ratio of enterprises, in particular the state-owned enterprises, has also been relatively high. the imbalances in the economic structure remain to be settled. Under such conditions, China still needs to continue its sound monetary policy, take stock of the performance of the economy, maintain the forward looking nature of monetary policy, and improve the quality of the decision making and execution of monetary policy.

In order to improve the quality of the decision making and execution of monetary plicy, efforts will be strengthened in the following aspects. First, it is necessary to decide an adequate grwoth rate of money supply. Given the projected 7 percent annual average growth of GDP and the 3 percent annual average rate of inflation during the Tenth Five-Year Plan period and the moderation of money velocity, the annual grwoth rate of money supply for that period will be targeted at about 14 percent. Money supply is projected to increase by RMB12.5 trillion yuan during the period to RMB 25 trillion yuan in 2005. Lending by financial institutions will grow at 13 percent on annual average basis, with a five-year increase of RMB8.4 trillion yuan, and the total lending will reach RMB18 trillion yuan during the period to RMB 25 trillion yuan in 2005. Lending by financial institutions will grow at 13 percent on annual average basis, with a five-year increase of RMB 8.4 trillion yuan, and the total lending will reach RMB 18 trillion yuan in 2005.

Second, it is also necessary to take good advantage of credit policy, which is an important part of China's monetary policy. Looking at the successfuly experiences of developing countries and regions, an effective combination of industrial and credit polices has played a crucial role in improving the allocative effeiciency of resources and structural adjustment.

During the Tenth Five-Year Plan period, China will make better use of credit policy  so as to guide commercial banks to adjust their credit structure, increase gradually their lending to the hi-tech industry and to the development of the western regions and the rural areas on the basis of market principle, thus promoting a strategic adjustment of China's economic structure. By the end of June 2001, the foreign currency deposits and loans of financial institutions reached over US$130 billion and US$80 billion, respectively. In addition to other resources, the total resources available for foreign currency lending will be about US$50 billion. Therefore, greater efforts need to be made to improve the extension of foreign currency lending while improving  the local currency banking services, and to encourage those domestic firms with demand for foreign currency to borrow foreign currency loans from local commercial banks.

Third, it is necessary to steadily push forward the process of liberalization of interest rates, which is cruicial to improving the quality of China's monetary control. At present, with poor liquidity of China's industrial capital, the weak responsiveness of state-owned enterprises to changes in interest rates and the weak capacity of the central bank's control of market interest rates, it remains necessary for the central bank to set the benchmanr rates for deposits and loans of commercial banks. Based on the foreign experiences of interest rate liberalization, the basic sequence for interest rate liberalization is to liberalize the foreign currency rates before the local currency rates; and the lending rates before the deposit rates. For lending rates, its float bands should be expanded before the rates are completely decontrolled. For deposit rate, it is desirable to liberalize the rates of sizable term deposit before the rates of general deposits. China will steadily push forward the process of interest rate liberalization with efforts forcused first on expanding the float bands for interest rates. The ultimate objective is to establish such a market interest rate system and mechanism for commercial banks to decide their own rates of deposits and loans based on market forces, and with the central bank rate as basic rates and money market rates as the intermediate rates, thus improving the macroeconomic management by the central bank.

Fourth, it is important to better coordinate the relationship between monetary policy and the capital markets. During the Tenth Five-Year Plan period, the percentage of direct financing in China ill increase considerably, and the capital markets will develop at a faster pace. The rapid development of China's capital markets will surely pose new challenge for the central bank's monetary policy. On the one hand, such development will increase the importance of the capital markets as part of the transmission mechanism of China' monetary policy. On the other, the effects of changes in asset prices on the real economy and finance will become more obvious. While the central bank would not target asset prices in its monetary policy operation, it will certainly watch closely the development in asset prices, and attach great importance to the information content of asset prices. For that purpose, the People's Bank of China wil further standardize the linkage between the money market and the capital market, properly determine the levels of interest rates, improve the regulation on stock collaterized lending, allow those eligible securities firms and fund management corporations to participate in the inter-bank market, and continue to provide institutional support for the healthy development of the capital market.

Facilitaing the share holding system reform of the wholly state-owned commercial banks and strengthening the service function of the banking industry.

The wholly state-owned commercial banks are the backbones of China's financial system. Over th next five years, China will continue to improve the organization of the financial system, and strengthen the service function of the banking sector. Our priority is to deepen the reform of the wholly state-owned commercial banks. We hope that in about five or more years, the four wholly state-owned commercial banks will be transformed competitiveness in the international financial markets. To achieve this objective, beginning this year, China will initiate a comprehensive reform of the wholly state-owned commercial banks on a step-by-step basis according to the requirement of establishing the system of modern enterprises.

Step One : To upgrade the management system according to the forms of the wholly state-owned corporations. The principal task is to streamline institutions and personnel, set up the internal control system, the prudential accounting system, the business performance evaluation system, and to reform the income distribution adn personnel management system, and to significantly improve the quality of lending and business efficienty.

Step Two: To transform the qualified wholly state-owned commercial banks into the state-controlled share holding commercial banks held by domestic enterprises, individuals and foreign investors, to improve the governance of commercial banks, and to fundamentally resolve the problems underlying the business mechanism of commercial banks.

Step Three: Allow the qualified state-controlled share holding commercial banks to be listed in the stock market.

In the meantime, efforts will be made to standardize and develop joint-equity commercial banks, to support them to form alliance or restructure on the market basis and to allow foreign capital to participate.  These banks are encouraged to appoint independent board directors, clarify the responsibilities of the board of directors and the board of supervision, and improve the bank governance. Efforts will also be made to accelerate the pace of the rural financial system reform, and to transform most of the rural credit cooperatives into the cooperative financial institutions serving all the members, with member participation and democratic management. We will also support the development of trust, finance and leasing firms to fully play their respective roles. Furthermore, we will continue to abide by the policy of legality, supervision, self-discipline and standardization, and to speed up the development of the securities industry on the basis of standardization. The insurance industry needs to be developed considerably so that its safeguarding functions for economic development could be strengthened.

Substantially reducing financial risks and safeguarding the financial safety of the state.

St present, the accumulated hidden financial risks in China's financial sector have not been completely dissolved, which are evidenced mainly by the relatively high ratio of non-performing loans of state-owned commercial banks, the capital inadequacy of some commercial banks and the payment difficulty of a few small financial institutions. Because of these, some pessimists believe that there is presently a likelihood of financial crisis in China.

Financial risks of a country are often assessed by price and exchange rate stability as well as the levels of external debt and non-performing loans. Since the introduction of the reform and opening policy in 1978, China's domestic prices have remained relatively stable except during the periods of 1988-89 and 1993-95 when inflation rose at a double-digit rate. The exchange rate has also remained stable with a moderate appreciation since the unification of official rate with the market rate in 1994. It has withstood the recent financial crisis in Asia. The price and exchange rate stability has facilitated strong economic performance. At end-2000, China's outstanding extenal debt amounted to US$145.7 billion, with an aggregate-debt-to-current-account-receipt ratio of 52.7 percent, a debt-to-GDP ratio of 13.5 percent, a short-term-to-total-debt ratio of 9 percent and a debt service ratio of 9.2 percent, all at comfortable levels by international standards. Four asset management companies were established in 1999 to dispose of the RMB 1.3 trillion yuan of non-performing assets acquired from the wholly state-owned commercial banks. As a result of concerted efforts, the NPL ratio of these banks has begun to decline since the fourth quarter of 2000 and the ratio of aggregate NPLs of all financial institutions to GDP has also been decreasing. In light of the economic fundamentals and development of the financial sector, financial risks in China are being contained, reduced and can be dissolved. We do not see any imminent financial crisis on the Chinese horizon.

Additional effective measures will be taken to ensure a 2-3 percentage point annual reduction in the NPL atio of the wholly state-owned commercial banks, strengthen their capital base and their resilience to risks. Further efforts will be made to study establishing a deposit insurance system, improve market exit mechanism and introduce international standards on disclosure and transparency. Financial supervision will be enhanced to reduce financial risks and ensure the safety of the national financial system.

IV. Further Improve the Exchange Rate Regime and Prudently Work Toward Full RMB Convertibility.

The efforts to open to the outside world have integrated China with the global economy. By expanding trade and purchasing large amounts of financial assets in the international markets with foreign exchange reserves and overseas positions of commercial banks, China has contributed to the development of the global economy and international financial markets. China's trade exceeded US$2.8 trillion in the past decade. The total foreign assets of the Chinese government, financial institutions and enterprises have reached more than US$300 billion. As of end-June, 2001, the accumulated capital inflow in the form of foreign direct investment and overseas listing of Chinese companies as well as public and private borrowing abroad has reached US$ 550 billion.

Foreign investment is estimated to have contributed about 2.7 percentage points to the 9.7 percent average economic growth during 1980 - 1999. We will continue to improve financial services and appropriately increasing local currency loans to foreign-funded enterprises while increasing funding for incremental capital by domestic participants in foreign-funded enterprises to strengthen their financing capacity.

As capital movement interacts with exchage and interest rate changes, a sustained increase in net capital inflow may exert upward pressure on the RMB exchange rate and negatively affect export, and vice versa. To maintain the exchange rate at a desirable level will require strong balance of payments performance and appropriate interest rate policy.

China maintains a market-determined managed floating exchange rate regime. The People's Bank of China keeps the RMB exchange rate at a relatively stable level through market operations. Such a regime has proved a good choice under the Chinese circumstances. Changes in trade and investment flows associated with China's WTO entry are likely to give rise to larger balance of payments fluctuations and stronger external shocks. While maintaining the same exchange rate regime, we will improve the exchange rate formation mechanism provided that the relative stability of the currency is not threatened. Domestic and foreign currency interest rate policies will be better coordinated so as to allow a greater role of the exchange rate in maintaining a good balance of payments position and weathering external shocks.

China has removed all exchange restrictions under the current account and has made encouraging progress in the past decade toward the goal of capital account convertibility. Except those on short-term capital movements, the remainiing capital account restrictions are mainly quantitative rather than prohibitive. For example, domestic enterprises are allowed to issue debt and equity securities in overseas markets and foreign investors may repatriate their profit. The prudential control on capital movements and phased liberation thereof are not only justified by the need to sustain strong economic growth, but also called for by the need to protect the interest of foreign investors. In anticipation of greater integration with the global market as a  result of WTO entry, China will create conditions for steady progress toward capital account liberation.

As an important member of the international community, we will strengthen cooperation with other countries, especially with other central banks in Asia. We will continue to support the role of the International monetary Fund in global financial affairs. We are committed to further exploring monetary and financial stability mechanism in the region aimed at preventing and dissolving crisis through strengthening economic and financial policy coordination while implementing the ChingMai Initiative signed by China, Korea, Japan and ASEAN members, including continuing bilateral negotiations on swap arrangements.

Ladies and Gentlemen,

In the new century, China remains committed to sustaining strong economic growth and further opening to the rest of the world. Before I conclude, let me express our thanks again to the overseas Chinese business community for their invaluable contribution to China's economic development. We welcome continued cooperative efforts from overseas Chinese bankers and entrepreneurs.

Thank you.


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