What is the evolution of Economic Reforms in China?

09Aug2016

How the Economic Reforms in China has evolved?

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Chinese track records on financial reforms

China’s opening up model can no longer meet the needs of its financial markets. The pace of opening up the financial sector is becoming incompatible with the country’s status as a leading economic power. Indeed, the openness of the financial sector in China remains marginal compared to the world’s countries. More recently, many reports outlined that the presence of foreign financial institutions in China has decreased rather than increased in recent years. However, new policies have been progressively implemented by the Chinese government to tackle this plight.

Economic Reforms in China: Opening Chinese Financial Markets

For a more than a decade, China’s government has gradually created many plans to liberalise movements of capitalising foreign investments by Chinese households, corporations and institutional investors. More specifically, the composition of gross outflows has shifted markedly from reserve accumulation to official and unofficial flows due to both the private and state sectors.

The Chinese government first started liberalising cross-border flows in 2002 by implementing the Qualified Foreign Institutional Investor (QFII) status. This plan allowed qualified foreign institutions to convert foreign currency into RMB and invest in Chinese equities and other RMBdenominated financial instruments. As of October 2015, a total quota of $78.9 billion had been granted to 277 foreign institutions, including 8 central banks and 10 sovereign wealth funds.
In 2006, Chinese officials proceeded with structural reforms in the financial sector with the Qualified Domestic Institutional Investor (QDII) Plan which allows Chinese domestic financial institutions to invest in offshore financial products such as securities and bonds, but more must be done in the future. However, the planned Qualified Domestic Individual Investor (QDII2) Plan allows individual retail investors with at least RMB 1 million ($160,000) in assets to invest in certain offshore financial products.

Most importantly, in 2013 the Chinese government strived to loosen its grip on channels for outflows and two-way flows by expanding Free Trade Zones’ (FTZs). Indeed, the Shanghai FTZ was launched in 2013, followed by three new FTZs in Guangdong, Tianjin, and Fujian in April 2015.

Connecting the Mainland to Hong Kong

Since 2014 with the “Shanghai-Hong Kong Stock Connect” plan, Chinese officials have allowed mainland Chinese investors to purchase shares of select Hong Kong and Chinese companies listed in Hong Kong, and lets foreigners buy Chinese A shares listed in Shanghai. In addition, in July 2015, it allowed eligible mainland and Hong Kong funds to be distributed in each other’s markets through a streamlined process.

Giving more flexibility to the exchange rate: on the path to internationalisation of the Yuan

On August 11, 2015, the People’s Bank of China (PBC) changed the reference pricing mechanism for the onshore CNY/dollar exchange rate. The reference price is now linked to the previous day’s closing price, but with the RMB trading now taking place in markets such as London that are in other time zones, the two prices are not necessarily the same. The key point is that the RMB exchange rate relative to the dollar is now more subject to market forces. This new policy was combined with a 1.9 percent devaluation of the RMB relative to the dollar.

From August 2015 until January 2016, there was substantial downward pressure on the RMB. China’s foreign exchange reserves, which peaked at nearly $4 trillion in June 2014, fell to about $3.2 trillion by January 2016. Since then, the pressure appears to have eased and the stock of foreign exchange reserves has stabilised. However, there is still a lack of clarity about the precise nature of China’s exchange rate policy, with PBC officials stating only that the value of the RMB is determined by supply and demand.

Reforming the banking sector

China’s financial system remains bank-dominated, with the state directly controlling most of the banking system. Recognising the importance of a better financial system for an improved allocation of resources within the economy, the Chinese government has instituted a number of reforms in recent years.

Bank deposit and lending rates have now been fully liberalised. Commercial banks can now set these rates freely, although the PBC still sets reference rates to guide banks. An explicit bank deposit insurance program has been in operation since May 2015. This program is intended to expose banks to some degree of market discipline by replacing the implicit full insurance of all deposits by the government.

In other words, China’s current opening up model has overprotected domestically funded financial institutions to a certain extent for a long time and undermines efforts to enhance the competitiveness of China’s financial market. However, the Chinese government recently achieved greater openness of the financial industry. Still, policymakers need to go forward with their efforts to liberalise the economy and make the best use of allocated resources.