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China’s Recent Financial Reforms: More than the Sum of the Parts?

by | July 5th, 2012 | 04:04 pm
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Although we have been critical of the pace of reform in China in recent years, it is important to acknowledge the flurry of activity that has taken place in the first half of this year. The Chinese and Western press have been chock-full of new financial initiatives pushed forward by policymakers.

Most of these initiatives have been small tweaks rather than significant reforms. But the growing number of proposals and initiatives currently underway is a sign that pro-reform forces are pushing for change.

At this point it’s an open question what the true significance of these reforms will ultimately be. Increasing the flexibility around the benchmark deposit rate is critical for economic rebalancing, but the reform’s short-term significance is undermined by the two recent interest rate cuts. Moreover, one especially promising reform, allowing direct issuance of provincial debt, has been shelved.

Below is a list of recent financial reform initiatives in China. Readers are welcome to write in and offer their thoughts on whether as a whole these reforms are worth more than the sum of their parts.

Reform Date Regulator Explanation
Renminbi Qualified Foreign Institutional Investor Program (RQFII) December 2011 China Securities Regulatory Commission (CSRC) Allow Chinese financial firms to establish renminbi funds in Hong Kong for investment in the mainland. Initial investment quota is set at 20 billion renminbi. Investors will be able to buy mainland bonds and equities, 80 percent and 20 percent respectively. This move increases two-way channels for offshore renminbi and promotes currency internationalization.
Wenzhou Financial Liberalization March 2012(announced) State Council Allow private lenders in the city to operate as investment companies with the goal of increasing small and medium enterprise (SME) finance. Wenzhou residents may invest as much as $3 million a person, with a city-wide quota of $200 million a year, to set up, acquire, or invest in nonfinancial companies overseas.
Provincial Social Security Fund Investment Liberalization March 2012 State Council Allow the Guangdong social security fund to entrust 100 billion renminbi to the National Council for Social Security Fund (NCSSF) for two years. The NCSSF will be allowed to invest up to 40 percent of these funds in the stock market, something provincial funds are currently prohibited from doing.
Exchange Rate Band Widening April 2012 People’s Bank of China (PBoC) The daily band for the renminbi /US dollar exchange rate increased from 0.5 percent to 1 percent—the first time since 2007 that flexibility has been increased. This reform allows more renminbi flexibility around the daily rate set by the PBoC.
Enlargement of QFII Quota April 2012 CSRC Increased the quotas for qualified foreign institutional investors to $80 billion from $30 billion. This reform is a further opening up of the capital account and an effort to combat hot money flows.
Over-the-Counter (OTC) Market April 2012(announced) CSRC Creation of a new OTC board composed primarily of SMEs. The aim of this new equity market is to provide a new financing channel for small unlisted firms, especially high-tech companies.
Foreign Exchange Trading Zone June 2012(announced) State Council Capital account controls will be relaxed with a quota of $45 billion. Companies in Qianhai will be encouraged to sell renminbi bonds in Hong Kong and to experiment with cross- border loans in the Chinese currency.
SME Bond Market June 2012 CSRC Creation of a high-yield (aka junk bond) market for SMEs. Small domestic companies which are not listed on the stock exchange are eligible to participate. Issuance will be conducted through private placement.
Credit-Backed Securitization Program June 2012(announced) PBoC, China Banking Regulatory Commission (CBRC), Ministry of Finance (MoF) Creation of a trial securitization program that would allow banks to turn loans in to securities and thus increase the funds for additional lending. Initial quota of 50 billion renminbi.
Interest Rate Benchmark Band Widening June/July 2012 PBoC Allow deposit rates to rise to 110 percent of the benchmark for a one-year deposit. Lending rate may fall to 70 percent of the one-year benchmark, except in the case of individual mortgages which will remain at 80 percent. The increased flexibility on the lending rate was expanded again in July.
Hong Kong Exchange-Traded Fund (ETF) July 2012 CSRC Approval of several Hong Kong ETFs that will be allowed to directly invest in the mainland shares as part of the RQFII program. This is the first time this type of fund has been approved.
Foreign Direct Investment (FDI) Rules Relaxation July 2012(announced) State Administration of Foreign Exchange (SAFE) Elimination of regulatory examinations for opening or adding to FDI-related foreign exchange accounts. Examinations will no longer be conducted on reinvestments of profits generated by foreign companies in China. Simplification of procedures for foreign investors buying Chinese equities in the over-the-counter market and applying for capital verification for investments in Sino-foreign joint ventures.