• Despite the sustained growth of China's savings, domestic capital resources have funded a declining proportion of fixed asset investment. The decline was partly attributed to the increased utilization of foreign funds. But more importantly, it was a result of the under-utilization of China's domestic savings, which has not only put a drag on the expansion of productive investment, but also impeded the growth potential of the economy.

• The under-utilization of China's domestic savings was partly a result of the government's declining ability to collect taxes due to the country's narrow income tax base. As the government increased its reliance on issuing bonds to offset the loss in tax revenue, its debt service burden has escalated. With growing financial burden, the room for the government to issue more bonds to tap domestic savings is also decreasing.

• A substantial portion of domestic savings was also left idle in the banking system, as banks have been reluctant to lend due to concerns over deteriorating loan quality. Unless the non-performing loan problems of China's banking system are fully resolved, banks are unlikely to substantially increase their lending. China will, therefore, have to rely on other funding channels to mobilize the country's domestic savings.

• As the government relaxes its control over stock investment, the importance of the stock market as a funding channel would grow. Through increasing the supply of quality shares and enlarging the pool of investible capital, recent liberalization measures taken by the government would help to bolster up the stock market. A booming stock market would make it easier for enterprises to issue shares to finance productive investment.

• The promoting of the stock market is also an important part of China's broader plan to reform the state enterprises. Having issued the shares, the management of the enterprises is responsible for delivering earnings to the private shareholders. This has the effect of forcing them to improve efficiency. As China steps up its effort to restructure the state enterprises, the stock market would play a more important role in mobilizing China's domestic savings.

The decline was partly attributed to increased inflow of foreign funds, which has helped finance a growing share of China's investment. More importantly, the falling proportion was also a result of the under-utilization of China's domestic savings. Back in 1987, nearly 90% of the year's domestic savings were mobilized to fund the investment of fixed assets. The ratio, however, fell to 71% in 1997 (see figure 2). Taking out the excess investment in industrial capacity, the gap would have been even bigger. The under-utilization of domestic savings, which was a result of China's inefficient taxation and banking systems, as well as the country's underdeveloped capital market, has put a drag on the expansion of productive investment and impeded the growth potential of the economy.

UNDER-UTILIZATION OF SAVINGS

Government

China depends too heavily on the loss making state-owned enterprises as a source of tax revenue, while the more profitable and growing non-state sector has contributed a disproportionately small portion. As the ability to collect tax revenue declined, the government has relied increasingly on issuing bonds to capture domestic savings. Between 1985 and 1998, government domestic debt revenue rose from 0.7% of GDP to 4.1% (see figure 3). Proceeds from the debt issuance were mainly used to finance infrastructure investment spending.

Banking sector

It would, however, take more than a lower reserve deposit rate and wider interest margin to prompt banks to lend more. Unless the problems of non-performing loan are fully resolved, banks are unlikely to substantially increase their lending. In this respect, the establishment of four asset management companies since March 1999 to take over the overdue loans of the country's state commercial banks should help. However, more needs to be done in improving bank management and banking practices, which are crucial in avoiding future problem loans.

PROMOTING STOCK MARKET

Until the non-performing loan problems of Chinese banks are fully resolved, China will have to rely on other funding channels, such as the stock market, to mobilize the country's domestic savings. Because of the government's restrictive control, the stock market has so far played a minor role in channeling savings to investment. In 1998, funds raised from the issuance of A-shares to domestic investors amounted to only RMB44.3 billion (see figure 5), compared to that year's government tax revenue of RMB926.3 billion and net bank deposit inflow of RMB267.5 billion. However, as the government relaxes the control over stock investment, the importance of the stock market as a funding channel to mobilize savings would grow.

Allowing state enterprises to buy shares

In July 1999, the China Securities Regulatory Commission announced the relaxation of a stock investment ban imposed on state-owned enterprises (SOEs) in May 1997. Under the new regulations, SOEs are allowed to use their retained earnings to buy the A-shares issued in initial public offerings by large companies with over RMB400 million in capital. By allowing the SOEs to mobilize their savings to buy shares, the government hopes to increase the investible capital in the stock market to help enterprises finance productive investment.

Allowing banks to finance stock investment

The government has also taken measure to channel bank funds to the stock market. In September 1999, the government lifted a ban imposed in July 1997 which prohibited banks from funding stock investment. Banks are now allowed to finance stock investment of selected brokerage houses and fund management companies. Under the new rules, eligible institutions can borrow up to 80% of their net capital from the interbank market for a maximum tenor of 7 days, or through the treasury bill repurchase market for tenors between 7 days and one year.

Allowing insurance companies to invest in mutual funds

Further in October 1999, the government allowed domestic insurance companies to invest, for the first time, their premium income in mutual funds, up to an amount equivalent to 15% of the companies' total assets. Prior to the relaxation, insurance companies mainly put their premium income in bank deposits, or invested in state treasury bonds and government-backed corporate bonds. As mutual funds in China mainly invest in A-shares, the insurance premium would indirectly be channeled to the stock market. The amount of investible capital in the stock market would further increase if insurance companies are allowed to invest directly in enterprise shares.

Selling state-held shares

On the issuer side of the stock market, the government unveiled a plan in December 1999 to sell part of its equity stakes in some of the listed state-owned enterprises (SOE) which posses strong credit standing and good potential for development. The plan is to reduce the average proportion of state-held shares in these listed companies from the current 62% to 51%. This would place about 37 billion state-held shares in the public hands, raising about RMB200 billion. Part of the funds would be invested in technological upgrades of the SOEs.

Through increasing the supply of quality shares and enlarging the pool of investible capital, recent liberalization measures taken by the government would help to bolster up the stock market. A booming stock market would make it easier for enterprises to issue shares to finance productive investment. To strengthen the role of the stock market in mobilizing domestic savings, the government should consider further liberalizing stock market regulations. In the long run, the government should let market forces decide which companies, and how much funds they could raise from the stock market. This would ensure that the investment funded by equity financing is efficient and profitable.

CONCLUDING REMARKS

Given China's centrally planned economic system, the government had in the past played an important role in mobilizing the country's domestic savings. However, as the ability of the government to collect taxes and issue bonds declines, the role of the government in channeling savings to investment is diminishing. Meanwhile, banks are also unlikely to substantially increase their lending, unless their non-performing loan problems are fully resolved. China will, therefore, have to increasingly rely on the stock market to mobilize the country's domestic savings.

The promoting of the stock market, in fact, also forms an important part of China's broader plan to reform the state-owned enterprises. Private sector equity investment not only provides a new source of enterprise capital, but also a means of disciplining the management and production of the enterprises. Having issued the shares, the management of the enterprises is responsible for delivering earnings to the private shareholders. This has the effect of forcing the enterprises to improve their efficiency. As China steps up its effort to restructure the state-owned enterprises, the stock market will play an increasingly important role in mobilizing China's domestic savings to spur productive investment. In this process, foreign banks, brokers, and fund managers can assist in bringing in expertise and new technology. This is in line with China's pledge to open up its stock market to foreign financial institutions in its bid to gain accession to the World Trade Organization.

CHINA MAJOR ECONOMIC INDICATORS