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20 June, 2001 Liberalizing Domestic Control |
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Second Quarter 2001 Executive Summary
The wider opening of China's market will attract substantial foreign
investment and steer the country through a faster yet more sustainable
pace of economic growth over the long run. In the process, however, China
will face increased foreign competition that could put mounting pressure
on the Chinese enterprises. Meanwhile, as China integrates closer into
the global economy, cross-border funds flow would also become more volatile,
which could pose a threat to domestic financial stability. ENTERPRISE STRUCTURE To help China meet the increased foreign competition that would accompany the WTO entry, the government has stepped up efforts to boost the efficiency of the Chinese enterprises. Apart from the much-discussed reform to revitalize the state-owned companies, the government is relaxing its restrictive controls on the enterprise structure to foster more competition in the domestic economy. Restructuring state monopolies An important step in this direction is the restructuring of the state monopolies. Under China's centrally planned economy, the government had maintained monopolistic control in a host of industries, such as telecommunications, power, civil aviation, railways, etc., through various state ministries that acted as both the industry regulator and sole operator. During the course of the past decade, however, the regulatory and operational functions of some state monopolies were separated, and the government had allowed more domestic players to participate in these industries. For example, in the telecommunications sector that China pledged to open to foreign operators after WTO entry, major restructuring took place back in the early 1990s. In December 1993, the Ministry of Post and Telecommunications handed its operational function to China Telecommunications Corporation, which became the sole provider of national telecommunication services in China. Further in July 1994, the State Council approved the establishment of China United Telecommunications Corporation to compete with China Telecom. Since then, the government had issued three more licenses to other companies engaged in communication services and split off the fixed line, mobile, and satellite divisions of China Telecom into separate companies. Through restructuring the state monopolies, the government hopes to introduce a mechanism for competition to boost the efficiency of the monopolistic industries. This is particularly important in the context of the opening up of China's market to foreign investment after WTO entry, as the restructuring will help raise the international competitiveness of the domestic players. Deregulating private economy At the other end of the enterprise ownership spectrum, the government is also committed to promote the private sector. In March 1999, China amended its constitution and elevated the status of private enterprises from a "complement" to the state sector, to an "important component" of China's socialist market economy. The constitutional recognition provided the basis for the relaxation of a series of discriminating policies that inhibited the development of the private economy. For the first time, private enterprises were granted the trading rights that were previously given only to foreign-invested enterprises and a handful of large state-owned and collectively-owned manufacturing enterprises. Effective January 1999, private enterprises with registered capital no less than RMB8.5 million may conduct their own foreign trade, instead of having to import and export through state-controlled foreign trade corporations. The capital requirement was lowered further in January 2001 to RMB5 million to match that of the state-owned enterprises (SOEs). Meanwhile, all the punitive taxes imposed on private enterprises at the local level were also scrapped in January 2000. The deregulating of the private economy would help level the playing field between the private and the state sectors to foster more competition among enterprises of different ownership. With increased competition, the SOEs will have to improve their efficiency to stay in business. On the political front, the promoting of the private economy could also help absorb the surplus workers being laid off from the state sector and alleviate the social impact of ongoing SOE reform on the stability of the country. FINANCIAL SYSTEM As regards the preserving of financial stability, steps will also be taken by the government to avoid a potential erosion of the country's foreign exchange (FX) reserves due to more volatile cross-border funds flow after WTO entry. Most importantly of all are the pledges to increase the flexibility of the country's interest-rate and exchange-rate systems, so that the forces of market could more effectively regulate the flow of funds across the border. Liberalizing interest rate controls Within a three-year time frame from 2000, China will liberalize its controls over interest rates. Effective September 2000, Chinese banks are already allowed to independently determine all on-shore foreign currency lending rates. They are also given the autonomy to set the interest rates on foreign currency deposits exceeding US$ 3 million. Prior to these changes, only foreign banks in China were allowed to set their own lending and deposit rates on foreign currencies. Rates offered by Chinese banks were fixed with reference to guidelines issued by the People's Bank of China (PBOC), the country's central bank. According to the government's plan, the next to be liberalized will be lending rates in local currency, followed by deposit rates. At present, Renminbi lending rates offered by banks are allowed to move only within a 10% band above or below the benchmark rates set by the PBOC, although for loans to small- and medium-sized enterprises the rates could deviate by up to 30% against the benchmark on the upside. However, local currency deposit rates must be kept at rigid levels administratively set by the central bank with no exception.
Widening Renminbi trading band With increased cross-border funds flow, the need for a
more flexible exchange-rate regime in China will also grow. Since early
1998, the PBOC has maintained a tight trading band of RMB8.2776-8.28
per US dollar for the Chinese currency, through active intervention
in the foreign exchange market. While the purchase of foreign currencies
by the central bank in the event of capital inflow to keep the Renminbi
from strengthening beyond the band is generally considered to be desirable,
the opposite could be quite destabilizing, as it would lead to a depletion
of the country's FX reserves. 
To better regulate the flow of funds across the border to avoid a potential erosion of FX reserves, China would reportedly allow the Renminbi to fluctuate within a wider band after its entry into the WTO, which hopefully could be finalized by the end of this year. It is, however, unlikely that the widening would be too drastic in the initial year after WTO entry. Given the current strength of the country's external payments position thanks to increased foreign direct investment inflow, the Renminbi would likely appreciate if the trading band widens substantially. This would put a further drag on exports at a time when overseas demand is decreasing due to the slowdown of the world economy. MORE NEEDS TO BE DONE Although China has done real work in liberalizing its controls over the enterprise structure and the financial system, more needs to be done before meaningful gain in efficiency and stability could materialize in the domestic economy. Disciplining state companies In the restructuring of the state monopolies, most of the new players are companies formed by government agencies or the local governments. As the state maintains ultimate control over the decision-making process of these entities, the economic benefits from introducing domestic competition would be slow to take shape under the current restructuring effort. Steps should, therefore, be taken to reduce government influence over these companies and allow market forces to determine key operating decisions such as production targets, pricing and distribution of products. One way to accomplish this is to allow private investors to acquire an equity stake in the state companies. Being held accountable to private shareholders that seek to maximize earnings, mangers of the state companies would be obliged to improve efficiency in the face of heightened competition. Funding private enterprises In the promoting of the private economy, a critical success factor is to address the dire funding needs of the private enterprises. Because of their smaller scale and lack of operation track records, private enterprises have long had a hard time getting access to financing from the state banks. According to some estimates, lending to the private sector accounts for less than 1% of total lending from the state dominated banking sector. To enable the private enterprises to compete on comparable footing with the SOEs, the government should encourage state banks to increase their lending to the private sector. More private commercial banks should also be approved to fund the private economy. In due time, quality private enterprises should be allowed to raise funds by issuing bonds and listing in China's stock exchanges. Guiding market interest rates Meanwhile, with the lifting of the administrative controls on interest rates, the central bank should increase the use of indirect monetary policy tools, such as reserve requirement, rediscount rate and open market operations, to guide market interest rates. Although these policy tools have been in place in China for some time, they are seldom used by the central bank. Since it was last lowered from 8% to 6% in November 1999, the reserve ratio has remained unchanged. Meanwhile, the last time that the rediscount rate was altered dated back to June 1999 when it was cut from 3.96% to 2.16%. The use of open market operations has also been very infrequent since it was first launched in April 1994. Managing exchange rate risks As volatility of the Renminbi exchange rate grows after the government allows the currency to fluctuate within a wider trading band, China should also put in place the mechanism for investors to hedge their exchange rate risks, such as expanding the Renminbi onshore forward market. At present, only the Bank of China provides onshore Renminbi forward contracts for import and export transactions up to a maximum tenor of six months only, but the volume was small and averaged only US$ 10 million a day in 2000. To a large extent, foreign investors still manage their exchange rate risks through "natural hedging", that is, matching the currency of their receipts and liabilities. Others have also made use of more costly offshore hedging instruments available from foreign banks outside China. CONCLUDING REMARKS China's accession to the WTO is not just a matter of easing the restrictions
for foreign companies to enter the Chinese market, it is also a catalyst
that will speed up the liberalization of domestic control in the country.
To help China meet the increased foreign competition that would accompany
the WTO entry, the government will have to relax its controls over the
enterprise structure to boost the efficiency of the domestic companies.
Steps will also have be taken to increase the flexibility of the financial
system to avoid a potential erosion of foreign exchange reserves as China
integrates more and more into the global economy. Through boosting the
efficiency of the Chinese enterprises and preserving the stability of
capital funds flow, the liberalization of domestic control would help
China benefit fully from the market opening that follows the WTO entry.
CITIBANK CHINA OFFICES CITIBANK, N. A. Jason Kwok Joe Lo Ellen Cheuk Alice Chan Citibank China Monitor is also available for retrieval in the following Citibank internal systems: CitiWeb, EM-HK Website, and the Bulletin Boards of Open-mail. For soft copies of this report, customers are advised to contact your Account Manager. This report is for information only. While the information contained in this report has been obtained from sources which we believe to be reliable, we can make no guarantee as to either the accuracy or the completeness of the information. |
