Capital market development in China

World Development, Vol. 19, No. 5, pp. 511-532, 1991. 0305--750X/91 $3.00 + 0.00 Printed in Great Britain. © 1991 Pergamon Press plc

Capital Market Development in China

ON KIT TAM* University of New South Wales, Canberra

Summary. - - This paper examines why and how capital markets have developed in a low-income socialist country. It shows that the development is the response of economic agents operating under a more market-oriented economic environment with a highly regulated and inefficient banking system. This development has presented new policy challenges and opportunities. The paper argues that the developmental effects of the emergence of capital markets in China can be as important as its impact on improving allocative efficiency and resource mobilization.

1. INTRODUCTION

In the 1980s, with the worldwide trend in financial deregulation and the internationaliza- tion of financial activities, the active development of capital markets in developing countries was considered by some international financial institutions as important and desirable. 1 The socialist economies, most of which retained state ownership of the means of production, foreign exchange controls and a highly regulated banking system, did not seem likely to embark on such a course of development, however. China was an exception.

Since 1984 China has seen an upsurge in the issuance of various forms of new financial instruments in the large cities and in many rural townships. 2 Most of the issued securities are nominally shares. 3 By the end of 1986, despite the negligible number of traded shares, "stock exchanges" had been established in two of China's main industrial centers, Shenyang and Shanghai. In 1988 the State Commission for Restructuring the Economy listed the emergence of a shareholding system as one of the major theoretical issues facing the country's reform process. 4 Former Chinese Communist Party (CCP) Secretary General Zhao Ziyang called for the introduction of a share system in enterprises amid mounting price inflation in late 1988. 5 Even after the political changes of June 1989, the development of a stock exchange and capital markets has not been completely dropped from public debates. 6

During its 10 years of economic reform, China has shifted away from its traditional Soviet system of monobanking and highly centralized credit and cash control mechanisms. 7 A rapid

process of monetization and remonetization of the country's economic activities has taken place. The introduction of seemingly active markets for financial assets such as equity shares shows that China had gone further in this respect than other, more mature, socialist economies before the momentous changes at the end of 1989. 8 It may also suggest that China has defied the general pattern observed in other developing countries at roughly comparable stages of economic development and monetization. Although the scale and institution building associated with China's capital market activities remain relatively small, the fact that such markets have emerged and generated much enthusiasm and debate in China is indicative of the potential and challenges in the country's economic and financial reform.

This paper attempts to explain why, how and to what extent capital markets have developed in this low-income socialist country. The paper will discuss the conditions and motivation for capital market development in China. It will examine whether the development of capital markets could play a role in China's advance toward an allocatively more efficient and less centralized and regulated economy. Section 2 provides the theoretical basis of the analysis of capital market development in China. Section 3 discusses the trends, characteristics and empirical data on this

*I would like to thank H. Arndt and two World Development referees for their helpful comments on an early draft of this paper. Part of this research was supported by grants from the Australian Research Council and the University College, the University of New South Wales. I am grateful to the Sichuan Academy of Social Sciences and the Chinese Academy of Social Sciences for their cooperation and assistance at various stages of my research.

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512 WORLD DEVELOPMENT

development. Section 4 examines some major policy issues arising from the development of capital markets in a socialist economy.

2. CAPITAL MARKETS AND FINANCIAL DEVELOPMENT

Like many other developing countries, China's development could, at first glance, be well served by the existing, bank-based financial system, over which growth-oriented government intervention is supposedly more effectively exercized. 9 Indeed, the literature on financial liberalization and development has traditionally focused on the allocative and mobilization roles of bank finance in economic development. Recent works by Woo (1986), Drake (1986), Cho (1986), Snowden (1987), and Wijnbergen (1983) have attempted to redress the neglected role of capital markets by the "new orthodoxy" of the financial liberalization literature of the 1960s and 1970s. These studies focus on the role of capital markets and their allocative implications.

In the past decade, China has introduced reforms in its banking system, which have helped to transform the mode of public and enterprise finance. A question that may arise from these reforms is whether differences in the financial asset attributes through which investments are now made have any effect on the control and governance structure of the enterprises. 10 Thus, as the Chinese economy is becoming more market oriented, budgetary grants, bank loans and financial equity may not be merely alternative sources of funds. They could be deter- minants of an alternative enterprise governance structure. The issue is particularly relevant because economic reform has not yet changed a critical financial characteristic of the old system: the financially undisciplined enterprise behavior stemming from de facto unlimited access to funds with no clearly defined property rights and responsibilities. This paper shows that although in principle China's capital market development was linked to concerns about governance structures, in practice it has largely been a dis- organized but nevertheless rational response of economic agents (including local governments) to restrictions and regulations over the formal financial institutions.

For the purpose of analysis, we adopt a narrow definition of "capital markets" where equity shares of various forms are bought and sold, with or without using the services of brokers, dealers and underwriters, u The term "capital" is used here to denote equity shares or stocks. However, it should be noted that there has been a high

degree of confusion in the use of the terms "shares" and "bonds," particularly in the early phases of capital market development in China. The lack of data and effective supervision over new issue and exchange activities has made accurate estimation of capital markets difficult. Statistical distinctions between enterprise debt and equity issues cannot always be made in practice.

Observers of the financial system in less developed countries (LDCs) have long recognized the absence of any significant capital market development. A number of plausible explanations have been offered. ~e The limited supply and demand for corporate securities are often considered to be the main obstacle to capital market development. On the supply side, the generally small size of the firms in the relatively small industrial sectors in LDCs means that few are in a position to issue securities to raise funds from the capital markets. The small number of larger firms already have easy access to bank finance, often at subsidized rates, or to internal funds generated within the firm or the family of companies (group) to which they belong. 13

The low level of income, the absence of a well- established legal and professional framework, and the public's "lack of confidence" in capital markets are often cited as reasons for the limited demand for securities. Foreign firms and joint ventures often look overseas for funds. The operation of an active, informal (curb) financial market, as in South Korea and Taiwan, may also

14 stunt the development of share markets. It is sufficient to note here that the expanding literature on the role of finance in economic development has raised many related theoretical and policy issues.~S

While quantitative tests have not produced conclusive results on any significant causal rela- tions between selected indicators of financial development and economic growth, existing evidence suggests that financial development could be an important factor in sustained economic growth. 16 In recent years, however, the financial liberalization argument based on rapid deregulation of the banking sector and loosening of controls over real interest rates is increasingly being revised and challenged. ~7 Acceptance of economic liberalization does not necessarily imply the acceptance of a policy to raise the real deposit and lending rates. 18 This rethinking and the move toward a more cautious approach to financial development and liberalization are based on several considerations. First, the theory of adverse risk selection has cast new light on the whole interest rate reform process. ~9 Moreover,

CAPITAL MARKETS IN CHINA 513

the contrasting experiences with financial development in East and Southeast Asia and in some Latin American countries have also raised questions as to the effectiveness and desirability of complete and rapid financial deregulation in developing economies. 2° More important perhaps for the subject of this paper, is the recognition that the "new orthodoxy" of the financial liberalization theories may have focused too narrowly on real interest rates and the formal banking system, and neglected the impediments of imperfect information, the oligopolistic banking structure, and the informal credit markets. 2t Complete liberalization of the banking sector will therefore not achieve efficient capital allocation in the absence of a well-functioning equity market. Substantial development of an equity market can be considered as a necessary condi- tion for complete financial liberalization.

The theoretical developments discussed above seem to have had little impact upon either policy making or academic research in China. Further- more, neither the financial liberalization debate in the West, nor the Eastern European literature on market socialism and economic reform have devoted much attention to the issue of financial development in the restructuring of centrally planned economies. Indeed, Nuti's observation that the development of monetary and financial institutions in the "reformed" socialist Eastern European economies had simply imitated without change a few capitalist institutions may be just as pertinent in China's case. 22

Despite the neglect of research and the absence of formal theory and ideology on the subject, China has experimented extensively with various forms of new financial institutions and instruments such as bonds and shares. The question here is whether capital markets have a place in the reform and development of a socialist economic system in which the ill-defined "public ownership" of the means of production remains the dominant ideology.

Direct finance by means of equity issues previously has not been accorded any priority in developing economies. An efficient banking system is often seen as the major form of financial development for developing economies. There is certainly a need to reform the traditional socialist monobanks in China. These monobanks have acted only as an instrument for central planning and control of credit and cash flows, and are the antithesis of competitive banks in the market system.

Despite the reforms introduced during the past decade, China's banking system does not function efficiently nor has it created an environment in which monetary policy objectives can be

effectively implemented. 23 The central bank has continued to rely primarily on discretionary administrative measures for monetary and credit controls. The problems facing China's banking system are complex. It is sufficient to highlight here several major weaknesses that have contri- buted to the growth in China's nonbank financial activities in recent years.

First, in rationing credit, Chinese banks, under pressure from local governments, have been unwittingly contributing to excessive credit expansion. 24 The compartmentalized system of China's banking organizations has facilitated the segmentation of the country's financial flows with adverse consequences in fund allocation and utilization. The Chinese central bank's inability to resist credit demands expanding to finance enterprise loans and government budgetary deficits is at the core of the problem. Apart from the now widely recognized problems generally associated with credit rationing, Chinese banks are also burdened with serious problems of loan recovery. While national statistics are not available, extensive local reports on the high percentage of overdue repayments and nonperforming loans, ranging from 20% to 80% of outstanding loans, suggest a serious constraint on the ability of the banks to perform fully their role as financial institutions. 25 Incompetence and a high level of bad debt are not uncommon in the bank lending of developing countries, but the problem of moral hazard in the Chinese banking system is serious and destabilizing since neither the banks nor the enterprises face any real threat of closure.

Credit rationing is usually expected to bias the system in favor of larger firms. The smaller Chinese firms, particularly those run by private individuals, are often unable even to open a bank account. The emergence of nonbank financial institutions such as urban credit cooperatives, and the development of the informal and formal capital markets are therefore part of the market response to the inadequacy and weaknesses of the banking system. Transaction costs in banking services for rural and smaller enterprises can be very high in terms of waiting time, distance from bank branches, and delays in clearing and transfer of funds. 26

The high percentage of bank borrowers who operate continuously at a loss, and the lack of professional and specialized training among Chinese bank officers further attest to the weaknesses of the present Chinese state banking system during this crucial stage of transition and reforms. 27

In other developing countries such as South Korea, where artificially maintained low-cost bank lending restricted access to finance, the


informal financial sector has expanded rapidly to satisfy the unmet demand for funds. Private lending in the curb market, initially in the rural sector, has certainly grown significantly in China in the past 10 years. 28 The rather mixed performance of China's formal rural credit institutions, comprising the Agricultural Bank of China (ABC) and the networks of rural credit cooperatives (RCCs), has not helped to alleviate the demand for funds during a period of rapid rural growth. 29

Subsidized bank loans in developing countries tend to favor larger companies. Smaller firms and farmers usually have to turn to the informal money markets for funds. In this respect, there is a difference between China and many developing countries. Because of their high profitability and importance as a source of local tax revenue, Chinese rural enterprises are generally able to obtain bank credits and have at the same time become active participants in promoting China's fledging capital markets. Capital markets in developing economies are not normally a prin- cipal avenue for financing investment. The Chinese experience in recent years therefore offers an interesting contrast.

3. CHARACTERISTICS OF THE CHINESE CAPITAL MARKETS

While there are no comprehensive, systemati- cally collected data on enterprise securities, and the available information is often not well defined, Table 1 indicates that there was a substantial increase in the volume of enterprise shares and other bond issues between 1985 and 1989. Compared with the flow of bank loans for fixed capital investment in Table 2, the outstanding stock of all enterprise securities was not insignificant. This occurred at a time when enterprises increasingly had to raise their own funds for capital investment, as Table 2 shows. Data in Table 1 also indicate that the volume of trading in the stock exchanges was insignificant and that the size of government-issued securities increased rapidly.

Since the early 1980s, smaller enterprises at the county and rural township levels have been the primary force in the development of new financial instruments such as bonds and shares in China. The larger state-owned enterprises did not participate initially, although later they too became active in share issues of various descrip-

Table 1. Estimates o f bond~share issues

1985 1986 1987 1988 1989

(1) Aggregate enterprise shares/ bonds*

(2) Issued shares by joint stock companies*

(3) Issued shares*

(4) Number of enterprises (medium & small) adopting share system

(5) Value of shares traded in stock exchanges**

(6) Total securities issued (including treasury bonds & other government bonds)*

(7) Number of stockbroking companies

(8) Number of nonbank financial institutions permitted to trade in primary & secondary markets

10 12 21 26

2.4 5

6 6

6,0011

0.2

67 1(~) 145

33 44

8(~1

2.3

Source: Xu Jingan (1987a), p. 184; Renmin Ribao (December 4, 1986); Jingji Yanjiu (1989), p. 26; Wang Mengkui and Xing Junfang (1987), p. 6; Jinrong Shibao (October 19 and October 28, 1988), p. 1 (May 30 and June 13, 1990), p. 1 ; Research Centre for Economic, Technological and Social Development of the State Council (1988); Jin Jiadong (1988), p. 6. *Billion yuan, balance at end of the year. **Billion yuan.


Table 2. Sources of fixed capital investment in China (billion yuan)

Foreign Funds raised* State budget Domestic loans funds by enterprises

1981 26.976 (28.1)t 12.20 (12.9) 3.636 (3.7) 53.289 (55.5) 1982 27.926 (22.7) 17.612 (14.3) 6.051 (4.9) 71.451 (58.1) 1983 33.971 (23.7) 17.550 (12.3) 6.655 (4 .7) 84.830 (59.4) 1984 42.100 (23.0) 25.847 (14.1) 7.066 (3.9) 108.274 (59.1) 1985 40.780 (16.0) 51.027 (20.1) 9.148 (3.6) 153.364 (60.3) 1986 44.063 (14.6) 63.831 (21.1) 13.216 (4.4) 180.851 (59.9) 1987 47.554 (13.1) 83.594 (23.0) 17.537 (4.8) 215.401 (59.1) 1988 40.268 (9 .0) 91.459 (20.3) 25.451 (5.7) 287.481 (65.0)

Source: SSB (1989), p. 477. *Includes retained profits, extrabudgetary funds, fiscal loans, and other forms of finance. t( ) = percentage of annual total.

tions for different purposes. Indeed, since the end of 1987 state enterprises have been targeted by Chinese economists and policy makers for bringing about a shareholding system in China. 3° Several large state enterprises were thus given permission to experiment with public issuance of shares. 31 It is perhaps not unexpected that state enterprises would not be the most active sector in the initial development of capital markets. After all, "privatization" of public enterprises in the highly developed market economies of the West has been a rather slow and difficult process, although the policy concerns and processes of change are obviously quite different from China's.

credit explosion in the fourth quarter of 1984 prompted the Chinese government to make a series of ad hoc attempts to rein in the uncon- trolled monetary growth. Table 3 and Table 7 provide some indications of the rapid money supply growth at the national and provincial levels, respectively, in the months leading to and following that explosion. This phase of capital market development after 1984 saw the increasingly more active participation of urban state enterprises. Their objectives included raising capital as well as circumventing regulations on the distribution of enterprise incomes and profits.

(a) An overview Table 3. Monetary and credit movements 1984--85

(billion yuan)

When a textile factory in Shanghai issued shares to raise money for a new workshop in 1981, it was accused of adopting capitalist ideas. 32 This ideological tenet has since gone January through some notable changes. Over the past few February years, raising capital through share or bond March issues by economic agents has become increas- April ingly more common. This process, carried out in May a rather uncoordinated and sporadic way, has June gone through three qualitatively distinct phases. July

The first stage of capital market development August in China began with the economic reform of September October 1978. It can really be considered part of the November rapidly developing informal credit sector, which December has been revitalized by the economic reform program. The decollectivized and liberalizing rural sector encouraged a process of virtually unfettered growth in new financial institutions and instruments during the early 1980s.

The second stage was reached when the bank

1984 1985 CIW BLNt CIW BLN

8.8 4.7 -8.7 0.4 - 1.9 329.2 -5.6 441.9 -0.9 -2.0 -2.0 -2.2

0.9 332.1 1.9 446.9 2.8 2.6 2.2 1.5 4.5 358.2 2.7 471.0 5.6 1.2 5.7 6.3 9.1 441.9 8.5 590.6

Source: People's Bank of China. *CIW Net injection/withdrawal of cash per month. tBLN Aggregate bank lending, balance at end of each quarter (consolidated total loans by all state specialized banks).


The third stage was reached in late 1987 under rising inflationary pressure as the central government failed to exercise effective monetary and credit controls. The incorporation of inflation expectation in the economic calculation of pros- pective asset holders raised the cost to the issuers as yields needed to be increased. The central government's proclaimed interim laws on securities issues banned state enterprises from issuing equity shares without special approval. The main policy focus during that time appeared to be the building of formal institutional arrangements, including the establishment of stock exchanges to promote secondary markets. Increasingly, capital market development was regarded as a means to convert enterprise organizations into various forms of joint stock companies.

(b) Informal credits

The early phase of China's capital market development was dominated by informal credits. These rapidly developing informal markets were initially based on rural borrowing and lending activities outside the officially sanctioned state- owned banking system (including the RCCs). They had their origins in the days prior to decollectivization. In the early 1970s, production brigades and teams had turned to tan pai, i.e., compulsory financial contributions from team members to finance major investments. Some rural collectives treated such contributions as loans and paid high rates of interest. The volume of such flows reached its peak in early 1978 when the Chinese government called for the basic mechanization of agriculture within three years. 33 However, that method of fund-raising by rural collectives ended with the economic reform, which resulted in the fast-diminishing role of the rural collectives, the demise of the national mechanization objective, and loosening of state contol over the scope of household economic activities.

The decolleetivization process gave rise to the need for new forms of financial assets. The break up of the collectives and the subsequent disburse- ment of their assets often necessitated new financial arrangements and instruments to implement such reorganization. Another stimulus stemmed directly from the collapse of the collectives and the ascendency of the household as the basic economic unit in the rural sector. As the prevailing formal financial institutions were set up to cater to the financial needs of collectives, with highly restrictive and inadequate services, new demands by the more diversified farmers, the self-employed, the individual traders, and

new workshops gave rise to formal and informal financial market development.

As Table 4 indicates, China's informal credit activities had a high positive real rate of interest, a characteristic common to other developing economies. Of the reported samples in the table, most of the loans supplied by private lenders were used for income-producing activities. In reality, however, the role of informal credit in financing the rapid growth in rural housing and other major consumption items may be pro- portionally more significant, although information on this is scarce. Column 5 of the table suggests that informal credit played a dominant role as a source of loans to rural households. In areas where informal credit activities flourish, they can therefore be expected to rival the ABC and RCCs. In such cases, informal credit is no longer marginal. Although China may not have experienced a genuine, orthodox financial liberalization process in the early 1980s, the impact of the informal credit markets on the country's financial management was still important. 34

First, by supplying an alternative source of funds, informal credit provided the formal financial sector with needed competition. Judging from the relatively well-documented economic and financial development in Wenzhou City, 35 such competition effectively forced the formal state-owned financial institutions to set up new companies capable of being more responsive to market forces, and able to circumvent existing government restrictions on interest rates and the scope of lending. Second, more organized financial institutions have evolved from the private, informal (and sometimes underground) credit associations (hui). Successful individual money lenders have become more organized financial intermediaries by operating private money shops (qian zhuang) which take deposits from the public and make loans. 36 In both areas, some private share issues may also be made in estab- lishing the equity capital base of the new financial entities.

The developments discussed above are certainly consistent with the general observation that a fragmented economy with financial disequilib- rium due to regulation and low real interest rates often encourages informal money markets operating outside the purview of the monetary authorities. 37 These developments also paved the way for the issuance of new share by township and village enterprises in the early 1980s.

(c) Enterprise securities issues

While there were many variations and no

CAPITAL MARKETS IN CHINA

Table 4. Informal financial markets*

517

Region

Proportion Interest of households Rates with loans Use Scaler

Sichuan Province 2-2% 100% (60 rural households) (per month)

Hubei Province 20-100% 74% (918 households) (per year)

Hunan Province over 20% n.a. (per year)

Jiangsu Province 2-5% n.a. (4 villages) (per month)

Baoji City 10-100% 100% (2,485 households) (per year)

Wenzhou City 40-50% n.a. (per year)

Qinggou Village, Jiangsu 24-70% 100% (700 households) (per year)

Heinongjian (3 counties) 30-90% 44% (per year)

86% for producing income 50% (commerce, transportation, industry)

73% for consumption (of 100% which 34% for house construction)

n.a. 10%

59% rural enterprises, 32% transportation

100% for producing income

100% for producing income

mostly for producing income

62% purchase of production inputs 13% commerce 25% consumption

200%

100%

1,300%

80%

Source: Du (1987), pp. 18-19; Nie (1987), pp. 4(~47; Jinrong Shibao (February 25, 1989), p. 1, (June 17, 1988), p. 2; Nongcun Jinrong, No. 7 (1987); Nongcun Jinrong Yanjiu, No. 7 (1987), p. 24; Liu and Lin (1987), pp. 45-46; Jinrong Shibao, (June 17, 1989), p. 1, (May 31, 1989), p. 1. *Rural informal credits totaled 40 billion yuan in 1989. tTotal outstanding informal loans as a percentage of loans from the formal sector, i.e., the ABC and RCC.

formal regulations on the issuance of shares by enterprises until 1987, 38 four main formats adopted during the various stages of development can be identified.

(i) Equity shares These shares were issued to reorganize the

properties, including land and factory buildings, of previous commune members and various enterprises set up by the now disbanded rural communes and brigades. Because of a lack of clear delineation and codification of property rights under the previous rural commune system, the reorganization achieved by such share issues simply represented a break from the muddled transfers of "ownership" and their subsequent

o 9 reversions on several occasions in the past. As the economic reform process unfolded, the possibility of takeovers and mergers among state enterprises also created new opportunities for property rearrangements. 4° As will be discussed in the next section, the controversial "enterprise

shares" (jiyegu) that state enterprises issued to themselves in various experimental attempts at separating enterprise management and control functions would later become a major point of contention in the ownership reform debate.

(ii) Employment~supply shares Employment-linked shares were issued by

collective and state enterprises. This format was more common among rural townships and villages. Since most of the new rural enterprises were formed with a very small amount of initial capital, many found it desirable to set up fund- raising schemes under which purchase of a certain amount of enterprise shares would entitle the asset holder to nominate someone to a position within the enterprise. Such quid pro quo arrangements were attractive to those rural households that could afford to pay the required sum, ranging from a few hundred to thousands of yuan. Such shares normally would pay interest well above bank deposit rates, with the addi-


tional benefit of dividend payments (which were sometimes guaranteed). Despite the lack of a secondary market, share liquidity was ensured, as most shares were fully redeemable upon request, The other attractive feature was that shares were a convenient way for rural households to get their family members employed as industrial workers, which was usually considered to be a more desirable occupation. Such share issues were generally not associated with any rights of representation in enterprise management. There were rarely formal articles of association, but the fact that the investors could have a family member working in the factory may have reduced their perception of risk.

This form of capital raising was not limited to the rural sector. Some urban collective enterprises with predominantly state ownership and control raised substantial amounts by linking the offer of employment to share subscription. For example, the Chengdu People's Shopping Com- plex stipulated that one position in the enterprise would be offered to any individual holding 20,000 yuan of shares. For other economic groups or government units, the amount was set at 100,000 yuan. The complex offered 70 new positions in that way. 41 In China's capital market development, most issues appear to have had some form of nominal endorsement by various levels of local government, although the validity and strength of such endorsements were never made clear. 42 A variation on this format of share issue is the linking of supply preference to corporate shareholders. The issuing enterprise in such cases often produces goods or materials in short supply. Such transactions can be regarded as a response by enterprises to get around the restrictions on intercompany loans.

(iii) Workers" shares Issuance of shares to existing enterprise work-

ers was common initially among rural enterprises and subsequently became popular in state enterprises. Such issues were sometimes used to expand production facilities or to modernize equipment, but more often they were simply a device to raise the level of wages and bonuses to workers in an attempt to avoid taxes and bank supervision over total remuneration. Most issues promised interest rates at higher than bank deposit rates in addition to fixed dividend payments. In some cases, shares were simply given to employees free of charge. 4~ The quantity of such issues was usually small in relation to total enterprise capital. Transactions were generally not properly conducted, with no "ownership" or management rights conferred. Thus, the claim that this form of capital raising would improve

workers' sense of belonging and initiative was not well founded. There is little evidence to suggest that workers' participation in management through shareholding or that enterprise privatization were really intended. It should be noted that not all purchases of such assets were voluntary. Some enterprises under financial pressure re- portedly resorted to coercion to "'sell" shares to employees. 44 The amount of such forced subscription could amount to 80% of a worker's annual wage. Such coercion sometimes meant that workers might be prevented from working until they had purchased their assigned amount. 45

Together, "employment shares" and "'workers' shares" constituted what were sometimes known as "personal shares" (in both state-owned and group-owned enterprises). According to the Agricultural Bank of China's survey of 12 counties, as of 1984 these two forms of capital raising already amounted to a total of 3(11) million yuan. 46 Some Chinese commentators believed the development of personal shares would result in the restoration of private ownership and with it "disastrous unrest, division and suffering. "47

(iv) Public shares The fourth type of shares involved enterprises

issuing shares for public subscription, either directly or through some form of brokerage agency. The main motivation for such issues was to raise initial capital to form a new enterprise or to diversify and extend existing economic activities. In some cases, money raised in this way was used to establish the initial equity base so that enterprises could then qualify for larger bank loans. In other cases, the share issues were used as a substitute for bank loans, especially during tight credit conditions.

The four types of shares have a wide range of variations, and some enterprises issued more than one type. In general, most were marketed informally and were never reported to any monitoring agencies. 4s Since most of them were new issue activities independent of any develop- merit in secondary markets, the true value of such securities is difficult to estimate. A study of developing countries by Wai and Patrick suggested that new issues of securities financed between one-quarter to one-fifth of domestic investment and that government securities accounted for 6(I-80% of the total new issues. ~9 China's early experience appeared not to re- semble that of other developing countries in this respect. Table 1 suggests that the nominal value of all outstanding enterprise securities at the end of 1985 was 10 billion yuan. The outstanding new issues of government securities at the same point


in time amounted to approximately 28.7 billion yuan. 5° Total fixed capital investment for the year was over 253 billion yuan (Table 2). If half of the outstanding enterprise securities were newly issued during 1985, and if they were used to finance capital investment, then their value would only account for about 2% of the year's total fixed capital investment. 51 Table 5 provides an indicative profile of share issues in various regions of China.

The development of capital markets in China has been closely linked to the process of fiscal, banking and enterprise reform. Because China's economic reform is partial and often uncoordinated, new opportunities are constantly created for enterprise managers, households, workers and local governments to maximize their perceived interests. With the exception of rural

industrial enterprises, the nonstate corporate sector is dominated by small, family-owned businesses which are unlikely to engage in issuing shares. On the other hand, state enterprises may be able to restructure their capital base if supported by the government departments (central or subnational) that "own" them. In a fiscal environment where local governments are moti- vated to expand their local revenue source, enterprises can normally expect support from the local government for their securities issues.

(d) Economic environment for capital market development

Although the new form of capital raising through securities issues did not receive official

Table 5. Surveys of share issues, 1988

(A) 23 Provinces, Municipalities, September 30, 1988 (1) Total share issues (cumulative)

for public subscription for private issues (mainly issued to enterprise employees) other 1.19 billion yuan

(2) Promised fixed interest rate 15-20% (in addition to dividends)

(B) 12 Provinces, Municipalities, August 30, 1988 (Total issues in this survey account for 87% of the 21.4 billion yuan in

21.4 billion yuan 14.09 billion yuan 6.12 billion yuan

(A1) above) State shares 36.6% Enterprise share 43.3% Individual shares 20.1%

(C) Sichuan Province Issued shares 104.76 million yuan (cumulative value) as of July 31, 1988

for public subscription 60% transferable, nonredeemable 87.5% number of cities with secondary markets 6

Shenyang City Issued shares 410 million yuan (as of June 1987)

Shanghai City Issued shares 1 billion yuan (as of May 1989)

number of enterprises involved 1,255 number of companies listed in the stock exchange 6

Chengzhou City Issued shares 53.86 million yuan (as of December 31, 1986)

for public subscription 78.17%

Sources: Jin Jiadong (1988), p. 6; Jinrong Shibao (November 14, 1988), (May 4, 1989); Shenyang City Commission for Economic Reform (1987); Chengzhou Finance Society (1987).


central government sanction until the end of 1983, 52 it had been common for enterprises to provide some kind of official guarantee for quick redemption of the issued securities. Such guarantees were often associated with the local min- istries that had administrative or planning responsibility over the issuing enterprises, or with the financial institutions that helped in the direct issue or the underwriting of the sale of securities. The asset holders could be led to believe that such guarantees were backed by the government.

In July 1984, Beijing's Tianqiao Department Store launched China's first public new issue of shares by a state-owned enterprise. Tianqiao's issue of three million yuan was fully subscribed at face value by ofher enterprises, individuals, and by the state (holding 24% of issued shares, the biggest share holder). 53 Neither company records or accounts, nor articles of association were released to the shareholders. The company's fixed assets were assessed at 1.7 million yuan. The funds raised by the share issue were used to expand retail outlets and to enter into supply arrangements with enterprises. The shares guaranteed a fixed interest rate of 15% per annum in addition to the possibility of dividend payments. The prevailing one-year bank savings deposit rate was 4.68%. Shares of 200,000 yuan would in principle give the shareholder the right to appoint a director to the board. The rights of shareholders were, however, ill defined and limited. Tianqiao's issue, although not implemented within a tightly constituted legal and financial framework, was nonetheless more orga-

nized and incorporated more formal stipulations that gave a semblance of a proper new issue of shares than many other issues up to that time.

The significance of this share issue, however, lay in the fact that Tianqiao was the first state enterprise to expand its equity capital base with explicit acknowledgement of the diluting effect on state ownership. While this by no means created a model or precedent for reforms in public ownership or in the system of enterprise management, it nevertheless signaled official tolerance, if not encouragement, of this new approach to capital raising. Many other experiments with share issues by state-owned enterprises of various sizes followed and the controversy over this question continued.

The Tianqiao issue was made just before the Chinese Communist Party's "Decision on Re- form of the Economic Structure" in October 1984. The "Decision" called for greater enterprise autonomy and the separation of "ownership" and "control" of state enterprises in a bid to improve operational efficiency. It legitimized a further liberalization of the ideological and economic environment. The tax-for-profit substitu- tion program, designed to give enterprises more autonomy over their finances was to be completed by the end of 1984. As Table 6 indicates, there has been rapid growth in money income, wages for urban workers and household liquidity. These increases probably provided favorable conditions for the marketing of new financial assets which promised a substantially higher rate of interest than regulated bank deposit rates, particularly when prices were rising. The

Table 6. Money income and liquidity in China (billion yuan)

Yearly change Wages Net Urban &

in paid to increases of rural Total retail state & bank & RCC savings

money price collective loans in the deposit income index enterprises rural sector (year-end)

Cash m hand

(year-end)

1980 253.6 6.0% 83.50 3.65 39.95 1981 271.67 2.4% 90.04 1.14 52.37 1982 302.62 1.9% 96.89 2.08 67.54 1983 344.06 1.5 % 104.29 2.64 89.25 1984 445.69 2.8% 125.33 12.72 121.47 1985 564.54 8.8o/o 153.63 2.10 162.26 1986 630.00 6.0% 165.13 7.45 223.76 1987 757.30 7.30/0 186.84 9.67 307.33 1988 960.30 1 8 . 5 % 229.46 4.12 380.15

28.12 33.29 37.33 45.82 65.93 82.00 97.21

116.13 169.3(1

Source: SSB (1989), pp. 598-599, p. 689.

CAPITAL MARKETS IN CHINA 52l

burgeoning growth of rural industrial enterprise, on the other hand, created a rising need for equity finance to complement finance from the state banking system as banks began to impose borrowing conditions that required some initial equity capital before loans could be granted. 54

In the administrative regions that were given greater autonomy to experiment with economic and financial reforms in 1985, local government policy was to "support and guide" the development of these financial innovations. 55 Govern- ments down to the township level were empowered to issue securities, and state enterprises could also issue shares subject to some vaguely defined ratios for capital gearing. Thus, state enterprises in cities such as Chongqing, Shanghai, Nanjing, and Chengdu started to issue securities. It appears that issues by state enterprises were mostly confined to workers within the enterprises. 56

Although the credit explosion at the end of 1984 helped to increase significantly the liquidity of both the enterprises and the households, it is not clear to what extent this expansion has affected their desire to engage in the buying and selling of securities. It was perhaps the announced tight monetary response after the credit explosion at the end of 1984 which gave real impetus to the development of securities issues. Two factors were at work during the months after the credit explosion.

The first was the temporary but significant decrease in bank lending (an attempt to squeeze credit), with rural enterprises being the hardest hit. Table 7 shows this dramatic change. Figures on national bank loans and net cash injection/ withdrawal in Table 3 are consistent with such movements. The second factor was that the excess demand for credit at the regulated interest rates was aggravated by China's inexperience in managing a banking system which was only institutionally completed in 1984. The four specialized banks in fact competed for lending business by lowering the effective interest rates for loans and by relaxing lending cri teriaY thus further diminishing the capacity to raise deposit rates. While price inflation was creeping up to double-digit figures, residents with growing bank deposits and cash in hand (Table 6) were increasingly looking for more attractive financial assets to hold, even though the general financial sophis- tication of the public, as well as of the banking and financial system, was not very high or mature.

The willingness of issuers to offer guaranteed higher rates of return with the common option of immediate redemption therefore appealed to

s8 potential holders. The spate of enterprise issues

Table 7. Sichuan Province." Changes* in bank and RCC loans granted to rural township and village enterprises

(million yuan per month)

Year Month Bank Loans RCC Loans Total Loans

1984.01 -41.47 14.84 -26.63 1984.02 -20.04 -21.49 -41.53 1984.03 32.40 17.14 49.54 1984.04 0.03 2.84 2.87 1984.05 7.08 0.09 7.17 1984.06 27.08 26.94 54.02 1984.07 18.80 -2.65 16.15 1984.08 37.47 21.18 58.65 1984.09 22.44 10.02 32.46 1984.10 37.52 9.55 47.07 1984.11 68.25 28.48 96.73 1984.12 389.56 35.46 425.02 1985.01 -300.71 17.47 -283.24 1985.02 - 198.73 -83.91 -282.64 1985.03 80.44 10.02 90.46 1985.04 - 128.34 -48.16 - 176.5 1985.05 -40.95 -32.89 -73.84 1985.06 4.40 - 1.72 2.68 1985.07 22.42 15.38 37.8 1985.08 - 18.48 7.92 - 10.56 1985.09 - 10.42 - 8.50 - 18.92 1985.10 - 11.60 -3.87 - 15.47 1985.11 26.19 2.18 28.37 1985.12 65.78 34.95 100.73

Source: Sichuan Branch of the People's Bank of China. *Change in volume of loans over preceding month.

since 1985 prompted some local governments to draft interim laws to regulate such activities, as there was no national legislation. 59 By early 1986, it appeared that the Chinese government was on the verge of adopting a more coordinated approach to the economic reform process by integrating price reform with financial and fiscal reforms. However, this coordinated approach with price reform as the centerpiece was never realized, and the focus of the reform strategy shifted in late 1986 to the introduction of a contract responsibility system in state enterprises. There were concurrently debates over whether the share-ownership system was an alternative to price reform or the next stage of economic reform.

The expectation that the government would eventually develop a policy for shareholding in state enterprises gave the overall development of capital markets much-needed legitimacy. National laws concerning the issuance of financial bonds were finally proclaimed in 1987, although ideological and practical problems associated with the "privatization" of state-owned


enterprises have prevented the adoption of clear- cut policies and laws on share issues. In spite of such difficulties, "stock exchanges" have been set up in a number of cities. In fact, the Chinese government was considering the establishment of a network of stock exchanges in 1988. ~ The alarming rate of inflation in 1988, on the other hand, seriously threatened the stability of the economic reform program. The liquidity and solvency of the country's banking and financial institutions were severely tested. Reports of bank branches running out of cash because of drastic withdrawals of deposit monies were frequent and extensive. The raising of bank lending and deposit rates on several occasions during 1983-88 was not sufficient to cope with the loss of depositors' morley illusion under worsening price inflation. The continued development of capital markets was in a precarious situation.

4. MAJOR POLICY ISSUES

The recent development of financial markets in China has represented a response to the new demands created by the economic reform process. This response has been the result of rational reactions by the country's economic agents, now operating more autonomously, to seek maximum returns on their activities. The response has been based on new opportunities created by the complex interplay between the deregulation brought by the reform and the persisting or newly imposed controls that restrict economic autonomy. There has been no clearly and consistently defined policy as to the objectives of capital market development and the preferred strategies to promote or restrict it. This characteristic is consistent with China's overall reactive and ad hoc approach to economic reform via "grasping the rocks to cross the river." Therefore, the supply and demand for shares have been seen. at different points in time and in different regions among different enterprises, as a policy issue for financial mobilization, a channel for workers' participation in management, a tax evasion device, a means to increase enterprise autonomy, a fundamental reform in property rights, a part of "privatization," a precondition for price reform, or an immature and undesirable development that creates unnecessary obstacles to economic and monetary controls.

The controversy in China surrounding capital market development also reflects the complexity of and confusion over several questions for policy consideration. As China's economic reform has been an incomplete process, centralized corn-

mand and deregulation of economic activities often coexist even within a sector or industry. The dual price system is a telling manifestation of the problem. The difficulty of finding an opti- mum solution to this multifaceted, second-best situation is serious. The discussions below will examine some of the major policy issues associated with capital market development in China.

One major issue is the relation between capital market development and the establishment of a shareholding system as the means to reform the management and ownership control arrangements of the state industrial sector. There are two relevant considerations here. First, capital markets in China will certainly not be capable of full development without the participation of the country's state enterprises, which account for over 70% of industrial fixed capital. There are certainly numerous kinds of shareholding systems through which such enterprises could be reformed. Various assertions have been made concerning the possible causal relationship between these alternatives and management efficiency, effectiveness of fiscal and monetary policies, workers' motivation, capitalist exploita- tion, and compatibility with socialist principles. 61 Second, the establishment of a shareholding system to separate ownership and management in Chinese state enterprises is closely related, but not identical, to the development of capital markets, as each requires different changes and conditions. On the basis of the limited changes and experiments that have taken place in China, capital market development and the attempt to separate state ownership control and management of enterprises have indeed proceeded on diverse modes and objectives. Despite the hopes of some Chinese policy makers and economists who wish to see the two develop in concert, m existing evidence indicates that there are still far too many obstacles and distortions in the Chinese economic system for this to occur.

The problems facing the further development of capital markets in China impinge upon two broad policy areas. The first concerns the Chinese government's perception of socialist principles regarding the country's ownership and enterprise management system. A closely related issue is the mode of enterprise behavior. The second area is the effectiveness of macroecono- mic policies in monetary and credit management.

(a) Socialist ownership and enterprise behavior

The first policy issue that concerns the Chinese leadership appears to be the perceived conflict


between capital market development and the ideological principle that socialism should be based on "public ownership." Although since 1984 there has been an increasing recognition, even among those who oppose the weakening of the dominance of state ownership, that state ownership need not always incorporate full direct management controls over enterprise operation, there remains a strong view among some Chinese leaders and economists that, in order to preserve the characteristics of socialism, the dominant position of state ownership should not be changed. Opinions as to how this can be achieved are diverse. 63

The contract responsibility system introduced nationally in 1987 was seen by the government as the most appropriate means of preserving socialist ownership and improving enterprise performance .64 Most Chinese economists, however, view it as a transitory step. Some regard it as unnecessary and regressive because it strengthens the bargaining process between enterprise management and the government while not achieving any significant progress in changing6~the .paternalistic relanonsh~p" " between the two. - W~thout a resolution on how state ownership should and could be maintained, 66 the future of the large-scale development of equity shares by state enterprises is not politically feasible. In this respect, the controversy surrounding the question of "enterprise shares" is indicative of the complex policy issues involvedY The loosely defined "enterprise shares" in Section (B) of Table 5 represent a significant proportion of the issued securities in that survey of 12 provinces.

Enterprise shares came about with the granting of more financial and operational autonomy to state enterprises. Such shares are created when enterprises reinvest the part of after-tax profits that they are allowed to retain. Enterprise shares are held by the issuing enterprise itself as an entity and are not transferable to individuals or workers. The existence of enterprise shares becomes controversial when an enterprise decides to expand operations through augment- ing its equity capital by public or private issues of new shares. Since the funds for enterprise shares originate from the enterprise's retained profits, which were generated using state-owned assets, and because such profit may be a result of government intervention and regulated product and input prices, there has been strong opposi- tion to an enterprise claiming to have acquired capital of its own in this way. 68 As the Chinese government has not yet reached a decision on whether to give up or transfer its ownership in state enterprises, the creation of enterprise

shares is seen as privatization of state assets by stealth.

The proponents of enterprise shares, however, believe that they will bring about an enterprise- based economy which can rid itself of the problems of centralized controls and intervention while maintaining the essence of socialist ownership. They see enterprise ownership as a viable form of "public-collective" ownership. 69 It is beyond the scope of this paper to address fully the theoretical and policy ramifications of alternatives for changing China's ownership system. However, it is important to note here that the restructuring of the ownership of China's state enterprises is already proceeding under the reform program, although the choice of financial mechanisms through which restructuring can be implemented varies.

The economic reform program has indeed established some necessary conditions for ownership restructuring. The process of fiscal decentra- lization has resulted in linking local governments' revenues and expenditures to the state-owned enterprises under their jurisdiction. In that context, the nature of state ownership has already undergone a de facto change, since these local governments now have predominant claims over the net revenue of such enterprises, and are in many cases responsible for their financial management. Takeovers of loss-making enterprises and the trend to form independent conglomerate groups comprising enterprises under different local government jurisdictions have fundamen- tally altered the way property rights are bundled and exercised.

Of the 400,000 state-owned enterprises, just 9,000 are classified as large or medium-size industrial enterprises. 7° Only one-quarter of the state enterprises are industrial, the rest are in commerce, marketing, or services. According to estimates by the National Commission for the Reform of Economic System, about 30% of state-owned fixed capital is idle. 7~ There is therefore a large number of enterprises which could and should be restructured. In fact, various forms of ownership transfer, such as contracting, leasing, and outright selling of assets, have been tried and are gaining increasing acceptance. 72

The objective of the separation of enterprise ownership and control is to gain economic benefits by eliminating government intervention in enterprise management. However, such benefits are usually assumed to be forthcoming as soon as a separation is made. The more complex question of the economics of the organization of the firm is usually overlooked. 73 This failure to consider the agency problems associated with the various competing claimants of enterprise in-


comes has led to an ill-defined set of rules and national approaches to the development of financial instruments for the separation of ownership and controls.

It may be relevant to consider here Drake's reasons for why many Asian private firms have not wanted to issue shares. These reasons include " . . . the risk of dilution if not loss of c o n t r o l ; . . . the possibility the firm's financial position may be fully disclosed to authorities; . . . pressure from shareholders for dividend p a y o u t s . . , firms may be deterred from issuing shares to the general public if governments hold down the issue price in the primary markets."74 Some of these reasons are exactly the ones that must be overcome in China to achieve the objectives of separation of ownership and enterprise control.

(b) Monetary and credit management

Opponents of capital market development have been concerned about the fluctuations and instability that may be caused by speculative activities and unscrupulous dealings. Some are worried that the development of capital markets will undermine the government's control over the volume of fixed capital investment and its program of key basic construction projects. Such worries are based partly on the questionable assumption that the current controls through the state-owned banking system have been effective.

Another frequently expressed concern is for the possible adverse effects of the withdrawal of savings deposits from the country's banking system and the consequent loss of control over the money supply. 75 The argument is that the higher interest rates offered by securities would drain savings deposits away from the regulated banking system. However, due to varying final uses and liquidity positions of households and enterprises, and the fungibility of financial flows, the net effect on the level of bank deposits cannot be predetermined.

From the perspective of altocative efficiency, the central issue is whether the country is better off with a predominantly bank credit system or with a stronger capital market system. The evidence from developing countries suggests that the bank credit system has been the first to develop for various reasons. However, the two approaches need not be mutually exclusive in China's case. Capital market development could remedy and complement the development and transformation of the Chinese banking and financial system. In addition to having positive micro- economic effects, the broad development of capital markets would enable the government to

achieve better results with its monetary policy. The capital markets could be used to influence bank lending and liabilities through government open market operations and rediscount policies. The reserve system could be made more effective. The potential problems with capital market development have more to do with the lack of an appropriate legal and commercial framework for their proper functioning than with their existence as such.

In China, as in other socialist countries, better utilization and allocation of existing resources are no less important to economic growth than is capital accumulation. Under the economic reforms of the past 10 years, the expanding private economic activities by individual and collective entities, together with the more autonomous state enterprises, have created an economic environment in which the demand and supply of financial instruments have grown markedly.

Compared to the experience in many developing countries, the enthusiasm for capital market development in China can be regarded as an exception. On the other hand, China's capital markets have developed in ways not dissimilar to the informal money markets in South Korea and Taiwan. 76 They can all be considered as a market response to the inadequacy of the regulated and restricted structure of the existing banking system. In China, capital market development has complicated the problems of the paradoxical coexistence of bank credit rationing and easily expandable credits for those who have access to them. Chinese banks have only limited capacity to charge differential rates of interest on the basis of the previous behavior and repayment performance of enterprises. They are generally not able to terminate loan contracts without encountering enormous political pressure from the various levels of government. Therefore, they cannot really carry out their financial intermediary role by making loan contracts an instrument for monitoring and selecting borrowers. 77 Although revenue-sharing contracts such as equity finance may have agency and incentive problems, there can be net gains in efficiency for China's state enterprises as a whole, They must reduce the social and private costs of the waste and resource misallocation associated with undisciplined, easy credit by lessening their dependence on bank credits for long-term capital requirements.

5. CONCLUSION

Capital markets in China grew out of the problems and weaknesses of the Chinese banking


system. Their development is still at an embryonic stage, and there are many problems and obstacles still to overcome. Capital market development has the potential to improve an economy's allocative efficiency and resource mobilization, in addition to producing all the usually recognized benefits of an efficient channel for external finance. What has emerged in China, however, has been a development that was dri~,en by the rising investment demands of econon:ic agents who tried to circumvent various financial restrictions and barriers, and their desire to exploit the financing opportunities in the distorted structures of the economic system. While this may lessen the expected benefits of capital market development, it nevertheless provides a viable alternative to bank finance, and a market-based mechanism that is capable of facilitating other key reforms of the Chinese economic system. In that context, its developmental effects on the reform and modernization process can be no less significant.

Unlike many other low-income developing economies, China already possesses many necessary conditions for capital market development. One missing factor is a well-defined property rights system, with a constitutional and legal framework to protect the claims of economic agents and enforce their responsibilities. Pro- gress in that area, coupled with market discipline and economic responsibility, will help the economic reform process and monetary management at the macro and micro levels. It can provide a relatively immediate and low-cost instrument to implement many of the basic objectives of the economic reform.

The development of capital markets at the present stage of economic development in China will probably involve a close relationship among

the financial institutions, industrial enterprises and some new forms of government trusts or state asset-holding companies. This new relationship could in itself help break down the extensive barriers to internal trade and financial flows.

Although the initial focus of capital market development in China would inevitably be on primary markets, the development of secondary markets would obviously be vital to its long-term success. Various ways have been suggested for promoting secondary capital markets in developing countries. 78 For socialist countries, it has been argued that the development of the functions and mechanisms of competitive bidding and management takeover via secondary capital markets could in fact be more important than for market-oriented developing economies because of the problem of poor and inefficient utilization in the former group of countries. 79

The change of China's top leaders after June 1989 has created uncertainties about the future of the country's economic reforms. While the new leaders are more disposed to employ centralized controls in the Conduct of economic management, a complete negation of the reform measures would be economically and politically costly. The social and economic momentum of China's reformed system will ensure that more positive changes will be made in the future to maintain growth. Since the reform program of the last 10 years has suffered from the absence of a long-term blueprint, the political crisis may turn out to be a catalyst for the eventual adoption of a more committed and comprehensive program of structural transformation to achieve economic growth and development. In that context, the promises and challenges posed by the development of capital markets, with all their policy issues, will remain.

NOTES

1. See, for example, Agtamel (1984), Hakim (1985), 4. Beijing Review, No. 34 (August 22, 1988), pp. 20- and Asian Development Bank (1985). 22.

2. See, for example, Wang G. (1986), Tam (1987), Xu J. (1987a).

3. In spite of the fact that some were really bonds or debentures, the term "shares" was initially favored mainly because it did not carry the ideologically negative connotations associated with the expansion of debt and interest income. The other factor contributing to the confusion in the usage of the term was the lack of understanding by the participants of the finer distinctions among various forms of financial assets.

5. Beijing Review, No. 40 (October 3, 1988), p. 5.

6. See, for example, "Interview with Jin Jiadong, Director of Financial Administration Bureau, People's Bank of China (Beijing)," China Economic News (July 9, 1990), p. 16; Renmin Ribao [People's Daily[ (Janu- ary 3, 1990), p. 1; Jinrong Shibao ]Financial News] (May 30, 1990), p. 1.

7. See, for example, Tam (1986), de Wulf and Goldsbrough (1986).


8. Shareholding has for a long time been the nominal ownership form for some of China's rural economic organizations - - the rural credit cooperatives, and the rural marketing cooperative since the advent of the commune system. Property rights were, however, highly restricted and ineffectual.

9. China's present system of enterprise finance is predominantly based on credits supplied by state- owned banks. Most Chinese enterprises have high debt/ equity ratios and the state banks are not at all effective in their expected role in monitoring enterprise performance (see, Tam, 1986; Tam and Wang, 1987). China's credit-based financial system would not meet Wade's (1988) criteria for an efficient system.

17. See McKinnon (1986), Fry (1988), Snowden (1987), Cho (1986).

18. Snowden (1987), pp. 84-85.

19. See, Stiglitz and Weiss (1981, 1983). For a discussion of its application in the theories of financial development, see McKinnon (1986), Cho (1986). See also Arndt (1982).

20. For an excellent discussion of this subject, see Fry (1088). For example, Fry (p. 326) cites price stability, fiscal discipline and policy credibility as the key factors that explain Asian success and Latin American failure in financial reforms over the past three decades,

10. In examining the issues of financing microanalyti- cally, Williamson's (1988) transaction cost approach maintains that the asset attributes of an investment project differ and that efficiency purposes are served by aligning projects with the varying competencies of governance structures of debt and equity in a discrimi- nating way. Because of the desire by the Chinese government to separate "ownership" from the control and management of enterprises, and to install in them a more efficient corporate organization (including their financing relationship with the state), a similar issue to Williamson's thus arises for Chinese enterprises.

21. Cho (1986), p. 192. More recent works by Wijnbergen (1983) and Buffie (1984), for example, incorporated the functioning of curb markets. Cho (1984, 1986), Snowden (1987) and Sudweeks (1987), for example, have explicitly included the securities market.

22. Nuti (1987), p. 4.

23, Tam (1986), World Bank (1987), pp. 47-55.

24. Tam (1986).

11. The classification of "capital markets" by Wai and Patrick (1973) into the broadly, intermediately, and narrowly defined is followed here with the modification that the narrowly defined markets may operate at times, as in China's case, at which the services of brokers, dealers and underwriters are not required.

12. See, for example, Wilson (1966), Wai and Patrick (1973), Left (1976), Lloyd (1977), Drake (1977, 1980, 1985, 1986), Dickie (1981). As Dickie has shown, comparisons among the capital markets of highly industrialized economies and the less developed ones are difficult to draw, although the evidence seems to suggest that most East Asian countries with lower per capita GNPs generally have considerably less advanced securities markets (Dickie, 1981, p. 193).

13. See, Left (1976).

14. Drake (1986), p. 107.

15. The pioneering works in this field were Gurley and Shaw (1960), McKinnon (1973), Goldsmith (1969), placing the role of finance in development under a regime of regulated rates of interest with inflationary pressure. A growing literature has since followed. See, for example, Abe, et al. (1977); the January 1977 issue of the Journal of Development Studies; Khatkhate (1980), Buffie (1984), Molho (1986), Fry (1982, 1988), Drake (1980), Gupta (1984), Woo (1986), and World Bank (1989) to name just a few. For discussion on the topic in the Asia-Pacific context, see Cole and Patrick (1986) and Fry (1988).

25. Most local reports refer to percentages of overdue and nonperforming loans of specialized banks in a province, county or township. See for example, Jinrong Shibao (October 14, 1988), p. 1; (December 24, 1987), p. 1; (June 17, 1988), p. 2; (December 12, 1987), p. 2; (October, 31, 1988), p. 2; (Novembr 28, 1988), p. 1; (November 23, 1988), p. 2; Nongcun Jinrong ]Rural Finance], No. 14 (1986), p. 18; Nongcun Jingrong Yanjiu ]Rural Finance Studies], No. 5 (1987), p. 23; Jinrong Yanjiu [Financial Studies 1, No. 9 (1987), pp. 54--56.

26. Chengdu questionnaire survey of 200 bank account holders in December 1987. The survey was conducted by the author in cooperation with the Institute for Economic Reform and Management of the Sichuan Academy of Social Sciences.

27. Such serious problems with the banking system have received increasing attention among Chinese policy makers and researchers. However, no significant changes and improvements are evident. For the Chinese debates, see, for example, Li Maoshen (1987); Liu Hongyu (1987); Yang Peixin (1987).

28. See, Lu (1988). For more general theoretical discussions on informal finance, see Drake (1980), pp. 122-154; Bouman and Houtman (1988), pp. 6%90.

29. Tam (1988).

30. See, for example, Li Maoshen (1987), Li Yining (1989), Wang and Xing (1987).

16. See, for example, Gupta (1984) and Woo (1986). 31. State enterprises were prohibited from issuing


shares under the interim draft regulation on enterprise bonds in 1987. See State Council (1987a, 1987b).

32. China Daily (June 7, 1984), p. 12.

48. Interview notes. Mr Shao Qiumin, General Manager, Department of Jnvestigation and Informa- tion, The Industrial and Commercial Bank of China, Beijing, December 10, 1986.

33. See Tam (1985). It has also been reported by Lu (1988, p. 8) that the newly reestablished Agricultural Bank of China tried in 1979, with little success, to put an end to the proliferation of private money lending by announcing the "Circular on stopping fund-raising by communes and brigades via high interest."

34. W ijnbergen (1983) and Buffie (1984) incor- porateu curb market activities in their studies of financially repressed economies. Buffie concluded that the curb market could make financial liberalization a potentially perilous undertaking.

35. For reports on the "Wenzhou model" of development, see, for example, Jingji Yanfiu (1986), Zhou and Di (1987), Ying (1987), Cheng and Shi (1987), Han and Sun (1988).

36. Han and Sun (1988), pp. 25-26.

37. Galbis (1977), p. 59.

38. The 1987 Interim Regulations only set out the principles governing the issuing of bonds and shares by enterprises. Specific laws and regulations were left to the local governments. As of early 1990, the Chinese government was still preparing draft national laws on the administration of the stock exchange, and the issuing of bonds and shares.

39. See Tam (1985) for discussion of this problem of ownership in the context of agricultural machinery and tools.

49. Wai and Patrick (1973), pp. 263-265.

50. Zhongguo Jinrong Nianjian (1989), p. 83.

51. SSB (1986), p. 24.

52. Central Committee of the Chinese Communist Party (1984), p. 2.

53. Interview notes. Ms Liu Fujen, Deputy General Manager, Tianqiao Department Store Beijing, Decem- ber 12, 1986. For details of this share issue by Tianqiao, see Beijing Review (April 10-16, 1989), pp. 21-24.

54. See Tam (1988).

55. Interview notes. People's Bank of China, Chong- qing Branch, August 24, 1985. For instance, the Chongqing region, which included the city proper and several large rural counties, was designated by the Chinese government as one of the "Central Cities" where increased local autonomy was given and was separated from the provincial line of planning and controls.

56. Interview notes, The Industrial and Commercial Bank of China, Shanghai Branch, December 7, 1986. While the Shanghai government had approved planned public issues by over a dozen enterprises, few had occurred.

57. For details, see People's Bank of China (1985a, 1985b).

40. At the end of 1988, it was estimated that a total of 2,856 enterprises were taken over or merged with 3,424 other enterprises. Jinrong Shibao (April 13, 1989), p. 1.

41. Interview notes. Mr Li Bangxiang, Deputy Gen- eral Manager, Chengdu People's Shopping Complex, November 29, 1988.

42. Interview notes. Mr Zhan Nianfang, Bureau of Monetary Administration, People's Bank of China, Chongqing Branch, Sichuan August 24, 1985.

43. Interview notes. Mr Yuan Hongcun, Division of Rural Finance, Ministry of Finance, Beijing, January 16, 1986; Department of Credits, Agricultural Bank of China, Beijing, January 18, 1986.

44. See, for example, Renmin Ribao (April 7, 1989).

45. Chengshi Jinrong Bao [City Financial Daily] (January 27, 1989), p. 3.

46. Lu (1988), p. 10.

58. In a 1987 questionnaire survey of 200 bank account holders in Chengdu City, the author found that this was indeed rated as one of the major considerations. The survey also showed that only a negligible proportion of the respondents regarded the safety and security of the bank as an issue at that time.

59. In 1985, a number of important laws and regulations on enterprises, bankruptcy, and the banking system were still being drafted by the Chinese government. The emergence and marketing of financial securities were therefore not subject to any specific laws and regulations. Local governments such as Shanghai, Guangzhou, Liaoning had introduced local regulations concerning such issues well before the central government announced its national legislation in 1987. It was reported that, since 1984, an average of 1,500 companies were adopting some undefined "share system" each year. Jinrong Shibao (January 10, 1989), p. 3.

60. Research Centre for Economic, Technological and Social Development of the State Council (1988),

47. Li Delu, et al. (1989), p. 3. 61. See, for example, Jiang(1988a);LiYining(1989);


Liu Bo (1989); Fung (1989); Song (1989); Wang Goumin (1987); Wang and Xing (1987).

62. See, for example, Jiang (1988b); General Plan- ning Division, State Commission of Economic System Reform (Ed.) (1988).

63. For summary of discussions in China, see for example, Fan (1987); Zhang and Xie (1987); Wu Yongming (1987), pp. 28-31.

64. See, Yang Peixin (1988).

65. See, for example, General Planning Division (Ed.) (1988); Li Yining (1989).

66. Some Chinese economists have expressed views that public ownership need not be the ideal system for socialism. See Fan (1987).

67. For detailed accounts of the various forms of enterprise shares, see Jiang and Lin (1986).

68. Interview notes. Mr Xie Niezhang, General Man- ager, Dong Hua Industries, Guangzhou, December 6 1988; Xiao Zhouji (1988).

69. Jiang (1988b).

71. Cai (1988), p. 84.

72. Tian (1988).

73. Hax (1989) discusses the general principles of the agency problems that need to be considered in Chinese firms.

74. Drake (1986), p. 100.

75. For debates on this and related topics, see for example, Xiao Liang (1988), pp. 85-108; Wang and Xing (1987).

76. For discussions on such markets in the two countries, see Edwards (1988), pp. 185-194; Shea, etal. (1985).

77. For theoretical discussion of this behavior, see Stiglitz and Weiss (1983).

78. They include tax incentives, imposition of debt equity ratios for companies, requirements of firms over a certain size to have some portion of their shares held publicly, and various forms of privatization schemes. See, for example, Wai and Patrick (1973), p. 289; Drake (1980), p. 208; Wilson (1966), p. 293; Snowden (1987), p. 91; Shirley (1988).

70. Cai (1988). 79. Vahcic (1988). See also Nuti (1987, 1988).

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Documents

Capital market development in China