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China’s WTO Entry and Its Financial Market Reforms

China’s WTO Entry and Its Financial Market Reforms. Rosita P. Chang, Crystal Xiaobei Chen, S. Ghon Rhee College of Business Administration University of Hawai’i International Symposium on Industrial Development and Enterprise Reforms in China

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China’s WTO Entry and Its Financial Market Reforms

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  1. China’s WTO Entry and Its Financial Market Reforms Rosita P. Chang, Crystal Xiaobei Chen, S. Ghon Rhee College of Business Administration University of Hawai’i International Symposium on Industrial Development and Enterprise Reforms in China August 18-20, 2001, Nanchang, Jiangxi, China

  2. Quick Summary of the Equity Market (I) a. Listed Companies 1088 All A-shares 1,060 All B-shares 114 A-share only 955 B-share only 28 Both A- and B-shares 86 b. HK-listed companies 52  H-share only 33 A- and H-share  19 c. NY-listed companies 12 d. Securities companies 100

  3. Quick Summary of the Equity Market (II) e. Market Capitalization $581 billion or 54% of GDP Tradable 33% Nontradable 67% All A-shares 98.68% All B-shares 1.32% Shanghai Stock Exchange 56% Shenzhen Stock Exchange 44% f. Market Turnover 378% g. Investor Accounts 58.01 million

  4. Shanghai vs. Shenzhen Stock Exchanges ShanghaiShenzhen No. of Members 305 326 No. of Listed Companies 572 514 No. of Listed Stocks 614 560 A-shares 559 451 B-shares 55 59 Market Capitalization ($bn) $325.35 $255.64 Tradable 32% 36% Nontradable 68% 64% Market Turnover 370% 387% A-shares 381% 396% B-shares 103% 89%

  5. Weak Links in Financial Markets 1. Market Fragmentation: Different Types of Equity Shares 2. Market Fragmentation: Different Types of Bond Instruments 3. Market Fragmentation: Trading of Bond Instruments 4. Underdeveloped Financial Derivatives Markets 5. Ailing State-Banking Sector

  6. Market Fragmentation:Different Types of Equity Shares Summary Statistics: P/E ratioRemarks A-shares 40-50 B-shares4-5 Over 10% of listed companies but less than 1.5% of market cap. H-shares 8-12

  7. Market Fragmentation: Different Types of Equity Shares Problems: a. Distorted price discovery b. Price speculation Shenzhen B-shares: 210% (1st 5 months of 2001) Shanghai B-shares: 160% Hong Kong H-shares: 53% c. Illegal capital flows Correctional Measures: a. Allowed companies with B- and H-shares to issue A-shares without going through the extensive IPO process (July 2000) b. Allowed local Chinese (with FX exchange accounts) to buy B-shares (Feb 2001)

  8. Market Fragmentation: Different Types of Equity Shares c. Beginning in June 2001, local investors who opened foreign currency accounts were allowed to invest in B- shares d. Silent on foreigners’ investment in China as the B-shares became available to domestic investors e. In June 2001, the government announced a sweeping crackdown on illegal foreign-exchange dealings: “hot money” into Hong Kong Recommendations: No. 1: Eliminate different types of shares No. 2: Cross-list all Hong Kong, Shanghai and Shenzhen-listed stocks

  9. Market Fragmentation: Different Types of Bond Instruments Summary Statistics Unit: Billion Yuan Types Issued (2000)Outstanding (2000) T-bonds 465.7 1,367.4 F-bonds 164.5 738.3 E-bonds 8.3 86.2 Problems: a. Differential interest rate control: i. E-bond yield can not exceed savings interest rate by 40% ii. 20% withholding tax only on E-bonds b. Short-term end of Treasury issues are missing c. Banks are major players while individuals are major investors

  10. Market Fragmentation: Different Types of Bond Instruments Recommendations: No. 1: Consolidate F-bonds into Treasury securities to create a bigger, deeper government bond market No. 2: Convert the E-bonds market into a corporate bond market No. 2: Eliminate interest rate control No. 3: Create balanced term structure interest rates for benchmark interest rates

  11. Market Fragmentation: Trading of Bond Instruments (I) Current Status Interbank Bond Market trades: T- and F-bonds Organized Exchanges trade: T- and E-bonds TotalShanghaiShenzhen Number 46 25 16 T-bonds 31 15 11 T-bond cash 14 7 7 T-bond repurchase 17 8 9 E-bonds 15 10 5

  12. Market Fragmentation: Trading of Bond Instruments (II) TotalShanghaiShenzhen Volume ($ billion)$230.98 $204.12 $26.86 T-bonds $228.23 $203.01 $25.21 T-bond cash 22% 22% 24% T-bond repurchase 78% 78% 76% E-bonds $2.75 $1.11 $1.65 Problems a. Intense competition is lacking on primary market b. Banks are dominant in the interbank bond market, while individuals are dominant in the exchange market c. Secondary market suffers from illiquidity

  13. Market Fragmentation: Trading of Bond Instruments (III) Recommendations No. 1: Develop a primary dealer system for Treasury securities (including F-bonds) No. 2: Utilize the bank-dominant interbank bond market for the People’s Bank of China’s open market operations No. 3: Develop an OTC market network along with interdealer broker system for secondary market trading of bond instruments to absorb exchange trading of bonds as well as T-bond repurchase No. 4: Allow Shanghai and Shenzhen exchanges to concentrate on equity and equity derivatives products

  14. Underdeveloped Financial Derivatives Markets (I) Current Status a. Financial derivative markets were banned (interest rate futures, equity index futures & options, bond futures) since 1995) b. Three Commodity Futures Exchanges in Operation i. Dalian (soybean, doubo, barley) ii. Shanghai (copper, aluminum, rubber) iii. Zhengzhou (wheat, green & red beans, peanut)

  15. Underdeveloped Financial Derivatives Markets (II) Current Status c. Trading Volume (2000): $194.29 billion Agricultural Products 64% Metal Products 36% Dalien 49% Shanghai 41% Zhengzhou 10% Problems a. Risk-hedging is impossible for institutional investors b. Liquidity of Underlying cash markets suffers

  16. Underdeveloped Financial Derivatives Markets (III) Recommendations a. Introduce financial derivatives products (equity index futures and options) immediately b. Introduce short-term interest futures and long-term bond futures as soon as interest rates control is lifted c. Allow Shanghai and Shenzhen Stock Exchanges to manage financial derivatives products rather than creating new derivative exchanges

  17. Ailing State-Banking Sector (I) Current Status a. Big 4 state banks hold 75% of banking assets and 60% of bank deposits Agricultural Bank of China Bank of China Construction Bank of China Industrial and Commerce Bank of China b. NPL Ratio = 40% of combined assets (Official estimate is about 25%) i. Bank of China’s recent Announcement in May 2001: 28.8% ii. MOF issued Rmb270 bn ($32.6 billion) of special bonds in 1998 to recapitalize the four state-banks which transferred Rmb1,400 billion (or $169 billion) to AMCs.

  18. Ailing State-Banking Sector (II) Current Status c. Poor Profitability: ROA=0.19% i. Interest receivable treated as income until loans are declared default ii. Loan-loss provision is subject to 1% of outstanding loan regardless of loan quality d. AMCs are not a viable solution in China i. No or virtually illiquid markets for real assets ii. How can you sell SOEs? iii. Approximately 60% of new loans (extended after NPLs were transferred to AMCs) still go to cash- strapped SOEs in the form of working capital iv. No legal framework is in place to facilitate sale of AMC assets to foreign investors

  19. Ailing State-Banking Sector (III) Recommendation List 4 state banks as well as other public sector sector banks on local and international exchanges. a. Will relieve the central government of its fiscal burden b. Will improve Corporate governance: Transparency and Financial Disclosure c. Will promote accountability of bank management d. Will encourage commercial operations

  20. Ailing State-Banking Sector (IV) Three Banks have been listed in China to raise a total of Rmb 106 (or $12.8 billion) Pudong Development Bank: Rmb 49 billion Minsheng Bank: Rmb 29 billion Shenzhen Development Bank: Rmb 28billion Bank of China’s Hong Kong Operation (in 2001?)

  21. Mahalo for You Attention!

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