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September 26, 1980
China:Mon ey and Banking
China is in the midst of a massive modernization program. The program's success will
depend on many factors, among them being
the development of a modern monetary and
banking system that can assist the nation in
attaining its goal of rapid and stable growth.
Thus, as a basis for appraising the nation's
economic prospects, it would be useful to
examine China's present monetary policy
and banking structure.
Money and prices
Chinese officials claim that China - unlike
most other countries - has succeeded in
keepi ng domestic prices relatively stable over
the past three decades. They admit to a few
lapses, such as in 1956, 1960-62, and more
recently in 1979, when prices had to be
raised because of "transient factors." However, they contend that those exceptions
prove the ru Ie: after each lapse, prices always
returned to roughly the original level. China's
urban-consumer retail-price index rose only
by 15 percent between 1952 and 1978, indicating an average inflation rate of only 0.5
percent a year over that quarter-century. Even
more remarkable, the index showed a
7-percent decline between 1962 and 1978.
It is difficult to evaluate this claim. Unlike
prices in a market economy, prices in China
are fixed by the planning authorities and do
not work to clear the· market. Any inflation
pressure would show up in shortages and
long queues, not necessarily in price increases. Nonetheless, in an era of worldwide
inflation, it is remarkable that basic commodities such as grains, meat, clothing, and
housing cost no more in China today than
they did twenty years ago.
Chinese-government officials explain that the
key to their apparent success lies in a
coordinated approach towards balance
between monetary growth and output
growth. In China, monetary policy is an integral part of overall economic planning. Each
year the central-planning authorities obtain
inputs from the various sectors of the economy and develop three major plans
covering output, manpower and finance. The
financial plan is composed of three segments
the state budget, the credit plan, and the
cash plan
which fit together to determine
the targeted growth in the money supply.
During the year, the monetary authorities
monitor money growth, while the economic
commission keeps track of output developments, and both submit aggregated monthly
and quarterly reports to the central-planning
commission. By July of each year, when
nearly all the crop estimates are in, the
planning authorities make a judgment on
what adjustments, if any, need to be made in
either monetary growth or production and
distribution plans. Adjusted plans are then
drawn up for the second half of the current
year, and these also serve as a basis for formulating plans forthe next year.
China, like other socialist countries, follows a
strict monetarist approach to monetary
policy, but of a 19th-century vintage - that
is, an analytical framework derived from the
simple quantity equation, PQ=M V. (The
price level times the total output of goods and
services -that is, GN P
equals the money
supply times the income velocity of turnover
of that money supply.) With the assumption
of relatively stable V, monetary policy
consists of adjusting M for a given Q in order
to attain price stability. Interestingly, the
monetary authorities define money to include only currency in circulation, and not
bank deposits held by the public. They use
this narrow definition because, in their view,
bank deposits are not "checkable" and
hence cannot be used as a means of payment.
In the absence of hard statistical data, it is
difficult to determine how well the simple
quantity-equation approach and the restricted money-supply definition have served in
implementing China's monetary policy.
However, the justification must lie partly in
the planning process in which the monetary
policy is embedded. As China shifts away
from a rigid planning process and as
individual enterprises gain greater autonomy
in the management of their financial affairs,
the authorities undoubtedly will begin rethinking these basic tenets of monetary
policy.
Although the banking system is allencompassing, traditional banking (in the
sense of deposit-taking and credit-extension
activities) occupies but a relatively small
fraction of total financing. That is because all
financing is disbursed through the banks, but
mainly in the form of state-appropriated
funds, which are about three times as large as
banking funds from both private and public
sources.
Domestic banking
State-appropriated funds generally pay for
plant, equipment, and infrastructure construction, as well as regular ("quota")
working-capi,tal needs of all enterprises. In
disbursing these funds, the banks serve as the
government's fiscal agent, being responsible
for insuring that the enterprises' financial
transactions are carried outas planned. Until
recently, these funds were provided free of
interest and repayment obligations. Financing by bank loans until recently has been
limited to meeting enterprises' "supra-quota"
working-capital needs, such as those arising
from seasonal fluctuations in activities,
temporary gaps in cash flow, and so on. In
fact, because of the relatively low loaninterest rate (5 percent or less per year) and
the tight constraints on state-appropriated
funds, enterprises have a strong incentive to
borrow from banks and use the funds for
non-prescri bed pu rposes. As a resuIt, a considerable amount of bank staff's time and
energy is occupied with policing this kind of
"misuse" of loan proceeds.
Changes are also occurring in domestic
banking. A single institution
the People's
Bank of China, with 15,000 offices and
330,000 employees - still dominates the
nation's domestic banking activities. However, there are now three specialized banks,
which have expanded their activities in the
past year or two. The Construction Bank, until
recently a bank in name only, has begun
experimenting with loan operations in the
basic-construction field. The Agriculture
Bank, after a number of ups and downs,
began operating early last year on a reorganized basis in the rural area. the Bank of
China is basically a foreign-exchange bank
and handles all the nation's financial transactions with foreigners. All four are government banks and nominally operate directly
under the State Council, the government's
highest administrative organ. In fact, however, the People's Bank of China is the first
among equals in the banking system; it
supervises the operation of both the Bank of
China and the Agriculture Bank, while the
Construction Bank functions under the joint
supervision ofthe Ministry of Finance and the
State Construction Commission.
Today, however, this system is undergoing
rapid and drastic change. Besides reestablishing the Agriculture Bank and upgrading
the hierarchy of the Construction Bank and
the Bank of China within the government
structure, the authorities also have begun
gradually to substitute bank lending for
state-budget financing. This is part of an
overall policy of greater reliance on the
market and lesson planning in the conduct of
economic activities. The shift began in 1979
on a limited, experimental basis, and has
since gone considerably further.
2
greater familiarity with the market. Others
have not done so well; some have lost money
in the process. Still, most international
bankers remain cautiously optimistic about
long-run prospects, counting on the day in
the not-too-distant future when China
emerges from the present adjustment period,
with reformulated investment plans, and
again seeks large-scale financing.
International banldng
China's international finance follows the
same planning process as domestic finance.
Each year, the Bank of Ch i na - together with
the Ministry of Foreign Trade, the Ministry of
Fi nance and other state agencies - subm its a
foreign-exchange plan for the following year.
Once the plan is approved by the State
Council, the Bank of China becomes responsible for monitoring and administering the
plan under the general supervision of the
People's Bank of China.
In the meantime, with the exception of a few
large projects (such as a huge hotel and tradecenter project in Beijing), current interest in
the banking community seems to focus on
joint-venture and compensation-trade
arrangements. (The latter are arrangements
whereby the exporter receives payments in
goods to be produced by the equipment shipped under contract.) Both types of arrangements involve considerable risk to all parties,
including the lenders. Inevitably, in order to
compensate the lenders for the large credit
risk, the cost offinancing is higher than usual.
The cost must be absorbed either by the
exporter or passed on to the importer, by
means (e.g., pricing the export equipment)
wh ich may not always be obvious to the
importing side.
Government officials take pride in the fact
that China has incurred little external debt
since the repayment of her heavy debts to the
Soviet Union in the early 1960's. Nevertheless, the world's financial markets became
intensely aware of China's presence in 1 978
and 1 979, when China negotiated about $28
billion in foreign credits, ostensibly to finance
her anticipated huge capital-import program.
More recently, however, China has drastically reduced her ambitious investment plans,
and has begun to shift investment priorities
from heavy industry to agriculture, light industry, housing and transportation. Chinese
government officials continue to emphasize
their desire to import modern technology and
equipment-but
only to the extent that the
nation can pay through exports or can borrow
comfortably with little debt burden. So far,
China has drawn only to a very limited extent
on its huge foreign credits, and has relied
largely on government-guaranteed export
credits with subsidized interest rates. The
authorities seem anxious to avoid incurring
large amounts of external debt, especially
d u ri ng the cu rrent period of high interest rates.
Overall, China is undergoing considerable
change as it proceeds with its "Four Modernizations." Monetary policy and banking
policy, like other aspects of the national
economy, will certainly be strongly affected
by this modernization process. In the monetary and banking field, as in other fields, the
critical question remains: howfarcan market
forces be used to improve economic efficien·cy within a socialist planned economy?
Hang-Sheng Cheng
In the international-banking community, the
earlier euphoria about lending prospects has
passed; in its place is a more realistic
appraisal of China's financial needs and
absorptive capability. A few banks have
gained a strong foothold in the China market
- especially the Japaneseand the British,
who have been in this business much longer
than the Americans, and hence have much
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BANKING DATA-TWELFTHFEDERAL
RESERVE
DIS TRla
(Dollar amountsin millions)
SelectedAssetsandLiabilities
Large CommercialBanks
Loans(gross,adjusted)and investments*
Loans(gross,adjusted)- total#
Commercialand industrial
Realestate
Loansto individuals
Securitiesloans
U.S.Treasurysecurities*
Othersecurities*
Demanddeposits- total#
Demanddeposits- adjusted
Savingsdeposits- total
Timedeposits- total#
Individuals,part & corp.
(LargenegotiableCD's)
WeeklyAverages
of Daily Figures
MemberBankReservePosition
ExcessReserves
(+ )/Deficiency(- )
Borrowings
Net freereserves(+ )/Net borrowed(- )
Amount
Outstanding
9/10/80
139,173
117,408
34,042
47,544
23,707
1,013
6,408
15,357
48,175
33,415
29,539
63,605
55,230
24,118
Weekended
9/10/80
-
21
136
156
Change
Changefrom
yearago
from
Dollar
Percent
9/3/80
5,954
4.5
254
- 191
7,309
6.6
6.9
39
2,200
17.5
216
7,075
2.1
53
488
- 51.2
1,062
11
- 17.2
83
1,330
20
25
0.2
709
1,703
3.7
575
2,282
7.3
1
1,023
3.3
9,984
18.6
542
382
10,056
22.3
4,224
21.2
349
Weekended
Comparable
year-agoperiod
9/3/80
-
8
133
141
9
60
69
* Excludestradingaccountsecurities.
# IncludeSitemsnot shownseparately.
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to the editor (William Burke)or to the author.... free,copiesof this
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