Still a Long Way to Go for China to attain Financial Liberalization...

What is Financial Liberalization

Financial Liberalization is the process of breaking away from a state of financial repression (which is commonly associated with govt. fixing of interest rates to its adverse consequences on the financial sector as well as on the country's economy). So Financial Liberalization is freeing interest rates, reducing reserve requirements to eliminate the directed credit schemes, while stabilizing the price level. But it is a narrow definition, an obsolete one.

Now, Financial Liberalization also involves easing of portfolio restrictions on banks, changes in the ownership of banks, encouraging competition among banks, integration of domestic entities to international markets and changes in the monetary policy. It includes a freely functioning of foreign exchange markets and eliminating restrictions on current payments and transfers.

What is the state of Banking System in China

(We will be limiting ourselves to the banking system in China after 1949 when the present govt. of People's Republic of China (PRC) came into power.)

Rapid nationalization and consolidation of Chinese banks took place in the initial years of PRC taking over and banking sector was the first sector to be completely socialized. However during the 1980's, banking system expanded and diversified to support reforms. First Stock Exchanges were opened in 1986 which were although small in size of operations like the Shanghai Stock Exchange.

Now lately, Chinese banks are functioning more like banks than before. China's banking system has remained in the government's hands even though banks have gained more autonomy. The People's Bank of China (PBOC) is China's central bank which formulates and regulates its monetary policy. PBOC has full autonomy in applying the monetary instruments like setting interest rates for commercial banks. China Banking Regulatory Commission (CBRC) took over the supervisory role from PBOC in 2003.

The Big Four

There are four mammoth government owned banks in China controlling majority of the money in the financial system of China.

1-      The Industrial and Commercial Bank of China (CBC) is the largest bank in China.

2-      The Bank of China (BOC) specializes in foreign exchange transactions of trade finance.

3-      China Construction Bank specializing in medium to long term credit for long term specialized projects like infrastructure and housing.

4-      The Agricultural Bank of China (ABC) specializes in providing funds to China's agricultural sector and offers banking services to farmers and other rural institutions.

In 1995, the operations of the ‘big four’ were commercialized. These are the first tier banks.

There are also second tier banks in China which are having much better asset quality and profit base. These were supposed to be run by private players but even now, major shareholders of these banks are local governments, and state owned and State controlled enterprises.

There are also more than 200 foreign banking institutions in China but they only play a limited role. Throughout the history of PRC, banking system has exerted close control over the finance and money supply.

Firstly, the interest rates for Chinese banks as well as foreign banks holding the deposits of Chinese citizens are regulated. But from 148 categories of interest rates, only 34 categories now reside under the regulation of the govt. The interest rates for rest are simplified or market driven.

Secondly, at the present indirect financing remains the main channel of financing for business companies. It implies that the stock markets have a very limited and highly regulated role, in case companies want to raise money, where companies (firms) can directly borrow from the public (households). Majorly, they will have to access banks which have all the deposits from general public and borrow the money. Due to this, assets of the banking sector are above 80% of the total assets of the entire financial sector. The BIG FOUR accounted for more than 61% of the loans. Second tier banks have assets somewhere around 14% of the total.

Major Restriction - All govt. departments, publicly and collectively owned economic units and social, political, military and educational organizations were required to hold their financial balances as bank deposits. They were also instructed to keep just enough cash to meet daily expenses. Payments for goods and services exchanged by economic units were only done through banks. “This helped to minimize the need for currency and minimize black money”, is what they say. It meant that besides one’s petty expenses, all other monetary transactions were to be done through banks. Considering that the online banking has just been introduced in China in August, 2010, one could imagine how restrictive and harassing this regulation has been for the Chinese corporations and institutions.

China is slowly de-regulating its banking system to keep pace with the rapid development it is encountering in the past decades. But there is still a long way to go for PRC to become financially liberal and stimulate savings and investments. The sequence of reforms, as in China national policy, is to liberalize the interest rate of foreign currency before that of domestic currency, lending before deposit. Large amount and long term before small amount and short term. As the first step, PBOC liberalized the interest rates for foreign currency loans and large deposits but the interest rates for savings deposits and loans in local currency will still take a long time before being liberalized.

There are still many weaknesses in the regulatory and legal system of China. For eg. there is no legal code to handle bankruptcy of financial institutions nor any regulations governing electronic transactions etc. Beside low capital base of asset quality, banks in China also suffer from poor corporate governance and lack of adequate risk management skill.

I recently saw news on the net that – Chains To Launch New Internet Banking System on August 30, 2010. It will allow depositors to check their separate bank accounts information and make "real-time" inter-bank transfers at one place. It’s mainly online banking system introduced very late in a booming economy hindering growth of commerce. Well.. better late than never.

By- Rahul Bansal
A sincere thanks to Amrita Ma'am for helping me.

Capitalism is a flawed system but other systems are much worse...

If perfection were really an available option, the choice of economic and political system would be irrelevant. In an imperfect world, with limited resources, [the basic problem of economics-scarcity!], the choice is not between capitalism and socialism but imperfect capitalism and imperfect socialism. Note that no country can be purely capitalistic or purely socialistic in nature. [See Notes at the end of the article if you want to know what exactly capitalism, socialism & communism mean]

Despite all its faults, if we were to closely observe the disordered picture of economic progress that we have made in the 20^th & 21^st century-capitalism as the choice of economic system is the clear winner.

Indian Scenario

First let us look into the Indian scenario. Our country has been steadily becoming more capitalistic in nature over the years. In fact, capitalism accounts form 3/4^th of our GDP. A sector wise analysis substantiates this.

Crops are planted & produced in our country according to expected prices/profits. Of course, other variables matter such as rainfall, irrigation and fertilizer use. But the driving force is profits. Capitalism, therefore, defines 17 per cent of India’s GDP, namely agriculture.

Services account for 55% of GDP, if you deduct the government’s share-there is still 40% of the GDP contributed by the private sector.

Some 2/3^rd’s of the manufacturing sector/industry which accounts for 28% of GDP, is purely private. That is another 18% approximately. Moreover most PSU’s are more profit oriented than ever.

Therefore we can comfortably say that capitalism accounts for approximately 75% of our country’s GDP.

Strength of Capitalism

Strength of capitalism lies in the incentive structure mechanism that is integral in a capitalist society. A simple example would help explain why capitalism is better than socialism.

Suppose, there are 4 students in a class- Rahul, Vishal, Aakriti & Tejas. They are awarded grades according to their performance.

The grades awarded were: Aakriti: “A”, Rahul: “B”, Vishal: “C”, Tejas: “D”

According to new rules, the college authorities decide that each student shall be given the same grade i.e. “C”. The new move de-motivates high performers like Aakriti and Rahul as they don’t have any incentive to perform better. Lack of incentive mechanism reduces everyone’s performance and efforts as they know irrespective of how they perform; they are going to get the same grade. Anyone who complained about the new system was chucked out of the chool or suffered severe punishment.

The earlier performance based incentive mechanism represents capitalism in real life, while the new system stands for socialism.

The case of Soviet Union and China-Transition from Socialism/Communism to Capitalism

Prior to 1991, the soviet economy was the second largest in the world, but during its last years as USSR, it suffered huge budget deficits and severe shortage of food, which ultimately resulted in its collapse.

From 1949-1978 China was a soviet style planned economy, during the Era of Mao’s regime. After the death of Mao Zedong, Deng Xiaoping began to reform the economy and transformed into market oriented economy-this started from 1978. The rest as they say is history-China’s meteoric rise as an economic powerhouse pulled millions out of poverty and its economic muscle is only next to U.S.

Even Fidel Castro in a recent interview has admitted that the Communist model has failed in Cuba!

SOCIALISM-The Big Lie of the 20^th Century?

Many term socialism as the big lie of 20^th Century. The strength of capitalism over socialism can be attributed to basically 2 reasons:

(a)Profits & Losses (b) Prices determined by Market Forces

Profits and Losses: In a centrally planned economy there is no way to accurately determine the success or failure of various programs. Which programs should be expanded or which should be contracted/terminated? –cannot be determined in a socialist economy.

In capitalism, since the firms operate with profit motive, there is greater efficiency and competitiveness to deliver superior customer service. Take for example: the telecom services sector in India,there are numerous competitive players in the market like Airtel, Vodafone, Reliance, Tata etc. offering so many different schemes to woo the Indian mobile phone user.

Prices determined by market forces: Capitalism ensures that market prices transmit information about relative scarcity and then efficiently co-ordinates economic activity.

Example: Take the example of OPEC oil crisis of 1970’s. OPEC countries restricted the supply of oil, hence the oil prices increased drastically. Consumers started driving less, car-pooling more, and started using public transportation for commuting. Producers in turn got the incentive of exploring and developing alternative fuels of energy resources.

In Socialism, since price of commodities are set by the government, they are either too high or too low- [in most cases] which leads to constant shortages or surpluses. The commodity prices do not change with the market forces of demand and supply which leads to problems.

Not all is right with Capitalism

Ill effects of capitalism are not due to capitalism but due to corruption of capitalism. There are numerous examples- right from Enron, WorldCom, Satyam to the recent BP oil disaster.

Obsession with the “bottom line” means that the broader concerns of stakeholders are sacrificed for the narrower interests of shareholders.

What we don’t need is “Crony Capitalism” where success of a business is dependent on favoritism-shown by ruling government in the form of tax breaks, government grants and other incentives. Take for example: the recent Vedanta controversy-if Anil Aggarwal had managed to strike a deal with the government for expanding its operations in tribal-occupied Orrisa through favoritism shown by the government-it would have been an example of crony capitalism. {But we must commend the firm stance taken by Jairam Ramesh, the environment minister and PM Manmohan Singh against the issue}

We need Sustainable Capitalism: is a new brand of capitalism which takes into account the long term view includes socio economic development and environmental sustainability.

Fall of Lehman Brothers and the Financial Meltdown-Is Capitalism to Blame?

Contrary to the popular perception, 2008 financial crisis did not take place primarily due to the ill effects of capitalism but due to seriously flawed monetary policy put in place over 2 decades ago by former fed reserve chairman- This encouraged the era of consumerism in America-people began consuming beyond their means as credit was easily available on artificially low interest rates. It increased the risk taking propensity of the average American consumer. However, one should note, that the seriously flawed monetary policy was the primary reason, not the only reason behind the financial collapse.

If Keynesian economics were to work, the current global meltdown would be shallow and short lived-the massive infusion of stimulus capital would have turned around the US economy in a short time. [Keynesian economics-advocated the intervention of central banks via fiscal and monetary policy to undo balances]

But U.S. economy is still deep down a rabbit hole-U.S. will take at least a couple of years to fully recover.

Lessons to be learnt: Many economists worldwide are preaching a new brand of Capitalism called “Controlled Capitalism”, in controlled capitalism-we need limited but controlled interventions in the free market, leaving to self regulate for most market.

From the above discussion we conclude that imperfect capitalism which is sustainable and controlled is the best choice amongst all other systems.

Note:

To put it in simple terms:

Capitalism means the economy in the hands of private sector

Socialism means the economy in the hands of public i.e. Government

Communism: is a broader term than socialism, it includes both the economy and the political system.

However the objectives of socialism and communism are largely the same.

The only exception is China-which has a Communist Government and a imperfect capitalist form of economy-

• Political System: China has a one party system i.e. the People’s Party of China (PPC) controlling the political system. China’s media is highly controlled-In a report released by “Reports without Borders” in 2005-China ranks 159^th out of 167^th in its annual freedom world index. Censorship of Media is a common practice to silence criticism about the government.


• Economy: After the era of Mao Zedong came to an end mainly from 1949-1978, China has largely been a capitalist economy and has become an economic powerhouse over three decades of market oriented reforms and becoming a more globalised and liberalized economy.

I leave you with this a deep thought- a quote by Winston Churchill
"The inherent vice of Capitalism is the unequal sharing of blessings, the inherent blessing of socialism is the equal sharing of misery!"

_____________________________________________________________

By: Tejas Singh

CHINA's Growth Story-The Way Forward....

THE BIG QUESTION: Will the economic miracle run out of steam?

China’s growth story so far has been spectacular to say the least. According to data released on 16^th of August, the world’s no. 1 exporter has surpassed Japan to become the 2^nd largest economy; just behind the U.S. -Japan had managed to keep its second spot in terms of economic muscle for the last 43 years, so dethroning Japan was a significant milestone. But “wait” before you think everything’s fine with the dragon economy-it is slowly, but surely losing its steam.

There’s no denying the fact that it had recorded a massive 11.9% GDP growth in the first quarter of 2010. But Q2 figures haven’t been that encouraging-10.3% is the growth rate, a sharp fall of about 1.5%. There are several economic threats that are haunting the Chinese economy.

A major contributor to the slowdown has been the “Real estate bubble” that has been building up. Excessive investment and speculative purchases is driving prices in the real estate sectors to unsustainably high levels. The government has phased out $586-billion stimulus spending, tightening curbs on lending and checking spiraling property prices, and thereby cooling growth in the property sector. Curbs on spending would directly and proportionally affect growth in the coming time.

Second factor that seems to plaguing the Chinese economy is the apparent upsurge in workers who have begun pushing for higher wages and better working conditions. According to estimates by Deutsche Bank –“the minimum wage increase is to be around 20 per cent in most provinces and cities”. Another report by World Bank mentioned that the average rural wages rose 16.4 per cent in the first quarter of the 2010 from a year earlier.

The third problem that China faces is rising raw material prices. China's export growth remains strong, though rising costs for raw materials have eroded the country's cost advantage. It would be worthwhile to note here that during the first half of 2010, the total value of imports and exports, accounted for nearly 37 percent of the Chinese GDP.

Other factors include the steep fall in Industrial Production. It experienced a surprisingly sharp slowdown to a growth rate of 13.7%, down from 16.5% in May 2010. Some economists are also worried that stagflation -- inflation coupled with lower growth -- could emerge, although it seems highly unlikely.

It is imperative for China to raise the bar when it comes to the quality of economic development. In 2009, China’s urban rural divide widened to its highest since 1978. The fact of the matter remains that China is still a developing nation over 40 million below the poverty line. Overtaking Japan in terms of GDP is not going to change the basic truth. China’s per capita income is over 10 times lower than Japan’s and its population is 10 times bigger. It is a rapidly ageing country and its one child policy shows signs of becoming a burden.

China’s growth is not sustainable. It has polluted rivers, severe air pollution & large scale deforestation. By 2020, China is expected to have 400 million tonnes of rubbish, which is equal to the entire waste generated on the planet in 1997.

Despite all this, the Chinese are optimistic about their economy. The government has said that a slowdown is good in the long-term as policymakers try to reduce the country's heavy reliance on exports and investment to drive growth. The government sees this phrase as mid course correction period rather than a slowdown of the economy. The focus is now being shifted to domestic markets to compensate for slowing of export markets. China has more than one million-millionaires today. Relatively strong job creation in the recent times has helped support robust consumer demand which is strengthening China’s inward growth.

A long-term estimate by the World Bank research suggests that China's annual economic growth rate will fall to an average of 7 per cent in 2016-2020 - about the level the government has said is its target for sustainable growth.

So, to sum it all, China faces a lot of economic challenges in the form of above mentioned problems. However through effective policy formulation, they can slowly get back on the track of growth-growth which is both sustainable and inclusive.

-Tejas Singh

The Curious Case of Chinese Currency-Yuan..

These days, i have been catching up on a lot of news concerning China. I have been fascinated by the astute manner in which they come out with different strategies-be it politics, economics or foreign affairs.

There are many strategic instances which can be quoted, like how smartly China has slowly and steadily made Tibet as part of their territory. And very recently their have been talks between Zardari and his Chinese counterpart Hu Jintao to build a railway line from China to Pakistan which would enable China to have a stronghold on the Indian border [with increased military base to attack if needed]

But, what i am going to discuss in detail is the changing phase of Chinese economy. Their currency, Yuan [Also known as Remnibibi] was in the spotlight recently. As we all know Chinese products are known for being cheap and quite a large chunk of the Chinese economy relies on exports. It had been pegged 6.83 to the USD since July 2008. Recently it was under heavy criticism from the US for not allowing Yuan to appreciate. China was accused of being a monopolist in the export industry [as they were literally stealing away the export business of other countries]. But things are slowly changing. I read a lot in the newspapers about how China is under pressure from other countries including India and US to allow Yuan to appreciate. Come to think of it, is China really "losing out" if Yuan appreciates? If you got your economics right- not so much, especially not the people of China. Read on, you will know why..

Ask yourself a question, essentially what are exports? They are -global demand for goods and services in the economy. Too much reliance on any component of demand is bad, in this case it is the exports. For instance, if there is a slump in global demand due to recessionary trends, Chinese exports will suffer and therefore the demand. Now if Yuan appreciates, the domestic demand would increase as the purchasing power of people in China would increase [taking the assumption that the Chinese are purchasing imports to satisfy their domestic consumption]. This would help the Chinese economy to reduce its dependence on exports. This would also mean more income in the hands of poor labourers which are paid abysmally low [which is how the Chinese are able to export products at such a cheap rate].

Now, it remains to be seen at what rate People's bank of China allow the Yuan to appreciate. China can play a clever game here, if the rate at which their currency appreciates is low, they can still maintain their world leader status as far as export market is concerned. Side by side, they would also steadily increase their domestic demand. This would further strengthen the Chinese economy. It's because of such clever strategies that i like to address China as- "our shrewd neighbour-China!!"

-Tejas Singh

Tiananmen Square Massacre- 21st Anniversary

From mid-April to earl June 1989, the world witnessed a massive civic movement in China. It began with students mourning in Tiananmen Square for the death of Hu Yaobang. Hu was the politician who was removed from the position of Communist Party general secretary in 1987 and who advocated liberalization, democratic and anti-corruption values. Within a week, the number of people gathered had increased to 100,000. On May 13 hundreds of students started a hunger strike in the Square. Collectively, all those gathered were protesting the corruption and income inequality that was getting progressively worse. The protesters were mostly students, from schools, colleges, demanding greater freedom, criticizing that they have absolutely no say in their government, or their lives. It was a peaceful protest for a free future, democratic government and to have some say in how their future can be decided.

But in the night of 3rd June, tanks rolled through Beijing with soldiers firing at civilians who blocked their path. The "Supreme" leader of China, Deng Xiaoping, ordered to clear the ground of the protesters from the hospital bed he was admitted due to cancer. The tanks reached Tiananmen Square and soldiers fanned out and fired into the air. By the dawn of 4 June, the students and workers were allowed safe passage out of the Square only after Zhou Duo, a writer and Taiwanese rock star Hou Dejian led successful negotiations with the army. But the damage was done. The Chinese government states that hundreds were killed. Student associations and the Chinese Red Cross say the figure is exceeding 5000, with more than 20,000 injured in a matter of few hours.

"One million Chinese can be considered a small number"-Deng Xiaoping

Soldiers continued firing for the next two days although the protests were quelled, and still, tanks rolled toward Tiananmen Square. On 5 June, TANK MAN appeared (see video). One man armed with nothing more than shopping bags astonishingly stopped a column of tanks. As they ground to a halt before him, he seemed to be waving them away with bags in hand.  Following the shock and horror generated by the crushing violence in the killings, in the silence of the aftermath, this lone man’s courageous actions spoke for the people who had been forcibly oppressed. 

Twenty one years have passed since the protests. That same year, the world witnessed the fall of the Berlin Wall. Since then the Soviet bloc has collapsed and China has developed in ways that might not have been predicted in 1989. In the world’s rush for progress, the memory of Tiananmen Square fades.

What will you think of a country, where the government opens fire at its own citizens, who are helpless, without any fighting material, no weapons, nothing. But the army fired with guns and tanks at its own unarmed citizens. It was a massacre in the heart of China, of the Chinese students by its very own army, on the land which looked like a battlefield. But the bravery of the citizens can be seen from the way they covered and protected international journalists by their own bodies, getting killed in the way, just to help them get the news to the world.

I can't help comparing it with the condition we are having in our country due to naxals. How the army is avoiding getting in the conflict, government trying to get the things in control, with as much humane way as possible. It clearly shows the advantages of a true democracy over socialism. Even when we have armed maoists massacring the people, we have a government who is trying to get the lowest possible death toll on both sides. Truely love India and its democracy. 

-By Rahul Bansal