Finance in China - Term Paper Example

Finance in China Contents Introduction 2 Literature Review 3 Features of the Chinese financial 5 Reflections of Chinas model of capitalism 9 Conclusion 12 References 14 Introduction The financial system plays an important role in the growth and development of the country. The financial system can be defined in the broader sense as the institution that includes the borrowers, lenders and the financial institutions within the financial system of the country. The financial system of China plays a critical role in the expansion of China and it is being considered as the second largest economy of the world. The financial system of China has managed to perform various activities in order to support the rapid economic growth and development of the nation. The main components of the financial system of china mainly include the banking sector, bond market and the stock market. The banking sector mainly dominates the financial system of China it contributes to around 128% of the total GDP of the country. The bond market of China is comparatively weak and underdeveloped since it contributes to around 41% of the total GDP of the economy and the stock market of China have contributed to around 44% of the GDP of the country. The important functions that are performed by the financial system of China are optimizing the allocation of the scarce resources, allowing the investors and the savers in maximizing the return for the given level of risk, allowing the risk to be diversified and transforming or converting the short term assets into funds that are required for supporting the long term projects. The comparison between the financial systems of China along with the financial system of other countries mainly explains that it is more preferable for china to develop its existing model rather than adopting and implementing the successful models from the developed countries of the world. China can adopt the debru model and the twin crisis model in its financial system. The financial system of China is mainly dominated by the advanced financial market of the world. Literature Review The author Levine, in his study has focused on the concept of capitalism and he in his study has explained the meaning of the concept state capitalism. The term state capitalism can be defined or explained as the economic system which includes the economic and the commercial activity that is mainly undertaken by the state along with the organization and the management for the means of production in a capitalistic manner which includes the accumulation of capital, centralized management and labour (Levine, 1997). The writers Reinhart and Kenneth, in their article has focused on the features of state capitalism in which he have explained the understanding of the conceptual framework for explaining the various extent of the state involvement in the economy. The state capitalism mainly includes the planning in the allocation of the resources and also free market economies characterizing the minimum intervention of the government. The writer explains the state capitalism in which the government of the country is engaged in various types of state owned enterprises for managing the exploitation of the resources. The state capitalism generally prefers the private owned companies to control certain sectors in the economy. They mainly prefer utilizing the sovereign wealth funds for investing their cash for the maximization of the state profit (Reinhart and Kenneth, 2009).The researchers Lízal and Svejnar, in their paper has focused on the nature of the state capitalism that it is mainly based on the private ownership as a means of production in which the profit can be utilized through making necessary investment in the employment of labour and capital. Capitalism is mainly based on the concept of free enterprises in which the intervention of the government is required to be restricted and prohibited. He has also emphasized on the fact that the theory of mercantilism is based on the concept that capitalism mainly exist in limited form in the economies related to all civilizations and it is also associated with the industrial revolution in which the merchants, bankers and the industrialist replaces the landowners in the social, economic and political importance at the time of innovations (Lízal and Svejnar, 2002). The writer () in his paper has highlighted on the concept of state capitalism which emphasizes on the extent of freedom that is provided to the economic enterprises but the government action is required to be curbed which have emerged from the terrible and severe working conditions, slavery in United states and Britain in case of the financial fraud. The writer has also emphasized on the important feature of State capitalism that explains that it is mainly dominated by the state owned business enterprises in the economy. The researchers Fama and French, in their study has emphasized that the state capitalism mainly includes the involvement of the government in the economy in order to recover the failures or the constraint in the market for achieving or attaining the social objectives that diverge from the profit maximizing goals. The researchers have also argued on the implementation of the concept of state capitalism in the economy since it focuses on the distortions that create political interference through the government capital (Fama and French, 2005). The writer Fama has explained some positive aspects on the implementation of state capitalism in the economy. The writer has explained that state capitalism will facilitate and provide high profit based incentives and the concept of state capitalism mainly explains the manifestation of persistence at various important institutions at the country level. State capitalism has high extent of dependence even after the period of privatization. The dependence of the state capitalism can be observed from the fact that the strong dependence of the state capitalism is developed since there is only few number of companies in which the government has ownership (Fama, 1980). Features of the Chinese financial Bond Market Bond market is considered as an important source of credit. The bond market of china is less developed as compared to that of the bond market in US and Europe. The capital market of China are underdeveloped and therefore the bond market of China are mainly dominated by the central bank bills and the government bonds in order to sterilize the monetary expansion that has resulted from the exchange rate policy of China in which the banks are state owned and it is mandatory to buy. Therefore the large number of bonds is mainly held for a long term by the respective banks and the amount of trading is very low. The equity market of China is mainly policy driven and it is dominated by the various state owned enterprises in order to ensure their assessment of finance. More than 35% of the corporate bonds of china are mainly held by the in banks in China thus making them the largest holder of the corporate bonds. The debt that is issued by the Chinese government came into existence only after the financial crisis that took place in the year 2008. The bond market of China is mainly engaged in the foreign direct investment, in the process of equity financing and also related to the non credit items. The corporate bond of China was less developed previously but it have gained popularity in the recent years and the market for the corporate binds have expanded rapidly .The main bond holders of China mainly includes the banks, insurers , government agencies and the exchanges. The private firm has very little access to the bond market and therefore they are forced to acquire the funds that they require from various informal channels (Leary and Roberts, 2010). Figure 1: Corporate bond of China. Stock market Chinese stock market also constitutes an important part for funding of business in China. The regulators of the stock market of China restrict the size of the stock market by monitoring closely on controlling the initial public offering of the stock market of China. China allows its initial public offering to continue with definite approvals on an ad hoc basis by taking into considerations various factors. The stock market of China is generally compared with that of the casinos since the stock markets are subjected to a high level of fluctuations. There are two important stock exchanges in China that is the Shanghai Stock exchange and the Shenzhen Stock exchange. Chinese stock market is subjected to high level of speculations and therefore the investors invest in the stocks with the hope that the value or the price is likely to increase in the future period of time (Reinhart and Kenneth, 2008). The stock prices reflect the value of the firm or the enterprises in order to capture the value of its future cash flow. There are some new features that have been introduced by the stock market of China which mainly includes the innovation and the promotion of the stock index in the future period of time and the other innovation that was introduced in the year 2010 includes allowing the traders to leverage the trading and also conduct short sales of the stocks that is traded in the stock exchange market in China. The speculations in the stock market damages and affect adversely the optimum allocation of fund in the stock market of China (Kim and Weisbach, 2008). Chinese banking sector The banking sector of China is highly developed which includes majority of corporate savings and households that are associated with the large number of banks and all the financial risks are associated with it. In comparison to the other developed economies of the world China is considered as the country with large number of shares in case of its bank lending operation although the share of financing in China in case of the capital market, the shadow banking sector has expanded and developed significantly. Therefore bank plays a major role in the financial system and financial structure of China. The whole economy of China is mainly controlled by CCP which is required to be balanced in the process of bargaining. The financial system of China is biased towards financing in the sector of the state for the state owned enterprises for the functioning of the small and medium sector enterprises that is detrimental to the small and medium size enterprises . The state owned enterprises maintained a low rate of interest (Katharina and Changgang, 2005). The interest rate is considered as the formal sector that is introduced and established administratively for ensuring the profitability of the banking sector and the banking industry for controlling and allocating the financial resources. The strict and the stringent rate of interest that has been fixed in favour of the borrowers above the rate of inflation resulting in the significant distribution as well as redistribution of the income from the depositors that exist in the economy it is mainly referred to as the financial repression (Kalcheva and Lins, 2007). There has been a constant growth in the shadow banking sector of China which comprises of the bank acceptance of bills, micro loans, trusted products, entrusted loans, underground lending and various leasing activities. The wealth management products and the trust sector of china imposes risk on establishing financial stability in the economy of china which includes the liquidity and the credit risk, the lack of transparency, moral hazards and the increase in the off balance sheet exposures of the economy. The respective authorities have become aware of the risk and therefore they have focused on the various steps and measures for the minimization of the risk (Ivashina and Scharfstein, 2010). The increase in the extent of the expectation of the shadow banking sector of China it has been observed that the system is not based on the market and it does not allow the market to price its risk and capital and therefore the authorities have introduced various standards for controlling the interest rate risk on the value of total loan for the state owned banks and therefore it provides a window guidance. The rapid growth and development in the banking sector of China is due to the decrease in the real interest rate on the bank deposits. The shadow banking sector mainly contributes to around 20% of the total asset and it has been increased by 33%.the banking sector of China comprises of the five large commercial banks which controls more than half of the total asset of the banking industry (Graham and Harvey, 2001). Reflections of Chinas model of state capitalism These features are the reflection of the model of state Capitalism of China since the feature of the financial system is considered as the system for the administrative approval and the market alone cannot perform the important and the fundamental functions of allocation of resources and this has resulted in the creation and development of a sound infrastructure and this features reflect the financial reforms included in the financial system that is responsible for fulfilling the needs and the requirement of the market based economy (Duchin and Sensoy, 2010). Taking into consideration the various features of the financial system of China it has been observed that it includes all the aspects that are related to the liberalization of the interest rate, strengthening of the regulations, supervising the operations of the capital market operations and the opening in the capital market with the aim of reducing or decreasing the regulatory arbitrage for improving the allocation of the resources through the pricing that is based on the market and eliminating the moral hazard from the guarantee on asset that is provided by the state and the features of the financial system reflects the future prospect, growth and development of China. The financial system of China in the current situation is being considered as the new phase in the financial industry. The financial system of China plays an important and major role towards the expansion and the development of the economy of China and it will also affect the rest of the world. China have adopted the state of capitalism and therefore china have to observe the limitations very significantly and therefore the state of capitalism supports that the need for the evolution and challenges is required to be identified by the financial system of China (Campello, Graham and Harvey, 2010). China financial system reflects the model of state capitalism can be understood as the financial markets of China is required to be market based and facilitate the market pricing to be considered as the basic mechanism for the allocation of risk and capital . These will mitigate and solve the imbalances and the risk which have developed the system in order to overcome the financial instability and therefore the components of the financial market is characterized or featured by the deep, broad and liquid stock and the bond market that is featured by maximizing the return that is generated from the investment rather than focusing on financing the state sector (Bo and Hsiang-Chun, 2014). The financial policy making in China over the last three and half decades, define the driver and direction of reform until today. In china it is not the state or government which makes the economic development the primary task. Rather in China all major financial decisions are made by the Party that is the Communist party of China. The party in China rules the economy of the country and guarantees prosperity for the country. The ultimate goal of the ones that are at the helm of CCP is to lead the country to a strong economy that would lead to the party maintaining its political power in China. All reform efforts in China has focussed in this direction and political reforms in the country is put out of questions. In China it is observed that the financial sector is deeply embedded in the political economy of the country. This has resulted in the formation of capitalism that is very specific to the country. The Capitalism that is practiced in China is commonly referred to as the red capitalism or the capitalism with Chinese characteristics. This is in line with the official goal of the party in the country that states to build a socialist country with the Chinese economy. The authority of the CCP in china is considered as relatively stable. The middle class in China still believes that the party has the ability to promote the development in China. The party in China also has the ability to ensure growth and rise of the living standards in the country. The financial sector in Chinese has seen development since 1978 in three different phases; an early stage that is until 1990, the era of bold reforms by Jiang Zhu until 2005 and the current stage that is exemplified by the stage of fading reforms. Figure 2Chinese CPI and domestic credit since 1986 Conclusion In the current scenario it has been observed that the financial sector and the currency of China is not capable of fulfilling their aim and the objectives because in China the party is responsible for running the process of allocation of capital and the market does not perform this functions and the accounting, legal and regulatory standards are also maintained and introduced by the party and not by the market. The limitations and the shortcomings that are encountered by the financial system of China generally lack what the currencies are required to achieve regarding the reserve currency status of China. The financial reforms focus on the fact that the economic growth of China is very lower in terms of its shot term perspective and more sustainable and balanced in terms of its long term perspective. The concept of state capitalism has been perceived in many ways in China. The financial system of China has emphasized that the free market level is considered as the best in comparison to all other models in the economic system focusing on increasing the efficiency and also global governance guided by the state regulations. The financial policy of China mainly focuses on rebalancing the implications of the state capitalism on China. The topic mainly ends with the analysis of the financial policy framework of China and its aim and implications on the state capitalism of China. References Bo, H. and Hsiang-Chun, M.L., 2014. Corporate investment during the financial crisis: evidence from china, International Review of Financial Analysis, 35, pp. 1-12. Campello, M., Graham, J. and Harvey, C., 2010. The real effects of financial constraints: evidence from a financial crisis, Journal of Financial Economics, 97, pp. 470-487. Duchin, R., O. and Sensoy, B.A., 2010. Costly External Finance, Corporate Investment, and the Subprime Mortgage Financial Crisis, Journal of Financial Economics 97(3), pp. 418-435. Fama, E. F., 1980. Agency Problems and the Theory of the Firm, Journal of Political Economy, 88(2), pp. 288-307. Fama, E.F. and French, K.R., 2005. Financing decisions: who issues stock, Journal of Financial Economics, 76 (1), pp. 549-582. Graham, J.R. and Harvey, C.R., 2001. The theory and practice of corporate finance: evidence from the field, Journal of Financial Economics 60, pp. 187-243. Ivashina, V. and Scharfstein, D., 2010. Bank Lending during the Financial Crisis of 2008, Journal of financial Economics. 97(3), pp. 319-338. Kalcheva, I. and Lins, K., 2007. International evidence on cash holdings and expected agency problems. Review of Financial Studies, 20, pp. 1087–1112. Katharina, P. and Changgang, X., 2005. Governing stock markets in transition economies, lessons from china, American Law and Economic Review, 7(1), pp. 184-210. Kim, W. and Weisbach, M.S., 2008. Motivations for Public Equity Offers: An International Perspective. Journal of Financial Economics 87(1), pp. 281-307. Leary, M.T. and Roberts, M.R., 2010.The pecking order, debt capacity and information asymmetry. Journal of Financial Economics, 95, pp. 332-355. Levine, R., 1997. Financial development and economic development: views and agenda, Journal of economic literature, 35, pp. 688-726 Lízal, L. and Svejnar, J., 2002. Investment, credit rationing, and the soft budget constraint: evidence from Czech panel data. The Review of Economics and Statistics, 84(2), pp. 353-370. Reinhart, C. M. and Kenneth, S.F., 2008. Is the 2007 us sub-prime financial crisis so different an international historical comparison, American Economic Review, 98(2), pp. 339-344. Reinhart, C.M. and Kenneth, S.F., 2009. The aftermath of financial crises, American Economic Review, 99(2), pp. 466-472. Read More