Please create a paper at least 8 pages in length using this information and adding on to each subject if needed. I need an introduction, body with subjects and conclusion
I need to write a 8 page paper on the financial markets in China. I have started the work and divided subject matter into different parts. Please write paper using these different subjects and add any additional data you may find to create a paper that has a introduction, body with each subject matter and a conclusion.
History and Financial Liberalization
Updates in gray by Sita
Focus Economics – Philip
From its founding in 1949 until late 1978, the People’s republic of China was a centrally planned economy. Following the death of Mao in 1976 and the consequent end of cultural revolution, Deng Xiaoping and the new leadership began to reform economy and move towards a market-oriented economy.
Deng Xiaoping, who was the core of the second generation of Chinese leadership, announced the official launch of the Four Modernizations including agriculture, defense, industry and science and technology. This increased the role of market mechanisms and reduced government control over the economy. The measures included, among others, breaking down the collective farms, opening China to foreign investment, encouraging business entrepreneurship, establishing special economic zones and introducing market incentives in the state-owned companies.
Jiang Zemin, the third generation of Chinese leadership, lead most of the state-owned companies, except large monopolies, were privatized or liquidated, thus expanding the role of the private sector in the economy at the cost of leaving millions unemployed. He also reduced trade barriers, ended state planning, introduced competition, deregulations and new taxes, reformed and bailed out the banking system, and drove the military stratum out of the economy.
Hu Jintao, the fourth generation of leadership, tried to reduce the income gap between the coastal cities and the countryside as China’s skyrocketing growth mostly benefited just one part of the population. This administration increased subsidies, scrapped agricultural taxes, slowed privatization of state assets and promoted social welfare.
Xi Jinping, fifth generation of leadership, the new Xi administration unveiled an ambitious reform agenda in an attempt to change the country’s economic fundamentals and ensure a sustainable growth model. Authorities expressed their willingness to tolerate lower growth rates as a necessary condition to push forward economic reforms. Xi coined the term “Chinese Dream” as his contribution to the guiding ideology of the Communist Party of China.
According to McKinsey research, China became the world’s largest economy in purchasing-power-parity terms in 2014. It is a global power in scale and became the world’s largest trading nation of goods in 2013. However, not all dimensions of China’s scale have translated into global integration. A huge majority of Chinese firms’ revenue still comes from the home economy. Operational and regulatory complexities in China’s financial markets remain a barrier to international players.
Economic Transformation
BMark
China’s economy has grown rapidly with an investment-led economic model. This model has been successful in the past but a transformation is needed to avoid a banking crisis. In 2018, GDP and employment growth dropped to the lowest levels in 25 years, corporate debt continued to soar, foreign reserves fell by around $500 billion, and by mid-2015 the stock market had dropped to a staggering 43 percent. Capital productivity and corporate returns are falling. Non-traditional loans and lending methods such as shadow banking has increased leveraged risk and the amount of non-performing loans to as high as 15% in 2019.
Financial Industry Landscape
China’s financial markets, like most developed countries, consist of stock exchanges, bank loans, bonds, and some international equity. For the past two decades, under Deng Xiaoping, China has liberalized its markets and adopt a more open and competitive environment for investors. Current financial system is dominated by 4 big banks and is complemented by a shadow banking system. The role of stock market has been limited and ineffective due to the excessive control from government. Despite China’s tremendous progress in trade, manufacturing and innovation, China’s financial system is one of the weakest links in the economy. Chinese households invest largely in real estate market due to lower returns on financial assets. Only less than 20 percent of household wealth is in the stock market.
Big Banks
BMark 1 hour China
China’s big four state-owned banks have been the dominant force in the banking sector. The four big banks are comprised of the Bank of China, the Industrial and Commercial Banks of China, China Construction Bank and the Agricultural Bank of China. Collectively, they have hundreds of billions of assets and liabilities and hundreds of millions of customers. Although these banks are publicly traded, their CEO’s is not appointed by shareholders nor do they report to them. Instead, he is chosen by the Organization Department of the Communist Party and holds a Vice Ministerial Rank in the government. China’s state-run capitalism creates a unique convergence between quasi-corporate and government-controlled policy. The structure allows the banks to benefit legacy assets and government connections. When the government wants to influence an area of China’s economy, the banks can run as an arm of the government. For instance, the banks can increase lending to state-owned enterprises and local governments to fund infrastructure and other strategic industries.
The majority of lending from the Big Four goes to big state-owned enterprises (SOEs) and local governments. Loans to SOEs are about a third of the cost of loans given to small and medium enterprises (SMEs). Big bank loans to local government fuels infrastructure and development of underdeveloped areas throughout China. Non-state-owned banks lack the capital and see the loans too high-risk low return to participate. For this reason, the Big Four are major supporters of local government’s growth initiatives.
BMark 1 hour China
Shadow Banking System
China’s shadow banking system has become an integral part of the financial system. China’s shadow banking is dominated by commercial banks due to the bank-dominated financial system. A key characteristic of China’s shadow banking is that banks hide loans within alternative accounting categories. A large lending market outside of the formal banking system called shadow banking exists. By 2012, shadow banking represented about half of Chinese finance. Shadow banking includes products and services like wealth management and trust assets. The phenomenon occurred for a variety of reasons. One reason is that big four banks prioritized and gave loans to SOEs and local governments. SMEs lending needs were not being met and these non-banking institutions emerged to supply the demand for loans for investment opportunities. Shadow banking system of off-balance sheet lending carries a sizeable risk to the Chinese economy. Shadow banking impairs the ability of monetary policy to influence money creation and risk-taking, thereby raising financial stability risks. Another risk is it impairs the effectiveness of banking regulations aimed at lending, and leads to the accumulation of systemic risk.
DQuinn – WSJ 1/7/20, “Beijing Decides China Needs Real Capital”
According to a recent article in the Wall Street Journal, xxx, Bejing has been keenly focused on decreasing reliance on shadow banks for providing capital investment opportunities to small businesses and households (i.e non corporate or government entities). Although the shadow banking structure has helped these smaller entities gain access to cash when the large state-owned banks would not help them, it has also introduced significant volatility and risk into the Chinese financial system.
Beijing financial experts and regulators are aware that the assets owned by shadow banks are often funded by short-term loans, making the financial instruments sold to investors less secure. However, investors typically are not aware of this and incorrectly believe these assets are backed by the financial institution This introduces significant risk into the financial ecosystem of these institutions. Also, because the shadow banks are using third-party lenders, and simply acting as an intermediary, the funds are not recorded on the shadow bank’s balance sheet. This results in financial regulators having no idea how big the system really is, further exasperating the chaos often felt in the Chinese financial system.
In an ongoing effort to combat this volatility, financial regulators continue to develop policies to steer investors toward big banks for safer, more long-term capital investments. The new policies are also aimed at modeling the United States financial structure where a larger proportion of the country’s aggregate investor portfolio is more heavily invested in mutual funds and retirement funds.
Stock Exchanges
A critical component any financial market are the stock exchanges which allow individuals and institutions to purchase an equity share in a company. Under Deng Xiaoping, two domestic stock exchanges were established, one each in Shanghai and Shenzhen in 1990 and 1991 respectively. They operate independent of each other. As of 2019, these exchanges had a combined market capitalization of 59.3 trillion yuan.
The largest stock exchange in China is the Shanghai Stock Exchange (SSE) located in Shanghai, the financial capital of China. Most companies listed are the large state-owned companies. Most investors are pension funds and banks.
The Shenzhen stock exchange is a smaller exchange and trades the shares of smaller, more entrepreneurial companies. These privately-owned companies are more innovative and profitable than state owned companies. Most of them are tech companies making this exchange similar to the NASDAQ.
The Hong Kong Exchanges and Clearing Limited or HKEx, is a stock market and derivatives market and is being integrated in to the Chinese exchanges. That makes HKEx loosely part of China’s stock market. HKEx is in Hong Kong, a city-state that was transferred from the United Kingdom to China in 1997. Mainland China selects Hong Kong's administrator, but it has its own currency, judicial system, and legislative branch until 2047.
Currency
Dquinn: https://www.chinatour.com/china-guide-and-tools/china-travel-tools/china-currency/ The official currency used throughout mainland china is the Renminbi. The word “Renminbi,” means “people’s money”. The basic unit of the Renminbi is the Yuan, comparable to the US Dollar. The Yuan symbol lis ￥. The Chinese is broken down into jiao and fen (i.e.1 Yuan=10 jiao; 1 (角), jiao=10 fen (分). A common term used by the Chinese to represent the yuan is kuai (similar to American “bucks”).
Financial Instruments
Though financial instruments might be the same, financial markets can differ significantly from country to country depending on how open or closed the markets are to domestic and international lenders, borrowers and investors. For example, the financial market in United States is open and competitive. But, China has a more controlled and closed financial market.
Regulations
Over the past three years the Chinese government has announced changes to existing regulation signaling that it is moving towards a more liberalized financial sector. For example, wholly foreign-owned banks can now operate in China. In 2018, China announced that foreign ownership in securities trading firms and insurance companies can now be 51% (previously only foreign minority ownership was permitted). Requirements for foreign investors in the Chinese stock market have also been liberalized by shortening the lock-up period for strategic investments from three years to one year.
In 2019, Standard & Poor’s obtained approval to operate in China and became the first foreign credit rating agency to enter china. However, operational barriers and regulatory complexities still remain. Uncertainty and confusion surrounding Chinese regulations may cause less appetite for foreign participation in the financial services sector.
A report by the American Chamber of Commerce in Shanghai notes that frequent informal and sudden changes to policy reduce the ability of US banks to plan. The chamber also cites ad hoc restrictions on cross-border capital flows, especially for banks specializing in cross-border services. Uncertainty and confusion surrounding Chinese regulations may cause less appetite for foreign participation in the financial services sector.
Garry F. Global Legal Insights
China’s Financial Regulatory Structure was originally called One bank and Three commissions which included the People’s Bank of China (PBOC) acting as the central bank while the China Banking Regulatory Commission (CBRC), the China Insurance Regulatory Commision (CIRC) and the China Securities Regulatory Commission (CSRC) played the roles of regulators for banking, insurance and banking industries, respectively . The rise of the shadow banking industry in China has disrupted this structure given the creation of firms and products that are considered hybrid financial institutions. Regulation in this environment has proved to be more difficult. According to Global Legal Insights, there have been several recent changes that have changed the regulatory environment for China:
November 2017, Financial Stability and Development Committee (FSDC) was established – financial regulator directly under the State Council and headed by a vice premier more highly ranked than the heads of other regulatory commissions and PBOC
Coordinates overall strategy for financial sector and formulate policy
Merger of banking and insurance regulators, CBRC and CIRC into one regulator – China Banking insurance regulatory Commission (CBIRC) in 2018
In July 2019, Office of FSDC released 11 measures to make the financial services sector more open and easier to access for foreign investors.
Impact of Trade tensions with US
Garry F. National Bureau of Asian Research (NBR) - China’s recent trade tensions with the U.S. are one result of an ongoing multi-year struggle with the US for Financial Power. With the 2008 financial crisis, globalization, which has largely benefited China has been seen as a threat in places such as US and Europe due to the large dependence on China for labor and goods. Also, China sees the U.S. financial power as a threat because it allows the U.S. to shape the way economic activity takes place and change another country’s behavior. Given the centrality of the dollar for global financial systems, the U.S. has been able to use foreign banks as an instrument to cutoff state actors such as North Korea and Iran. China objects to this U.S. structural power in international finance and views it as a threat to its economy.
Amid this backdrop of tensions between the two countries, the trade war officially erupted with Donald Trump announcing tariffs on Chinese imports with the goal of forcing China to the negotiation table to correct what he believed to be trade practices that were unfavorable to the US. China retaliated with their own set of tariffs which has led to negative impacts on the markets for both countries.
(WSJ) Notably, for China the impacts have included the following:
Falling exports which has hurt manufacturers in Chinese port cities, putting some small companies out of business; larger suppliers have been looking for ways to reduce costs or pass them on to American buyers
Chinese exports in 2019 stagnated when compared to an export growth of 10% in 2018
Because of slowdown in global trade, factory jobs in China have decreased
Economic Growth ran 7% in 2017 and is predicted by the world bank to be 6% in 2020 which would be the slowest pace in 3 decades
Many businesses in China put investment and expansion plans on hold and laid off workers
(UNCTAD)
US Tariffs resulted in a decline in imports of tariffed products by about 25% in the first half of 2019
Trade Diversion Effects in the US Markets to other countries has had some impacts on China in terms of lost trade but the China market has survived for the most part. The biggest benefactor of trade diversion effects in 2019 was Taiwan (a province of China) technically lowering the impact on China.
Source: UNCTAD
Page Break
Effect of Coronavirus
The coronavirus pandemic was first identified in Wuhan, Hubei, China in December 2019.
As of April 2020, it has infected over a million people in at least 212 countries and territories globally, according to the World Health Organization. The virus outbreak has become one of the biggest threats to the global economy and financial markets. China has been in the fore front of this pandemic and its financial markets have certainly shown signs of the turmoil. China’s financial markets have led the waves of financial volatility in stock indexes, currency, government bonds, and corporate bonds. The table below highlights data from The Wall Street Journal Market Data which demonstrates the very recent volatility in China’s primary stock index and currency compared to the United States.
|
Stock Index
|
Currency
|
China
|
Shanghai Composite Index (SHCOMP)
|
Chinese Yuan (USDCNY)
|
|
Date
|
Index
|
%Chg
|
Date
|
Index
|
%Chg
|
Jan 1 (baseline)
|
½
|
3085.20
|
|
1/2
|
6.9632
|
|
Current
|
4/7
|
2815.37
|
-9%
|
4/7
|
7.0459
|
1%
|
Period High
|
1/13
|
3115.57
|
1%
|
1/13
|
7.1114
|
2%
|
Period Low
|
3/23
|
2660.17
|
-14%
|
3/23
|
6.8597
|
-1%
|
United States
|
Dow Jones Industrial Average (DJIA)
|
US Dollar Index (DXY)
|
|
Date
|
Index
|
%Chg
|
Date
|
Index
|
%Chg
|
Jan 1 (baseline)
|
½
|
28868.8
|
|
1/2
|
96.5
|
|
Current
|
4/7
|
22653.9
|
-22%
|
4/7
|
99.9
|
4%
|
Period High
|
2/12
|
29551.4
|
2%
|
3/20
|
102.82
|
7%
|
Period Low
|
3/23
|
18591.9
|
-36%
|
3/9
|
94.89
|
-2%
|
On the positive note, when looking at the overall volatility in the past three months, it is likely that China’s efforts at controlling the epidemic with extraordinary methods has helped (https://www.mckinsey.com/business-functions/risk/our-insights/covid-19-implications-for-business). This includes building hospitals in ten days, instituting large-scale lockdowns, and leveraging surveillance technology to ensure compliance. These measures have been successful in rapidly reducing transmission of the virus, particularly as the economy and financial markets have been restarting. Further, effective use of public-health best practices including widespread deployment of testing, rigorous contact tracing informed by technology, a focus on healthcare-provider safety, and real-time integrated tracking and analytics have decreased the spread. Regardless, uncertainty will remain high as investors try to determine the long-term impact on corporate earnings and the global economy so that more volatility is to be expected.
Appendix