Friday, September 15, 2006

Evolution in China of financial architecture, capital controls, and monetary policy

I noticed two aspects of what is going on in China which struck me as being quite different from what is going on in India. Financial Times has a story filed from Beijing titled Financial watchdog considered for China where he says:

China is debating the establishment of a new "super regulator" for its finance and banking industries to improve co-ordination in a sector in which reform has been increasingly hamstrung by infighting and inertia.

The establishment of an institution is likely to be on the agenda of a closed-door meeting later this year of senior leaders and finance industry officials, according to government advisers and scholars.

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The so-called Finance Work Committee meeting, to be chaired by Wen Jiabao, the prime minister, has only been held twice before and both times has been followed by major policy changes.

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Topics under discussion ahead of the meeting include the introduction of a form of monetary or inflation targeting, instead of the present emphasis on tracking money supply as a benchmark for the macroeconomy.

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With the major decisions largely behind the government on the reform of the state banks, a key focus for reform remains the capital markets, where development has badly lagged growth in the real economy.

Elements of the capital markets and brokerages are governed by separate banking, insurance and securities regulators, as well the People's Bank of China, the central bank. Local governments also have significant shareholdings in brokerages, making them difficult to sell off.

This sounds like a discussion about financial architecture of the type one has not yet seen in a meaningful way in India. In India, we have all sorts of problems with financial architecture, but in the period after the half-creation of PFRDA in 2002/2003, no progress has been made on resolving problems. The debate on regulation of commodity futures is an example of a failure (so far) in doing the right thing.

The second piece I noticed was a story about a Chinese attempt at doing a "trial" of greater convertibility in one geographically restricted area. This is in keeping with many other Chinese "experiments" with reform which have been first initiated in a small way in a part of the country.

This is also much ahead of the Indian convertibility discussion. My sense is that barring the Indian FII framework, which is superior to the Chinese QFII framework, the Chinese have greater de facto convertibility than what is in place in India. To say this differently, when the INR offered a one-way bet, the size of buying by RBI on the market was smaller than what China has had to do in a similar situation.

Is this a reflection of a greater commitment to liberal economics in China? Or is this a mere set of press releases which are well timed given the Singapore meetings? China is very non-transparent, and no outsider really knows.

2 comments:

  1. Ajay, I assume the selected Chinese geographical area will be open with respect to both domestic and cross boarder transactions. It sounds like a second Hong Kong--with one critical distinction. In particular, it is not clear how they can combine full liberalization for a limited region, while retaining the national currency. Any thoughts?

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  2. Exactly. Hong Kong has a distinct currency, and is kept out of China for the purpose of capital controls. Hong Kong has convertibility - is part of the great wide world for financial flows with it's own currency - while it is not a part of China in this regard.

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