Financial Reform and Economic Development in China
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Financial Reform and Economic Development in China

James Laurenceson and Joseph C.H. Chai

This book is a comprehensive, balanced and realistic assessment of China’s financial reform program and future direction. Covering not only the banking sector but also non-bank financial institutions, stock market development and external financial liberalization, the authors examine the impact of financial reform on economic development in China during the reform period. This volume will facilitate a more accurate assessment of the Chinese approach to financial reform, and will therefore, allow more informed future policy choices for both China and other developing and transitional countries.
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Chapter 2: Domestic Financial Liberalization and Financial Depth in China

James Laurenceson and Joseph C.H. Chai


2. Domestic financial liberalization and financial depth in China INTRODUCTION As noted in the introductory chapter, the existing literature examining financial reform in China displays several shortcomings. At the most basic level, the trend in DFL has yet to be clearly established. On one hand, the SOBs continue to allocate most of their loans to the state sector of the Chinese economy (Table 2.1). On the other hand, the SOBs have experienced a declining market share (Table 2.2) as a result of vast institutional diversification (Table 2.3). The rapid financial deepening that has taken place during the reform period is also indicative of substantial financial reform (Table 2.4). Therefore, the initial aim of this chapter is to shed light on the complex issue of whether in fact meaningful DFL has taken place. DOMESTIC FINANCIAL LIBERALIZATION IN CHINA This section begins by tracing reforms in the three areas where the government has traditionally intervened in China’s financial sector; interest rate controls, financial intermediation controls and credit allocation controls. An account of the recent institutional reform of the PBC is also provided. An overall financial repression index for the reform period is then constructed which captures changes in the above policy variables. Interest Rate Controls The pre-reform period has been described as the ‘dark ages for interest rates’ (Yi, 1994, p. 77). During this time interest rates were fixed at negligible levels and rarely varied. In general, DFL should ultimately be revealed indirectly through rising real interest rates. Once interest rate...

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