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Reviewing 1990s: a comparative study of reform transition Governor ZHOU Xiaochuan Governor ZHOU Xiaochuan People’s bank of China on April 26, 2004 on April.

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Presentation on theme: "Reviewing 1990s: a comparative study of reform transition Governor ZHOU Xiaochuan Governor ZHOU Xiaochuan People’s bank of China on April 26, 2004 on April."— Presentation transcript:

1 Reviewing 1990s: a comparative study of reform transition Governor ZHOU Xiaochuan Governor ZHOU Xiaochuan People’s bank of China on April 26, 2004 on April 26, 2004 world bank world bank

2 OUTLINE  Theoretical market economy  The centrally-planned economy  Radical correction Vs Gradual correction Trade Trade Banking Banking Capital market Capital market  Summary  What should have?

3 Theoretical market economy  General equilibrium & partial equilibrium  Based on production function: everybody makes his own money according to fair market prices: everybody makes his own money according to fair market prices: No cross-sector transfer of interest No cross-sector transfer of interest No cross-sector subsidy No cross-sector subsidy  Specific development strategy and income distribution are realized by fiscal policies

4 The centrally-planned Economy  Top priority was the industrialization (including military industry)  prices were tools to mobilize resources for industrialization.  The industrialization strategy realized via: Farmers subsidized industries Farmers subsidized industries consumer-goods industries subsides heavy industries consumer-goods industries subsides heavy industries Exporters subsidized importers, ( especially heavy industries importers) Exporters subsidized importers, ( especially heavy industries importers)  Other controls : hurdles to the free movements of resources: capital, labor

5 Radical Correction  Unemployment ↑  Per capita income↓  Savings rate ↓ Opportunity of restructuring: low Opportunity of restructuring: low  qualified companies as borrowers: few  Redistribution may cause instability

6 Gradual correction  Reducing the repression on agriculture, consumer goods industries or exporters  Find some other resources to subsidize, giving room and time for restructuring  Need additional resources to undertake the reform  Banks were needed to play intermediary roles in relatively low standard

7 GATT & CMEA  Some idea about labor division, comparative advantage and trade  GATT was based on market rules  CMEA was based on plan & negotiation rules Negative sentiment: USSR was a superpower with Chauvinism Negative sentiment: USSR was a superpower with Chauvinism Small economies wanted to escape Small economies wanted to escape

8 Changing trade partners  From CMEA to EC  Many sectors could not swiftly follow to change the production  Many consumers were somewhere between sky and ground  There should not be the same standards

9 Typical CMEA Foreign Trade: Romania: Exports/ GDP

10 Czech External Trade

11 Russia: External Trade

12 Poland External Trade

13

14

15 CIS Unemployment Rates

16 Central & east Europe: Unemployment Rates

17

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19 Border Trade Debate in Early 90s  Reality: Goods: low quality, low brand Goods: low quality, low brand Trade : barter trade, contertrade,normal trade Trade : barter trade, contertrade,normal trade Customs: concessionary Customs: concessionary Payments: any currency or no hard currency Payments: any currency or no hard currency  Western dream Goods: high quality, high brand Goods: high quality, high brand Hard currency payments Hard currency payments Bank settlement and finance Bank settlement and finance Formal customs inspection or tariff Formal customs inspection or tariff  Difficulty: who can afford? who can afford? Who was in shortage of FX Who was in shortage of FX What banks were incapable? What banks were incapable? What the custom did? What the custom did?  Result: GDP down, western dream UP

20 Gradual Correction: financial resources needs Liberalized the prices of agricultural goods, meanwhile subsidies to the wholesale and industrialization Liberalized the prices of agricultural goods, meanwhile subsidies to the wholesale and industrialization Encouraged exporters, meanwhile subsidies to specific importers Encouraged exporters, meanwhile subsidies to specific importers Liberalized the prices of consumer goods, meanwhile subsidies to heavy industries Liberalized the prices of consumer goods, meanwhile subsidies to heavy industries  Thus to bring immediate benefit, to maintain reform momentum  Sequencing the reform with finance constraint

21 Did China have the fiscal resources? Subsidy↑ Subsidy↑ Tax exemption and tax reduction↑ Tax exemption and tax reduction↑ Poor financial discipline, low accounting standards, slow tax reform and legislation, corruption in tax collectors→tax revenue ↓ Poor financial discipline, low accounting standards, slow tax reform and legislation, corruption in tax collectors→tax revenue ↓  China had to use other resources  No capital to undertake the needed reform at all fronts

22 Tax Revenue/GDP China: Data sources: IFS Data sources: IFS

23 What other resources to use?  Commercial bank: Policy loans Allowed undercapitalized companies to borrow at very high leverage Allowed undercapitalized companies to borrow at very high leverage Supported SOEs surviving in production Supported SOEs surviving in production Supported SOEs renewing the technologies Supported SOEs renewing the technologies Supported SOEs slowing down the layoffs Supported SOEs slowing down the layoffs Supported SOEs training new skilled workers Supported SOEs training new skilled workers Directly supported the fiscal overdraw and expenditures in industries Directly supported the fiscal overdraw and expenditures in industries Supported the restructuring and welfare program Supported the restructuring and welfare program

24 What other resources?  Stock market Allowed low standards of accounting, disclosure during IPO and secondary offering Allowed low standards of accounting, disclosure during IPO and secondary offering Allowed low quality companies to issue bonds Allowed low quality companies to issue bonds In favor of SOEs In favor of SOEs Relieve of inflation pressure Relieve of inflation pressure

25 Possible outcomes  Easier balance among development, stability and reform  Create bank NPL for disposing in the future  Create task to rebuild the discipline and confidence in capital market  It depends on how much Pareto improvement it could gain  It depends on whether saving rate could be maintained at good level

26 Observed results after 1990s  Positive: Economic growth maintainedEconomic growth maintained Export growth maintainedExport growth maintained Employment and Workers income maintainedEmployment and Workers income maintained Savings rate maintainedSavings rate maintained Reform momentum maintainedReform momentum maintained  Negative: Banks NPL Banks NPL Capital market distortion Capital market distortion with low standardwith low standard scandals in capital marketsscandals in capital markets Tension between government and investorsTension between government and investors Slow opennessSlow openness

27 What happened to SOEs in restructuring 1/3 succeeded 1/3 succeeded partially privatized or turned to Joint ventures→ went public→ state equity enhancespartially privatized or turned to Joint ventures→ went public→ state equity enhances however, they did not pay much to the banks! 1/3 failed 1/3 failed →Bank NPL →Default of pension liability 1/3:still remain to be seen 1/3:still remain to be seen Low standards in product, low end of marketLow standards in product, low end of market Some are good, but pension burden is highSome are good, but pension burden is high Labor market rigidity and low mobilityLabor market rigidity and low mobility

28 Value-added output by sector:

29 Exports and Savings in Banks

30 Pareto Improvement: slow but ahead

31 Comparison with shock therapy in banking sector Quick raise all standard→can bank staff catch up quickly? Quick raise all standard→can bank staff catch up quickly? Close insolvent banks → may lower the depositors confidence → lower saving rate in GDP Close insolvent banks → may lower the depositors confidence → lower saving rate in GDP Few customers are qualified borrowers →declined role of intermediary →less financing for reform and development Few customers are qualified borrowers →declined role of intermediary →less financing for reform and development Broad money/GDP remains low even declines Broad money/GDP remains low even declines Foreign banks did not fill the gap as expected Foreign banks did not fill the gap as expected

32 CIS Broad Money/ GDP

33 Central and east Europe: Broad Money/GDP

34 Financial Resources: M2/GDP in Transition Economies in 2002

35 Does China have the capacity to solve NPL  CONDITIONS Industrial restructuring and policy loans coming to the end Industrial restructuring and policy loans coming to the end Thanks to Asian financial crises Thanks to Asian financial crises Changed banks’ credit culture Changed banks’ credit culture Basically stopped the government interventions Basically stopped the government interventions After 1998, NPL ratio reduced 50% After 1998, NPL ratio reduced 50% Pareto improvement can be clearly identified Pareto improvement can be clearly identified fiscal revenue↑ fiscal revenue↑ reserves↑ reserves↑ Broad money ↑ Broad money ↑ saving↑ saving↑

36 It is affordable to solve the remaining 50% NPL  Fiscal resources  Future fiscal resources by growing economy  Foreign exchange reserves and gold reserves  Moderate inflation  Reasonable interest rate spread  Good enthusiasm of foreign investors to join in

37 Stock market grew up from 0  China set up 2 stock exchanges in 1991  All precondition were not met  Rules first or practice first?  Equity financing were badly needed.  Some central and east European countries also started in early 1990s.

38 Preconditions Standard Standard AccountingAccounting DisclosureDisclosure Corporate governanceCorporate governance Supervision Supervision ProfessionalismProfessionalism Fraud IPOFraud IPO Price manipulationPrice manipulation Institutional investors Institutional investors Maturity of individual investorsMaturity of individual investors Capital market services Capital market services Accounting firmsAccounting firms Law firmsLaw firms Rating agenciesRating agencies Evaluation agenciesEvaluation agencies

39 Preconditions Legislation & regulations Legislation & regulations Company lawCompany law Bankruptcy lawBankruptcy law Security lawSecurity law Fund lawFund law  Having good companies for listing?  Doing wrong, government has to compensate the innocent investors→need resources

40 China reached Total capitalizationTotal capitalization Domestic 2 exchanges: 40-50% GDP Domestic 2 exchanges: 40-50% GDP Overseas market: 20-30% GDP Overseas market: 20-30% GDP Equity financing > 5 trillion RMBEquity financing > 5 trillion RMB Listing companies> 1300Listing companies> 1300 Daily trade volume ≈ 2.5 billion USDDaily trade volume ≈ 2.5 billion USD  Substantially improve corporate governance and corporate culture Substantially help SOE reform Substantially help SOE reform

41 The liability remains  Investor claim compensations because of : Low standard Low standard Poor supervision Poor supervision Man-made distortion Man-made distortion Corporate scandal Corporate scandal  The Pareto improvement done by developing stock market ﹥﹥ total claim of compensation. However,  China need to find a channel and avoid moral hazard

42 Some transition economies  Started early  Voucher privatization

43 Market capitalization/GDP

44 Some other transition economies  Romania  Ukraine  Bulgaria  Central Asian economies

45 Tentative conclusions  Gradual corrections + financing reforms + Pareto improvement + ex post clearance + final transition Realistic development of trade Realistic development of trade Not textbook type banking reform Not textbook type banking reform Emphasize equity capital market function Emphasize equity capital market function Solve problems with growing strength based on economic development Solve problems with growing strength based on economic development

46 Tentative conclusions  The path of China in 1990s: half designed, half compromised Very few economists officers had position of designning Very few economists officers had position of designning Many officers disliked shock therapy, undermined financial problem, believed in SOEs Many officers disliked shock therapy, undermined financial problem, believed in SOEs  If the path could be better: A bettr and earlier round fo tax reform A bettr and earlier round fo tax reform A stronger banking reform after Asia financial crisis A stronger banking reform after Asia financial crisis A better negotiation with CIS and Central and east Europe about trade A better negotiation with CIS and Central and east Europe about trade

47 Remaining Burden: Pension Liability  Postponed reform, easy up the current fiscal balance  Demographic trend: aging population  Implicit fiscal deficit liability  Does economy future provide enough resources to meet the liability?  Reconsider the sustainability of PAYG

48 What should we have done or should have never done in 1990s?  50% NPL for bail-out other sectors  10% NPL caused by low standard of law enforcement  Pension reform before realizing aging trend  15% NPL caused by poor internal control based on mistaken decentralization  15% NPL by real estate bubble

49 Thanks for attention


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