The transfer in China of responsibility for the approval of medium- and
long-term corporate bond issues by listed companies from the National
Development and Reform Commission (NDRC) to the China Securities Regulatory
Commission (CSRC ) may turn out to be a watershed decision in China's
transition to a more market-oriented economy.
The involvement of CSRC in corporate bond issues since the new rules were
issued in August 2007 is a natural sequel to the establishment of a market for
short-term corporate bonds (one year maturity or less) under the auspices of
China's central bank, the People's Bank of China (PBoC), in May 2005.
Depending on how this institutional change is followed through in
practice, it marks a potentially important relaxation of state control over the
economy. There is now a chance that a commercial corporate bond market will
finally emerge in China. This is a high priority for the reform and development
of China's financial system since the move would reduce corporate
dependence on bank loans, stimulate capital market development and serve the
need of institutional investors for debt instruments with a wider range of
maturities and risk profiles [1].
Most Chinese bonds are issued by the government and government-owned policy
banks, and the corporate bond market provides only 1.4% of the total financial
needs of corporations in China (about 85% is financed by banks and about 14% by
equity) [2]. Early indications are promising: during the first half of 2008, 21
listed firms raised about US$10.9 billion (74.5 billion yuan) from
non-guaranteed corporate bonds authorized by CSRC, more than the amount raised
by all listed companies in the stock market during the same period.
The development of a commercial corporate bond market would improve the
efficiency of China's financial system by reducing the capital
bottlenecks that pervade the system.
There are indicators that suggest the government has selected the Tianjin
Binhai New Area, southeast of Beijing, as the next hub for concentrated
development and for trying out new ideas for financial reform that could, if
successful, be replicated elsewhere in the country. Tianjin could become the
next Shenzhen, the industrial and commercial district neighboring Hong Kong, or
Pudong, Shanghai's financial district.
The Tianjin Binhai New Area, which consists of three administrative districts
(Tanggu, Hangu and Dagang) and eight industrial zones currently under
construction, offers an excellent opportunity to accelerate capital market
development in China. Earlier ideas for the development of Tianjin as a
financial center, namely to make the yuan freely convertible in the Binhai New
Area and to make Bank of China's Tianjin branch the gateway for direct
and unlimited household investments on the Hong Kong stock exchange, were
grounded just as soon as the idea took off. However, global financial
volatility has breathed new life in China's financial reforms.
Vice Premier Li Keqiang, while inspecting the port city recently, stated that
local officials should accelerate efforts to develop the Binhai New Area into
"a northern portal of the country's reform and opening up drive, a base
of modern manufacturing and scientific research and application, and an
international shipping and logistics center". Cui Jindu, vice mayor of Tianjin
for financial affairs, stated that the city would concentrate on the
development of venture capital and private equity investments and position the
city as a center for non-securities funding. He also wants to promote corporate
bonds as an alternative funding source for enterprises established in the
Tianjin Binhai New Area.
Corporate bonds and financial system development
Some local, unofficial and essentially unregulated markets for corporate bonds
and equity shares emerged spontaneously in the mid-1980s [3]. It was not until
after the opening of local stock exchanges in Shanghai and Shenzhen (1990-91)
that the central government began to piece together a national framework for
their regulation and supervision. These efforts were initially frustrated by
the overheating of China's economy in the early 1990s [4].
The high inflation of those years, combined with high rates of loan and
corporate bond defaults, led Beijing to recentralize administrative control
over the financial system, introduce parallel fiscal reforms and promote a more
serious credit culture.
To punish the PBoC for its lax supervision of the financial system, Beijing
replaced its governor and transferred responsibility for corporate bonds from
the PBoC to the SPC (State Planning Commission - predecessor of NDRC) in 1993
[5]. However, the SPC did not use its new mandate to develop commercial capital
markets, but to raise funds for selected state-approved projects through
"corporate bonds", instead of bank loans or budget appropriations.
The terms for such bonds, which had to be fully guaranteed by a major state
commercial bank, were set by the SPC (NDRC). The rate of interest was usually
not related to bond maturity. Because of the 100% state bank guarantee and
other administrative controls, practically all corporate bonds were rated AAA
by state-sponsored rating agencies. Only about half the corporate bonds issued
under that system were listed on the exchanges; market turnover was low and
yield curves were essentially flat.
During the 1980s and early 1990s, priority was given to the reform and
marketization of the real economy. Financial institutions continued to serve as
agents of the state for plan implementation. They did not yet operate on
commercial principles.
Financial sector reform per se began to receive more serious attention in the
mid-1990s when China's economic planners realized that - like the
markets for goods and services - financial intermediation had to be based on
market principles. China became a member of the Bank for International
Settlements in 1996.
The Asian financial crisis of 1997-98 added urgency to financial sector reform.
Especially after the collapse of South Korea's economy at the end of
November 1997, the Chinese authorities became deeply concerned about weaknesses
in their own banking system, poor financial performance of most state-owned
enterprises and the undeveloped nature of domestic capital markets. The
official "credit plan" was abolished in 1998, but de facto state influence over
the allocation of financial resources is receding only slowly.
Since banking reform moved center stage around the turn of the century,
significant progress has been made. Capital market development became the next
priority. The Third Plenum of the 16th Communist Party's Central Committee in
October 2003 called for "a greater role for direct financing through
establishing a multi-tier capital market system and encouraging the growth of
institutional investors" [6].
As result of these and other developments, China's financial system has
significantly broadened and deepened since the turn of the century. Many new
instruments have entered the market and yield curves for government bonds,
which were mostly flat until about five years ago, have become sloped as they
normally typically are in mature capital markets [7]. Now is the time to
liberalize and commercialize corporate bonds. The promotion of Tianjin as a new
financial center and area for concentrated development offers a good
opportunity to also promote the development of genuinely commercial corporate
bond market.
Remaining obstacles
Impressive as financial system development has been in recent years, a number
of relatively serious obstacles to the development of capital markets,
including corporate bond markets, remain.
Effective market discipline has yet to be established. The government continues
to exercise considerable influence on the allocation and pricing of financial
resources through administrative interventions. This affects the assessment of
risk, reduces pricing flexibility and generally limits the beneficial effects
of market discipline.
Market supervision is relatively weak: insider trading, price manipulation and
inadequate disclosure remain serious problems.
Investor education remains limited. Although institutional investor
participation has sharply increased, most individual investors continue to
regard these markets as casinos.
The market for corporate bonds remains highly segmented. There are now at least
three kinds of corporate bonds: (a) short-term bonds with a maturity of one
year or less, issued under the auspices of PBoC since May 2005 and traded over
the counter (or OTC) on the Interbank Market, (b) medium- and long-term
corporate bonds issued by major unlisted state-owned enterprises under NDRC
auspices, fully guaranteed by a major state bank, traded on the exchanges, and
(c) non-guaranteed medium- and long-term bonds issues by listed companies under
the auspices of the CSRC, traded OTC on the Interbank Market.
A fourth category of corporate bonds now seems to be emerging: in April this
year, the NDRC approved the issue of non-guaranteed debenture bonds by two
unlisted state-owned enterprises - China National Materials Group Corporation,
or SINOMA, and Dalian Port Corporation Ltd. There is a need for consolidation
of the corporate bond market and its supervision.
China�s credit rating industry remains undeveloped. There are at present
five licensed credit rating agencies (CRAs), but most are under (indirect)
government control and not truly independent. Investors pay little attention to
their ratings. China has not so far permitted wholly foreign-owned agencies to
rate locally issued bonds, but several foreign CRAs, including Moody's
Investors Service, have been given permission to increase their minority
participations in ventures with Chinese CRAs to 49%.
Financial repression. The control of deposit rate ceilings by the PBoC tends to
push some financial intermediation underground and retards the
commercialization of official debt markets.
Notes
1. At present the total amount of corporate bonds outstanding accounts for only
about 3% of China�s stock market capitalization. In developed market
economies the corresponding ratio would typically range between 100-200%.
Corporate bonds account for about 1.4% of funds external funds mobilized by
China's corporations (Hale).
2. Hale, G. (2007), "Prospects for China's Corporate Bond Market".
Federal Reserve Bank of San Francisco Economic Letter.
3. Green, S. (April 2003), "China's stock market. A guide to its
progress, players and prospects." The Economist.
4. The overheating was due to excessive bank credit expansion, large-scale
corporate bond issues sponsored by local governments and a general lack of
discipline in the financial system.
5. Bottelier, P. (2008), "China's Emerging Domestic Debt Markets", in
Policy Reform and Chinese Markets, edited by Belton M Fleisher et al Edward
Elgar.
6. Zhou, X. (2006), "China's corporate bond market development: lessons
learned." BIS Papers No 26.
7. See for example http://eyield.chinabond.com.cn/cbweb/index.
Pieter Bottelier is a senior adjunct professor at The Johns Hopkins
University's School of Advanced International Studies (SAIS). Prior to this, he
served at the World Bank from 1970-1998 and was the chief of the World Bank's
resident mission in Beijing from 1993-1997.
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