An article on Financial Market of China. Regulatory functioning at People's Bank of China. Currency exchange rates. Various market instruments and broad regulatory environment.

1. International Finance
Article on Financial Market of China
Point of Discussion
1. Regulatory functioning of Central bank of the China
2. Instruments of the market.
3. Exchange rate with reference to other currency
4. Broad Regulatory Environment
Prepared by Bhooshan Kanani

2. Introduction of People’s Bank of China (PBC)
People’s Bank of China (PBC) was established on 1 December 1948 based on the consolidation of the former Huabei Bank, Beihai Bank and Xibei Farmer Bank. In September 1983, the State Council decided to have the PBC function as a central bank. The Law of the People's Republic of China on the People's Bank of China passed by the Third Plenum of the Eighth National People's Congress on 18 March 1995 legally confirmed the PBC's central bank status. In March 2003, the First Plenum of the Tenth National People's Congress approved the Decision on Reform of the Organizational Structure of the State Council, separating the supervisory responsibilities of the PBC for the banking institutions, asset management companies, trust and investment companies and other depository financial institutions. Instead, the China Banking Regulatory Commission was established to supervise the financial industry. On 27 December 2003, the Standing Committee of the Tenth National People's Congress approved at its Sixth Meeting the amendment to the Law of the People's Republic of China on the People's Bank of China, which has strengthened the role of the PBC in the making and implementation of monetary policy, in safeguarding the overall financial stability and in the provision of financial services.
Functions of PBC
Under the guidance of the State Council, the PBC formulates and implements monetary policy, prevents and resolves financial risks, and safeguards financial stability. The Law of the People's Republic of China on the People's Bank of China provides that the PBC performs the following major functions: issuing and enforcing relevant orders and regulations; formulating and implementing monetary policy; issuing enminbi and administering its circulation; regulating inter-bank lending market and inter-bank bond market; administering foreign exchange and regulating inter-bank foreign exchange market; regulating gold market; holding and managing official foreign exchange and gold reserves; managing the State treasury; maintaining normal operation of the payment and settlement system; guiding and organizing the anti-money laundering work of the financial sector and monitoring relevant fund flows; conducting financial statistics, surveys, analysis and forecasts; participating in international financial activities in the capacity of the central bank; performing other functions specified by the State Council.
Independence of PBC
The PBC performs its functions and carries out business operations independently according to laws and free from intervention by local governments, government departments at various levels, public organizations or any individuals.

3. Institutional Arrangement of PBC Management and Organizational Structure of PBC
The PBC needs to report to the State Council its decisions concerning the annual money supply, interest rates, exchange rates and other important issues specified by the State Council for approval before they are put into effect. The PBC is also obliged to submit work report to the Standing Committee of the National People's Congress on the conduct of monetary policy and the performance of the financial industry. All capital of the PBC is invested and owned by the State. The top management of the PBC is composed of the governor and a certain number of deputy governors. The governor of the PBC is appointed into or removed from office by the President of the People's Republic of China. The candidate for the governor of the PBC is nominated by the Premier of the State Council and approved by the National People's Congress. When the National People's Congress is in adjournment, the Standing Committee of the National People's Congress sanctions the candidacy for the governor of the PBC. The deputy governors of the PBC are appointed into or removed from office by the Premier of the State Council. The PBC adopts a governor responsibility system under which the governor supervises the overall work of the PBC while the deputy governors provide assistance to the governor to fulfill his or her responsibility. The head office of the PBC is located in Beijing, the nation's capital and consists of 18 functional departments (bureaus).
MONETARY POLICY IMPLEMENTATION
Monetary Policy Committee
Article 12 of the Law of the People's Republic of China on the People's Bank of China provides “the People's Bank of China is to establish a monetary policy committee, whose responsibilities, composition and working procedures shall be prescribed by the State Council and shall be filed to the Standing Committee of the National People's Congress. The Monetary Policy Committee shall play an important role in macroeconomic management and in the making and adjustment of monetary policy”. Rules on Monetary Policy Committee of the People's Bank of China stipulates that the Monetary Policy Committee is a consultative body for the making of monetary policy by the PBC, whose responsibility is to advise on the formulation and adjustment of monetary policy and policy targets for a certain period, application of monetary policy instrument, major monetary policy measures and the coordination between monetary policy and other macroeconomic policies. The Committee plays its advisory role on the basis of comprehensive research on macroeconomic situations and the macro targets set by the government.
The Composition of Monetary Policy Committee
The Monetary Policy Committee is composed of the PBC's Governor and two Deputy Governors, a Deputy Secretary- General of the State Council, a Vice Minister of the State Development and Reform Commission, a Vice Finance Minister, the Administrator of the State Administration of Foreign Exchange, the Chairman of China Banking Regulatory Commission, the Chairman of China Securities Regulatory Commission, the Chairman of China Insurance

4. Regulatory Commission, the Commissioner of National Bureau of Statistics, the President of the China Association of Banks and an expert from the academia. The Monetary Policy Committee performs its functions through its regular quarterly meeting. An ad hoc meeting may be held if it is proposed by the Chairman or endorsed by more than one-third of the members of the Monetary Policy Committee. The opinions expressed in the meeting of the Monetary Policy Committee will be recorded in the form of “meeting minutes”. Such minutes or any resultant policy advice, if approved by more than two-thirds of the members of the Monetary Policy Committee, should be attached as an annex to the proposed decisions of the PBC on annual money supply, interest rates, exchange rates or other important monetary policy issues to be reported to the State Council for approval. In the case the PBC files its decisions on other monetary policy related issues with the State Council, it should enclose the meeting minutes or policy advice of the Monetary Policy Committee at the same time.
Objective of the Monetary Policy
Monetary Policy Instruments
The objective of the monetary policy is to maintain the stability of the value of the currency and thereby promote economic growth. The monetary policy instruments applied by the PBC include reserve requirement ratio, central bank base interest rate, rediscounting, central bank lending, open market operation and other policy instruments specified by the State Council.
Instruments of monetary policy in China
The PBC classifies its present set of monetary policy instruments into four categories
1. Instruments with ratios, i. e. reserve requirements;
2. Instruments with interest rates, i.e. central bank lending rates;
3. Quantitative instruments, i.e. open market operations (OMOs); and
4. Other instruments, i.e. central bank bills.
The classification used in this work somewhat differs from the four categories.
First, two main categories of central bank instruments are distinguished: (i) price-based; and (ii) quantity-based instruments.
Second, all four above-mentioned categories are subsumed under the category of price based instruments.
Certainly, open market operations (OMOs) are originally designed to control the monetary base and therefore can be counted as a quantity-based instrument. But, in a market-based financial system, every amount of monetary base has its corresponding price. Thus, the major central banks in the world use OMOs to control the money market rate rather than the monetary base.

5. The PBC is no exception to this. For instance, the PBC carried out 24 repurchase operations (“repos”) in 2001. In 19 operations, quantity tenders with a fixed interest rate were used. In the same year, in 26 reverse repos, solely quantity tenders with fixed interest rates were operated.15 Quantity-based instruments are instruments that are non-market conform, i.e. instruments that change the amount of money in the financial system without taking into account the price of money. Instruments that would fall into this category are nowadays abolished credit plan or newly introduced instruments like window guidance. Capital controls also can be counted to this category since controls leverage on the quantity of capital and not on its price. As a third kind of instruments, price and wage controls as non-central bank instruments will be highlighted. Non-central bank instruments influence the final targets of the monetary policy in China without being primarily monetary policy instruments.
Instruments of the People’s Bank of China as the Central Bank of China
1. Price-based indirect instruments
In a very simplified description, the interest rate channel can be described as follows: (i) in the case of a too expansionary monetary stance, the monetary authorities would increase their primary lending rate; and (ii) in a completely market-based environment, the stance of the lending rate will be displayed in the interbank money market and through the expected channels, transformed them into all different maturities. Thus, the commercial banks’ refinancing costs will rise due to the increase in the primary lending rate. The higher the costs of financing for the commercial banks will lead to the higher interest rates for outflowing credits to third parties. Higher interest rates in turn will lead to a lesser demand for credits from the non-banking sector and thus lead to a slowing of the real sector. The reverse logic would apply for the situation of a too restrictive monetary stance. The interest rate instrument influences final targets via its interaction with intermediate targets. In China, the interest rate channel of monetary transmission is blurred. Due to the partially interest rate liberalization, price-based instruments in China have two different underlying mechanisms of action. First, there are instruments that transform the central bank’s policy stance through the interest rate channel of monetary transmission, i.e. OMOs or minimum requirements. Second, there are instruments that are not yet subject to full liberalization and thus act under the disguise of price-based instruments, i.e. PBC lending and deposit rates.
a) PBC lending and deposit rates
The PBC lending and deposit rates works in a similar market-oriented way as facilities of Western central banks such as in the case of the European Central Bank (ECB), where the marginal refinancing and the deposit facility constitute the upper and lower limit of the money market interest rates. In certain circumstances, the PBC lending and deposit rates have to be seen as an administrative order from the monetary authority that leverages on existing money already at the disposal of the commercial banks. Thus, credits to non-bank third parties are not necessarily based on a utility-calculation in terms of costs for refinancing from the PBC

6. b) Discount and Re-discount rates
Before 1998, the discount and rediscount rates were set within a floating range of 5 per cent to 10 per cent below the commercial banks’ loan and PBC lending rates respectively. Since 1998, the rediscount rate was determined in line with other central bank lending rates. In 2004, the rediscount rate was installed as the benchmark rate of central bank lending, i.e. the PBC was given the possibility to change the central bank lending rates within a floating range around the rediscount rate without prior approval of the State Council. However, the turnover of operations within the rediscount instrument itself is too small to have some significant influence on the growth of monetary base. Thus, today the rediscount policy primarily aims at influencing the commercial paper market.
c) Reserve requirements
The PBC introduced minimum reserve requirements in the year 1984 in order to control the financial sector liquidity. At first, the officials set different reserve obligations for the different deposits with regard to their origin and the institution actually holding the reserves. In 1985, the PBC combined all different reserve requirements and set one minimum reserve requirement at 10 per cent.
d) Open Market Operations (OMOs)
In 1993, the PBC introduced the instrument of open market operations (OMOs) into its monetary policy toolbox. But the authorities soon had to realize that the institutional foundation with the absence of an inter-bank market and only rudimentarily liberalized interest rates was not strong enough to establish well-functioning OMOs.
Open market operations include: (i) national bonds; (ii) Central bank bills; and (iii) financial bonds from other financial institutions, the so-called policy banks. They are traded as repurchase and outright market operations. Repurchase operations include: (i) repurchase agreements for the purpose of monetary base withdrawal (“repos”); and (ii) reverse repurchase agreements for fuelling monetary liquidity (“reverse repos”). Additionally, the central bank issues central bank bills, securities issued by the PBC.

7. 2. Quantity-based direct instruments
Before the reform era, the credit plan acted as the financial framework for the state investment plan. Necessary credits to reach the given output targets have been summed-up. Since the 1980s, the instrument of the credit plan has been adjusted several times according to the new financial and economic environment. In 1996, still, the credit plan was the most important monetary policy instrument of the PBC. Only in 1998, when the credit plan was officially abolished and OMOs were established, the latter became the main monetary policy instrument in the PBC’s toolbox. Today, preferential lending to certain areas and industries is still observable. Thus, credit allocation in those areas does not follow cost-utility criteria, i.e. credit allocation is not steered by the price but by the required and/or desired amount of money. The two instruments of window guidance and direct PBC lending are mainly used for the quantity- based allocation of credits in the Chinese financial system.
a) Window guidance
The PBC started to adopt the policy of “window guidance”30 in 1998. The framework for the Chinese window guidance was closely modelled according to the Japanese system, which had been in place for more than 40 years until its suspension in the early 1990s. This policy uses benevolent compulsion to persuade banks and other financial institutions to stick to official guidelines. Central banks put moral pressure on financial players to make them operate consistently with national needs
b) Direct People’s Bank of China lending
Direct PBC lending as a monetary instrument is in the legacy of the planned economy, the usage of which was officially discontinued in 1994. However, the last decade or so was marked with a high amount of the central bank money permanently being in the financial system, evidence for instance, by excess reserve ratios well above the 10 per cent margin in the 1990s which only gradually came down to 7.61 per cent in 2001 and 5.38 per cent at the end of 2003. In 2005 and 2006, excess reserve holding stabilized between 4 and 5 per cent. This high amount of the central bank money to a great extent is caused through long-term central bank’s loans that are subject to low interest rates without being linked to the predominant monetary policy stance.
c) Capital controls
A third instrument within the quantity-based instrument toolbox of the central bank is capital controls. However, the instrument of capital controls differ fundamentally from window guidance and direct PBC lending as the capital controls’ aim is not the amount-driven credit allocation but the quantitative limitation and guidance of financial flows between China and the rest of the world. The most obvious solution, however, would be to constrain the capital mobility and thus reach a fixed exchange rate regime that still enables an autonomous monetary policy.

8. Chinese currency and Foreign Exchange Rates
Early Currency in China With a history of over 3000 years, Chinese currency existed in both Ancient and Imperial China. In 1914, the Silver Dollar was established as the official currency of the Republic of China, with copper, fen, and nickel coins being added in the 1930s. During this time silver appreciated in value, and China could no longer retain the silver standard. In 1935, a new currency known as Fǎbì, was issued.
Introduction of the Gold Yuan and Chinese Yuan Renminbi The Gold Yuan replaced the Fǎbì in 1948 at a rate of 1 Gold Yuan to 3 million Yuan Fǎbì. That same year, the Yuan Renminbi (often called RMB) was introduced as a way to help stabilize the Communist held areas of mainland China. In 1955, a re-evaluation took place and a new Yuan Renminbi was introduced at a rate of 1 new Yuan to 10,000 old Yuan.
The Renminbi in Foreign Exchange During the command economy, the Chinese Yuan Renminbi was set to unrealistic exchange values and as a result, severe currency guidelines were put in place. When China's economy opened in 1978, the Yuan Renminbi was only used domestically and foreigners used exchange certificates; this led to a powerful black market. From 1997 to 2005, the Chinese government pegged the Chinese Yuan Renminbi to the US Dollar at approximately 8.3 CNY to 1 USD. In 2005, a flexible mechanism of exchange rates was phased in, with the RMB being re-evaluated to 8.1 Renminbi per US dollar. The Chinese government launched a pilot program in 2009, allowing some businesses in Guangdong and Shanghai to execute business and trade transactions with counterparties in Hong Kong, Macau, and select nations. The program has since expanded to all areas of China and all international counterparties. China has also made agreements with Australia, Japan, Thailand, Russia, and Vietnam to allow for direct currency trade, instead of converting to the US Dollar. As a managed float, the Renminbi's value is determined by a basket of foreign currencies
Currency Facts
Name: Chinese Yuan Renminbi
Symbol: ¥ Jiao: 角
Minor Unit: 1/10 = Jiao
CNY Profile: Inflation: 2.6%
Coins: Freq Used: ¥1, 5角, 1角
Banknotes: Freq Used: ¥5, ¥10, ¥20, ¥50, ¥100, ¥1 Rarely Used: ¥2, 2角, 5角, 1角

9. Regulatory Environment of China:
Regulatory reform priorities measures to deal with slowing growth, rising unemployment, and other dislocations arising from the world economic crisis are now at the top of the economic policy agenda of the People's Republic of China. The financial problems that began in the wisdom of China's strategy of carefully pacing financial liberalisation in line with the strengthening of the capacities of financial institutions and markets to prudently manage the resulting risks.
Average Annual growth in GDP
Country
Period
Percentage
China
1987 – 2007
9.8
Japan
1950 -1980
7.7
Korea
1950 - 1980
9.1
India
1987 - 2007
5.9
The basic goals of China's financial reform - to strengthen the soundness and governance of financial institutions and to develop and diversify financial markets - remain valid although in some cases specific measures may need to be adapted to future changes in international standards and practices. But the serious problems in financial regulation underlying the world crisis mean that redoubled and ongoing efforts to strengthen financial regulatory institutions and capacities in all countries, including China, are essential.
As China's authorities have emphasized, sustaining open markets and avoiding protectionism will be essential to avoid the vicious circle of protectionism and economic contraction that occurred during the 1930s. China's extensive measures to open its markets and improve competition over the past decade have paid significant benefits to the domestic economy and contributed importantly to the liberalisation and expansion of world trade.
Continued efforts by China in these areas (including avoidance of resort to anti-competitive policies to deal with short-term disruptions) will help to ensure that the vicious circle does not emerge. By promoting more efficient markets and fostering innovation, the reforms will also strengthen the foundation for a sustained recovery and continued economic development.
The current crisis may make some regulatory reforms to utilities and infrastructure sectors more difficult to achieve in the near-term. However, these reforms still need to be pursued to correct distortions that now exist and to ensure healthy development of the industries in the future.

10. Finally, the crisis has graphically underscored the risks that arise when regulatory institutions
and practices fail to improve and adapt sufficiently to changing economic conditions. Poor co-ordination
among key regulatory bodies and other government agencies, gaps and adverse
incentives created by outdated or poorly formulated regulations, and deficiencies in regulators'
ability to predict or detect problems before they became serious fostered financial excesses
and allowed them to grow to systemic proportions. Improvement in regulatory quality is
equally important to China, given the rapid and extensive changes that are occurring in its
economy. Better co-ordination among government regulatory bodies, particularly those at
different government levels, will be important to the success of current efforts to deal with the
economic downturn. Better coordination along with greater clarity and transparency in
regulatory measures and processes and the development of means to predict and measure the
impact of regulations also will be important to the success of broader economic reforms.
Reference Links:
http://www.seacen.org/GUI/pdf/publications/bankwatch/2012/3-PBC.pdf
http://www.x-rates.com/table/?from=CHF
http://www.xe.com/currency/cny-chinese-yuan-renminbi
http://mgeiger.wordpress.com/instruments/
http://unctad.org/en/Docs/osgdp20082_en.pdf
http://www.pbc.gov.cn:8080/publish/english/963/index.htm