China’s Financial System: Renminbi’s Currency Behavior

A Research Paper Provided to the Department of Financial Management
College of Arts and Sciences
San Beda College

In Partial Fulfillment of the Requirement for FME01
(Islamic Finance and World Banking)

Submitted by:
James, Narson
Mangaoang, Kristine Joy L.
Manlapig, Michella Bianca I.

August-October 2015

Table of Contents
I.

IV.

China’s Financial Background and Overview…………………………………….…03
II.
A. China’s Financial System Architecture……………………………………...03
B. World Bank’s Assessment of the Country’s Financial System……………...04
III.
China’s Current Financial State……………………………………………………...08
V.
A. Elaboration of China’s Current Stand Based From The Official Ratings
VI.
1) Comparison (Annual)
…………………………………………………….08
VII.
2) Study/Investigation on
the Said Rating
VIII.

a) Stock

Plunge…………………………………………………………...09
IX.
b) Renminbi’s Value
Flunk……………………………………………….13
X.

III.

Effects of China’s Wild Fluctuation to;

……………………………………………..15
A. Our country, Philippines……………………………………………………...15
B. Global Financial Institutions………………………………………………….16
XI.
XII.

IV.

China’s Blueprint against Complete Financial System

Deterioration……………...…17
A. Financial Reform……………………………………………………………..17
B. Strategize Renminbi’s Ideal/Peg Value………………………………………19

2 0 I.XIII. XVI. China’s Financial Background and Overview XIV. China’s Financial System Architecture . Conclusion……………………………………………………………………………. A. V. XV.

.XVII. XVIII.

this report summarizes the findings of the Financial Sector Assessment Program (FSAP) exercise for China undertaken in 2010 by a joint IMF/World Bank team. and potential asset bubbles. XXII. The State Council has the overarching responsibility for the financial system.XIX. The figure above shows China’s Current Financial Architecture. high savings by private enterprises without access to capital markets. iv) Capital markets’ underdevelopment limits alternatives for corporate funding and household investments. It exercised this responsibility by establishing and chairing a high-level ad-hoc committee of the key financial agencies in June 2008. continued bank dominance of the financial system. In China there are five key macro-financial linkages: i) The banking system directly facilitates quasi-fiscal policy through its use as a credit channel. ii) Banking system directly facilitates monetary policy. and represents an impediment to solving structural problems in the financial sector: low rates of return on savings. The mission recommended that a permanent Financial Stability Committee be established. high precautionary savings through banks. . iii) Low cost of capital distorts the savinginvestment balance of the economy. China has adopted an institutional approach to financial regulation. with three separate commissions and the PBC sharing responsibilities. XXI. v) Lack of contestability of markets or ownership for large firms limits competition. XX. building on the experience from the ad-hoc committee. but the credit growth targets undermine the efficiency of credit allocation. The financial system plays a direct and critical role in the transmission of macroeconomic policies.

0% of the country’s total output. China has become the world’s manufacturing hub. Since the introduction of the economic reforms in 1978. B. Given the solid fiscal position of the government. in 2013. China weathered the global economic crisis better than most other countries. the stimulus measures . Meanwhile. In November 2008. the primary sector’s weight in GDP has shrunk dramatically since the country opened to the world. China’s modernization propelled the tertiary sector and. while the secondary sector still accounted for a sizeable 45. XXIV.XXIII.0 trillion (USD 585 billion) stimulus package in an attempt to shield the country from the worst effects of the financial crisis. where the secondary sector (comprising industry and construction) represented the largest share of GDP. XXVI.2 trillion.1%. in recent years. which triggered concerns that the country could have been building up asset bubbles. The massive stimulus program fuelled economic growth mostly through massive investment projects. However. the State Council unveiled a CNY 4. 35 years later it jumped up to second place with a nominal GDP of USD 9. In 1978— when China started the program of economic reforms—the country ranked ninth in nominal gross domestic product (GDP) with USD 214 billion. overinvestment and excess capacity in some industries. it became the largest category of GDP with a share of 46. XXV. World Bank’s Assessment of the Country’s Financial System The Chinese economy experienced astonishing growth in the last few decades that catapulted the country to become the world's second largest economy.

including greater exposure to external shocks. But still financial infrastructure and relevant legal systems need to be further upgraded. conglomerate structures. and oversight of the financial sector. low inflation and a sound fiscal position. China’s financial system reforms are progressing well. The inter-linkages across markets and institutions are growing. Particularly. and off-balance sheet activities are on the rise. an . By the early years of 2010. while households’ consumption remained repressed. Apparently. In the coming decades China will have strong liquidity internationally. The system is becoming more transparent as it opens up. the policies implemented during the crisis to foster economic growth exacerbated the country’s macroeconomic imbalances. In order to tackle these imbalances. China exited the financial crisis in good shape. The global downturn and the subsequent slowdown in demand did. XXVII.did not derail China’s public finances. performance. a solid banking system. the new administration of President Xi Jinping and Premier Li Keqiang started to unveil economic measures aimed at promoting a more balanced economic model at the expense of the once-sacred rapid economic growth. Improvements are seen in the structure. with GDP growing above 9%. the stimulus program bolstered investment. XXVIII. However. severely affect the external sector and the current account surplus has continuously diminished since the financial crisis. China is confronted by a build-up of potential sources of vulnerabilities. however. and de-facto banks and informal credit markets.

XXXIII. XXIX. and a huge market with differential capacities. a high and stable savings rate.3 percent in 2014. XXXII. There was even this rise on their currency the Renminbi only from the previous year (2014).effective financial firewall. XXX. and weaken further in 2016.8 percent this year from 7. XXXVII. XXXVIII. As a matter of fact. it can also be forecasted. . and continuous financial stability until the first half months of the current year (2015). XXXIV. XXXVI. Renminbi’s value flunked and the countries Stocks deeply plunged all within a month after its economic peak. More is that China is currently in the industrialization stage. But after the constant elevation of their financial sector. Chinese economic growth has the foundation to exist without crisis and maintain a sustainable high speed. it expects China’s growth to slow to 6. XXXV. XXXI.

XLII. the downward trend in all-important fixed-asset investment was kept intact. But for 2015 a lot of people are considering a slowdown of the Chinese economy. While industrial production and retail sales recorded mild gains. China was known to be the remarkable developing country. the Ministry of Finance stated that it would boost fiscal policy to rekindle growth. on 8 September. China Has Biggest One-Day Stock Crash Since 2007.9 percent of total world output and foreign trade volume that amounted to 8 percent of total world volume in 2009. II.XXXIX. China’s foreign reserve has accounted t 28 percent of global foreign exchange reserves. China underwent a near-death experience when their country’s two stock exchanges entered free fall. XLVI. China’s stock market bubble was always bound to burst. Meanwhile. XLI. XLIII. XLV. China achieved economic output that accounted for 7. China’s Current Financial State On 2014. A government . data for August corroborate the view that economic fundamentals remain weak.and their currency the China’s Yuan pushes deeper into global financial system all of this has happened from the span of a month or two. XLIV. XL. Aware of the difficult situation.

once credited with near-magical powers to browbeat its economy into growth looked to have misplaced its wand. . XLVII. Suspicions abounded that a decades-long era of superlative—if recently softening—economic expansion might be coming to an end.

limiting the number of residences one owner could buy in such cities as Beijing and Shanghai and levying a new tax. China had already experienced a dangerous bubble in its residential housing market. And its maturing economy needs less of the commodities—such as raw materials for infrastructure. by far the biggest single contributor. Adding each country’s GDP figures into a global total is of course not the same as working out their real role in driving the world economy. but in that case their government had succeeded in engineering a relatively soft landing by raising interest rates. or ready-made components for manufacturing—that other emerging countries rely on selling. But relative to the hopes of five years ago.XLVIII. Its 67% investors compose of people who’s undergraduate. they suddenly took off last summer. stocks had begun to seem like a sure bet for Chinese investors who wants to be a real quick wealthy man. have been crippled by falling oil prices and political stalemate. Other would-be powerhouses of the 2000s. All this has dented hopes that emerging economies might prop up global growth. such as Brazil and Russia. it certainly seems like the world is stuck in a traffic jam XLIX. It was all easy for small investors to assume that the bull markets was implicitly backed by a kind of unwritten government guarantee. becoming a cauldron of avid buying. China. L. These two stock exchanges are Shanghai and Shenzhen. that the . selling and profit-taking. Shanghai and Shenzhen had gone even higher in less than a year. is showing signs of slowing. The two stock exchanges guaranteed a much higher rate of return than traditional low-interest bank saving accounts.

causing broader concern about the impact a Chinese economic meltdown could have on the rest of the world. But in the last few months. LI. Those prices have now been crashing down. its stock market has seen an incredible rise in prices. “The bull market was itself a policy-driven one. and the state would step in to take care of things before the bottom fell out. which was a disappointment for investors who thought it would do. On this occasion it was something the Chinese central bank did not do. so only major policies can save it” Schell said to the New York Times. Jason Abbruzzese mentioned in his article that China is one of the world's largest economies. LIII. Their first plan is attempting on managing the collapsing share prices through more state interventions. Andrew Walker mentioned about some specific factor driving shares lower on particular days. LII. When Shanghai stock exchange composite index plunged over the course of a few short weeks in June and July.good times were only beginning to roll. its precipitous fall stunned the nation. and pointed to the government’s role in inflating the bubble as a reason for it to forcefully intervene to prop up prices. One young investor blamed “the state’s inadequate regulations”. It did not take steps to stimulate more bank lending. but also one of the most fragile. and sharply. But there was no new stimulus and so shares fell. LIV. Chinese markets begun to respond to the government’s many interventions and started slight rebound by the end .

It is trying to clean up the debt mess left over by the stimulus of 2009. has its thumb on the scales. by some counts. It is the second largest economy and the second largest importer of both goods and commercial services. because China is a closed society and the negotiations among . almost doubling over the past seven years. when the government. Even if China holds up well enough now. At the same time structural trends are turning against China. there is still the worry that a sharper slowdown lies ahead. LVI. from Japan to Spain.of August. the foreign investors who had bought into Chinese companies through the Hong Kong exchange began pulling their capital out of Chinese stocks. LV. when it unleashed a mammoth investment spree to fight off the global financial crisis. China is now such a big force in the global economy that it would inevitably affect the rest of the world. Its working-age population is now shrinking. So it is still far too early to speak of China’s stock markets having established or returned to normalcy. has reached more than 250% of GDP. Investors feared the real possibility that shareholders who re-enter the market may find themselves in the future holding untradeable and therefore illiquid shares if the government again decides to freeze market operations in response to a sharp decline. It is hard to imagine that all this behind-the-scenes manipulations will not dent the confidence of investors in the future: the already tenuous connection between share prices and actual corporate value will now be even more uncertain. LVII. Debt. in effect. The government faces daunting challenges in managing the economy. Increases of that magnitude have presaged crises in other countries. After the crash.

But most people don't own shares . LX. LIX. China today is that it is in the middle of process of uncertain change in many ways. When the stock bubble. The obvious contradiction between a largely self-regulating financial market and a highly controlled and centralized economy is a graphic representation of China’s divided modern-day self. On Andrew’s Walker article he mentioned that those who have borrowed money to buy shares in the last few months have been hit very hard. according to Capital Economics. it is likely to still be fast enough to generate rising living standards for most people. all we can see are the results that follow.its leadership are so impervious. A more disruptive slowdown would mean many business failures and job losses. LVIII. we on the outside rarely know who really makes decisions about important issues or by what process they are made. Unenviable predicament is hardly limited to . In once purely socialist command economy is now partially socialist and partially capitalist. If China manages a smooth transition to a slower and more sustainable growth rate. For most Chinese the wider issue is about the health of the country's economy.only one person in 30 does. which had so inflated the listed value of shares that a natural correction was inevitable.

But now most of the investors are worried about what happened at China. the government intentionally shrank the value of the RMB in order to encourage exports. In certain ways the response of the nation’s leaders to the recent market crash is emblematic of a much larger dilemma said Schell. Jason Abbruzzese claimed. to fall further to stimulate exports Andrew Walker said. Chinese consumers have been helping to boost the world economy with their spending as more and more Chinese reach the middle class. Most of us would ask. The country imports more than $1. While under the struggle of China’s Stock Plunge. LXI. many people was surprised when the value of Renminbi against dollar fluctuated because the Chinese government is very strict on controlling its value. China is a drastically important company to the world economy. the importing goods from China was also cheap. the Yuan. they could relax the rules on bank lending or they could increase spending. what might the Chinese authorities do next? LXII. China’s businesses compete with regional rivals to supply the world with everything from raw . They could also encourage the currency.4 trillion of goods yearly from across the world. If the RMB is cheaper. China has been one of the largest contributor to the world economic growth and low global inflations. LXIV. They could cut interest rates. LXIII. They have several options to stimulate the economy which can affect the stock markets.China’s stock markets. But the truth is.

LXXIV. known as the yuan or renminbi. LXV. LXXI. LXXV. LXXIII. LXVII. LXIX. is making a seemingly relentless push deeper into the global financial system. The country’s currency. LXX. For today: LXVI. Yuan’s depreciation was a way to make their country’s financial system more market-oriented. LXXII. LXVIII. .steel to fridges and a cheaper yuan will make China’s export less expensive.

LXXX. While investor risk appetite in global markets continue to be weighed down by prevailing uncertainties and the impending rates lift-off in the US. LXXIX. among other external shocks. LXXXI.LXXVI. of which only $2. LXXXIV. should our trade be adversely affected. “Nevertheless.5 million were in stocks with the balance placed debt papers in China. Meanwhile. LXXXIII. III. dousing concerns among investors. The market recognizes the sound economic stewardship and deep-seated reforms over the past five years. shielding the economy from external shocks and bolstering domestic demand buoying the economy LXXXII. Effects of China’s Wild Fluctuation to. The DOF pointed out that Chinese portfolio investments in the Philippines were negligible as of May this year while Philippine investments in Chinese stock markets amounted to $252. The Philippines. The Department of Finance (DOF) asserts that the Philippine economy can withstand the effects of the recent collapse of the stock market in China.” Beltran said. . the world’s second largest economy. Strong macroeconomic fundamentals and a market-based framework differentiate the Philippines. LXXVIII. especially if growth in China slows significantly more than market expectations. the Bangko Sentral ng Pilipinas (BSP) affirmed that they are ready to make contingency measures as the slowdown in the Chinese economy continues.5 million. LXXVII. the Philippines remains a bright spot and stands out due to our consistent record of high growth and strong fundamentals.

which has caused the Euro to slump. and for the machinery and equipment that are exported to Chinese firms. why the EU is on the verge of recession. accounting for 5% of German exports. LXXXVII. components for products such as smartphones will be made in other countries from Japan.” Governor Amando Tetangco Jr. and why Draghi is hinting at a possible easing. given our policy rates are still relatively higher than zero. LXXXVI. however some of these countries are more diversified. Korea and Taiwan and then shipped to low-wage China for assembly. According to Lucas Karl Hahn. Brazil. and then are re-exported to consumers in countries such as the United States and in the EU said Hahn. They will be affected in some electronic and manufacturing activities. specializing in the same sorts of manufactured goods might do relatively well. said. LXXXV. China is one of the largest supplier in manufacturing and electronics. The countries that will be negatively affected are those countries who are largely in partnership in trading with China. The countries which might conceivably be economic competitors of China. China is a key source of . Australia and Canada will be affected.The currencies for these countries have fallen this year. That is part of the reason why Eurozone growth is so sluggish.we also have room to support growth and manage inflation. but only for the share of smartphones that Chinese consumers purchase from them. Country commodity exporters such as South Africa. with robust services and manufacturing sectors. China is Germany's second-biggest export destination (second to the US) outside the Europe.

but . Iran. minerals. XC. XCV. Nigeria. CVIII. LXXXVIII. CIV.incremental demand for commodities such as oil. CI. CVI. essential to Sequencing reforms at the appropriate pace will be a challenge. XCIX. CV. IV. Saudi Arabia and Russia need crude to be far higher to balance their budgets. XCVI. XCVIII. CIII. XCII. metals and agricultural products. XCI. China’s Blueprint against Complete Financial System Deterioration. CIX. C. XCVII. Many countries such as Venezuela. XCIII. CII. CVII. This countries are getting killed by cheap oil prices. LXXXIX. Oil exporters are hurting too. XCIV. Hahn mentioned.

CXIX. the government now fears it. and the market kept doing what it wanted. citing as evidence the social unrest that was brewing during the collapse. Since its establishment on . Plagued by a deterioration in sentiment and deleveraging. It is responsible for the design. it must admit that it failed to control the market.500) will mean that they pile the risk back on. CXVII. Instead of delighting in the power of the market or worrying about the next stock market boom-bust cycle. The government surely has some measures to control the movement. CXVI. we should instead try and discern what lessons the Chinese government took from this whole experience.China’s stock market is really different from other countries. After the stock market collapse. It tried. there will be those within the government that are suggesting to slow market reforms and maintain control as long as possible. CXII. printing. and tried some more. CXIV. This suggests that another crash awaits the market at some point in the future. leverage and all. development and financial stability while minimizing risks.CX. CXIII.687 back to 4. China’s sustained growth. While for the decreasing value of China’s Currency. it kept falling. Undoubtedly after the market’s declines over the last two weeks. and issuance of the Chinese currency. Offering investors what is essentially a risk-free return of 22% (driving the market from its current level of 3. economists worry that instead of respecting the market. CXV. The core theme of China’s economic reform is reducing the role of the government in the economy in order to let market forces play a larger role. The People's Bank of China is the leading authority for the administration of Renminbi. This will be crucial to maintaining a balance between CXI. CXVIII.The latest support measures will surely drive a recovery in the market regardless of how dangerous they may be. If the government is honest with itself.

the annual Government Work Report and the Report on Monetary Policy Implementation with those plans they provided and settled with a fixed quantity of then economic growth target which includes maintaining the basic stability of RMB at a rational and balanced level in accordance with the framework of allowing exchange rates to be determined by market supply and demand. From the finance perspective. and commemorative coins fashioned out of both ordinary and precious metals. most probably to recover China must attend to another long term plan like the Five-Year Plan they had which stipulated China’s middleterm economic growth. CXXVI. and inappropriate monetary policies. is the economic cycles that are deeply rooted in the .December 1. are main culprits. coins. First. CXXIV. RMB’s exchange rate and relevant policies are key issues which will closely relate to China’s long term economic development. China should consider growth without crisis as the core of its overall financial strategy. Conclusion CXXV. CXXIII. V. whether trying to deal with the global financial crisis or to prevent a crisis from happening in the future. CXXVII. imbalanced trade. 1948 this bank has issued five series of Renminbi and developed a currency system that includes banknotes. ineffective supervision. CXXII. which have been mentioned repeatedly. CXXI. The real cause of a modern financial crisis. however. referencing exchange rates to a basket of currencies and managing exchange rates on a floating rate basis. among the underlying causes of and reactions to the global financial crisis. currency value is unstable. meanwhile RMB is depreciating. CXX.

global economic and financial system. China must conduct the reform of the financial monitoring and regulatory system from the following aspects. 2. 4. CXXVIII. CXXIX. Potential methods include more flexible requirements on capital and establishment of countercyclical loss reserves. Monitoring and regulatory objectives: Priority must be placed on macroeconomic stability while upholding the opening-up policy. With this understanding. high financial leverage. as shown by financial crises during the last 20 years. Coordination between different policies: Financial monitoring and regulatory policies should be consistent with monetary policies. and timely monitoring system and an early-warning mechanism to detect various normal unstable factors as early as possible. Efficiency must be subordinated to stability in the financial system. and unusual offshore borrowings and capital flows. 1. while using effective economic regulation and controls to achieve coordination between the financial system and industrial economy. Monitoring and regulatory methods: China should reform current methods that are based on rules by researching and formulating countercyclical regulatory methods. effective. CXXX. 3. China should monitor the major macroeconomic and financial index by establishing an accurate. Organizational structures: China should have a monitoring and regulatory system that is closely connected to the central bank to promote the balance between stability and efficiency of internal factors within the financial system. . such as sharply rising asset prices. CXXXI.

.CXXXII.