Chinas Financial System: Renminbis 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.

Chinas Financial Background and Overview.03

II.
A. Chinas Financial System Architecture...03
B. World Banks Assessment of the Countrys Financial System...04
III.
Chinas Current Financial State...08
V.
A. Elaboration of Chinas 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) Renminbis Value
Flunk.13
X.

III.

Effects of Chinas Wild Fluctuation to;

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

IV.

Chinas Blueprint against Complete Financial System

Deterioration...17
A. Financial Reform..17
B. Strategize Renminbis Ideal/Peg Value19

XIII.

V.
Conclusion.2
0

I.

Chinas Financial Background and Overview

XIV.
XV.
XVI.

A.

Chinas Financial System Architecture

XVII.

XVIII.

XIX. The figure above shows Chinas Current Financial Architecture; 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.
XX.
XXI. The financial system plays a direct and critical role in the transmission of
macroeconomic policies. 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, but the credit growth targets
undermine the efficiency of credit allocation; iii) Low cost of capital distorts the savinginvestment balance of the economy; iv) Capital markets underdevelopment limits
alternatives for corporate funding and household investments, and represents an
impediment to solving structural problems in the financial sector: low rates of return on
savings; high precautionary savings through banks; high savings by private enterprises
without access to capital markets; continued bank dominance of the financial system; and
potential asset bubbles; v) Lack of contestability of markets or ownership for large firms
limits competition.
XXII. China has adopted an institutional approach to financial regulation, with
three separate commissions and the PBC sharing responsibilities. The State Council has
the overarching responsibility for the financial system. It exercised this responsibility by
establishing and chairing a high-level ad-hoc committee of the key financial agencies in
June 2008. The mission recommended that a permanent Financial Stability Committee be
established, building on the experience from the ad-hoc committee.

XXIII.
XXIV. B.
XXV.

World Banks Assessment of the Countrys 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. In 1978
when China started the program of economic reformsthe country ranked ninth in
nominal gross domestic product (GDP) with USD 214 billion; 35 years later it
jumped up to second place with a nominal GDP of USD 9.2 trillion.

XXVI.

Since the introduction of the economic reforms in 1978, China has become
the worlds manufacturing hub, where the secondary sector (comprising industry and
construction) represented the largest share of GDP. However, in recent years, Chinas
modernization propelled the tertiary sector and, in 2013, it became the largest
category of GDP with a share of 46.1%, while the secondary sector still accounted for
a sizeable 45.0% of the countrys total output. Meanwhile, the primary sectors
weight in GDP has shrunk dramatically since the country opened to the world.

China weathered the global economic crisis better than most other countries.
In November 2008, the State Council unveiled a CNY 4.0 trillion (USD 585 billion)
stimulus package in an attempt to shield the country from the worst effects of the
financial crisis. The massive stimulus program fuelled economic growth mostly
through massive investment projects, which triggered concerns that the country could
have been building up asset bubbles, overinvestment and excess capacity in some
industries. Given the solid fiscal position of the government, the stimulus measures

did not derail Chinas public finances. The global downturn and the subsequent
slowdown in demand did, however, severely affect the external sector and the current
account surplus has continuously diminished since the financial crisis.

Apparently, China exited the financial crisis in good shape, with GDP
growing above 9%, low inflation and a sound fiscal position. However, the policies
implemented during the crisis to foster economic growth exacerbated the countrys
macroeconomic imbalances. Particularly, the stimulus program bolstered investment,
while households consumption remained repressed. In order to tackle these
imbalances, 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.
XXVII.

By the early years

of 2010, Chinas financial system reforms are progressing well. Improvements are
seen in the structure, performance, and oversight of the financial sector. The system is
becoming more transparent as it opens up. China is confronted by a build-up of
potential sources of vulnerabilities, including greater exposure to external shocks. The
inter-linkages across markets and institutions are growing, and de-facto banks and
informal credit markets, conglomerate structures, and off-balance sheet activities are
on the rise. But still financial infrastructure and relevant legal systems need to be
further upgraded.
XXVIII.

In the coming

decades China will have strong liquidity internationally, a solid banking system, an

effective financial firewall, a high and stable savings rate, and a huge market with
differential capacities.
XXIX.

As a matter of fact, Chinese economic growth has the foundation to exist

without crisis and maintain a sustainable high speed. More is that China is currently
in the industrialization stage, it can also be forecasted. There was even this rise on
their currency the Renminbi only from the previous year (2014), and continuous
financial stability until the first half months of the current year (2015).

XXX. But after the constant elevation of their financial sector, Renminbis value flunked
and the countries Stocks deeply plunged all within a month after its economic peak, it
expects Chinas growth to slow to 6.8 percent this year from 7.3 percent in 2014, and
weaken further in 2016.
XXXI.
XXXII.
XXXIII.
XXXIV.
XXXV.
XXXVI.
XXXVII.
XXXVIII.

XXXIX.
XL.
XLI.
XLII.
XLIII.
XLIV.
XLV.
II.
XLVI.

Chinas Current Financial State

On 2014, China

was known to be the remarkable developing country; China achieved economic output that
accounted for 7.9 percent of total world output and foreign trade volume that amounted to 8
percent of total world volume in 2009. Chinas foreign reserve has accounted t 28 percent of
global foreign exchange reserves. Meanwhile, data for August corroborate the view that
economic fundamentals remain weak. While industrial production and retail sales recorded mild
gains, the downward trend in all-important fixed-asset investment was kept intact. Aware of the
difficult situation, on 8 September, the Ministry of Finance stated that it would boost fiscal
policy to rekindle growth. But for 2015 a lot of people are considering a slowdown of the
Chinese economy, Chinas stock market bubble was always bound to burst, China Has Biggest
One-Day Stock Crash Since 2007,and their currency the Chinas Yuan pushes deeper into global
financial system all of this has happened from the span of a month or two, China underwent a
near-death experience when their countrys two stock exchanges entered free fall. A government

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

XLVIII.

All this has dented

hopes that emerging economies might prop up global growth. China, by far the biggest single
contributor, is showing signs of slowing. And its maturing economy needs less of the
commoditiessuch as raw materials for infrastructure, or ready-made components for
manufacturingthat other emerging countries rely on selling. Other would-be powerhouses of
the 2000s, such as Brazil and Russia, have been crippled by falling oil prices and political
stalemate. Adding each countrys GDP figures into a global total is of course not the same as
working out their real role in driving the world economy. But relative to the hopes of five years
ago, it certainly seems like the world is stuck in a traffic jam
XLIX.

These two stock

exchanges are Shanghai and Shenzhen, they suddenly took off last summer, becoming a
cauldron of avid buying, selling and profit-taking. Its 67% investors compose of people whos
undergraduate.
L.

Shanghai and

Shenzhen had gone even higher in less than a year, stocks had begun to seem like a sure bet for
Chinese investors who wants to be a real quick wealthy man. The two

stock

exchanges guaranteed a much higher rate of return than traditional low-interest bank saving
accounts. China had already experienced a dangerous bubble in its residential housing market,
but in that case their government had succeeded in engineering a relatively soft landing by
raising interest rates, limiting the number of residences one owner could buy in such cities as
Beijing and Shanghai and levying a new tax. It was all easy for small investors to assume that
the bull markets was implicitly backed by a kind of unwritten government guarantee, that the

good times were only beginning to roll, and the state would step in to take care of things before
the bottom fell out.
LI.

Jason Abbruzzese

mentioned in his article that China is one of the world's largest economies, but also one of the
most fragile.
LII.

But in the last few

months, its stock market has seen an incredible rise in prices. Those prices have now been
crashing down, causing broader concern about the impact a Chinese economic meltdown could
have on the rest of the world.
LIII.

When Shanghai

stock exchange composite index plunged over the course of a few short weeks in June and July,
its precipitous fall stunned the nation. Their first plan is attempting on managing the collapsing
share prices through more state interventions. One young investor blamed the states
inadequate regulations, and pointed to the governments role in inflating the bubble as a reason
for it to forcefully intervene to prop up prices. The bull market was itself a policy-driven one,
so only major policies can save it Schell said to the New York Times. Andrew Walker
mentioned about some specific factor driving shares lower on particular days. On this occasion
it was something the Chinese central bank did not do. It did not take steps to stimulate more
bank lending, which was a disappointment for investors who thought it would do. But there was
no new stimulus and so shares fell, and sharply.
LIV.

Chinese markets

begun to respond to the governments many interventions and started slight rebound by the end

of August. 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, when the government, in effect, has its
thumb on the scales. 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. After the
crash, the foreign investors who had bought into Chinese companies through the Hong Kong
exchange began pulling their capital out of Chinese stocks.
LV.

China is now such a

big force in the global economy that it would inevitably affect the rest of the world. It is the
second largest economy and the second largest importer of both goods and commercial services.
Even if China holds up well enough now, there is still the worry that a sharper slowdown lies
ahead. The government faces daunting challenges in managing the economy. It is trying to clean
up the debt mess left over by the stimulus of 2009, when it unleashed a mammoth investment
spree to fight off the global financial crisis.
LVI.

Debt, by some

counts, has reached more than 250% of GDP, almost doubling over the past seven years.
Increases of that magnitude have presaged crises in other countries, from Japan to Spain. At the
same time structural trends are turning against China. Its working-age population is now
shrinking.
LVII.

So it is still far too early to speak of Chinas stock markets having established or
returned to normalcy, because China is a closed society and the negotiations among

its leadership are so impervious, we on the outside rarely know who really makes
decisions about important issues or by what process they are made; all we can see are
the results that follow.
LVIII.

On Andrews Walker

article he mentioned that those who have borrowed money to buy shares in the last few months
have been hit very hard. But most people don't own shares - only one person in 30 does,
according to Capital Economics.
LIX.

For most Chinese the

wider issue is about the health of the country's economy. If China manages a smooth transition
to a slower and more sustainable growth rate, it is likely to still be fast enough to generate rising
living standards for most people. A more disruptive slowdown would mean many business
failures and job losses.
LX.

When the stock bubble,

which had so inflated the listed value of shares that a natural correction was inevitable. The
obvious contradiction between a largely self-regulating financial market and a highly controlled
and centralized economy is a graphic
representation of Chinas divided modern-day
self. China today is that it is in the middle of
process of uncertain change in many ways. In
once purely socialist command economy is now
partially socialist and partially capitalist.
Unenviable predicament is hardly limited to

Chinas stock markets. In certain ways the response of the nations leaders to the recent market
crash is emblematic of a much larger dilemma said Schell.
LXI.

Most of us would ask,

what might the Chinese authorities do next?

LXII.

They have several

options to stimulate the economy which can affect the stock markets. They could cut interest
rates, they could relax the rules on bank lending or they could increase spending. They could
also encourage the currency, the Yuan, to fall further to stimulate exports Andrew Walker said.
China is a drastically important company to the world economy. The country imports more than
$1.4 trillion of goods yearly from across the world. Chinese consumers have been helping to
boost the world economy with their spending as more and more Chinese reach the middle class,
Jason Abbruzzese claimed.
LXIII.

China has been one

of the largest contributor to the world economic growth and low global inflations. But now most
of the investors are worried about what happened at China.
LXIV.

While under the

struggle of Chinas Stock Plunge, many people was surprised when the value of Renminbi
against dollar fluctuated because the Chinese government is very strict on controlling its value.
But the truth is, the government intentionally shrank the value of the RMB in order to
encourage exports. If the RMB is cheaper, the importing goods from China was also cheap.
Chinas businesses compete with regional rivals to supply the world with everything from raw

steel to fridges and a cheaper yuan will make Chinas export less expensive. Yuans depreciation
was a way to make their countrys financial system more market-oriented.
LXV.

For today:

LXVI.

The countrys currency,

known as the yuan or renminbi, is making a seemingly relentless push deeper into the global
financial system.
LXVII.
LXVIII.
LXIX.
LXX.
LXXI.
LXXII.
LXXIII.
LXXIV.
LXXV.

LXXVI.
LXXVII.
LXXVIII.
III.

Effects of Chinas Wild Fluctuation to;

LXXIX.
LXXX.
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, the worlds second largest economy.
LXXXI.
Strong macroeconomic fundamentals and a market-based framework
differentiate the Philippines. 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.
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 $252.5 million; of which only $2.5 million were in stocks with the
balance placed debt papers in China.
LXXXIII.

While investor risk appetite in global markets continue to be

weighed down by prevailing uncertainties and the impending rates lift-off in the US, the
Philippines remains a bright spot and stands out due to our consistent record of high
growth and strong fundamentals, Beltran said; dousing concerns among investors.
LXXXIV.

Meanwhile, the Bangko Sentral ng Pilipinas (BSP) affirmed that

they are ready to make contingency measures as the slowdown in the Chinese economy
continues, among other external shocks. Nevertheless, should our trade be adversely
affected, especially if growth in China slows significantly more than market expectations,

we also have room to support growth and manage inflation, given our policy rates are still
relatively higher than zero. Governor Amando Tetangco Jr. said.
LXXXV.

The countries that will be negatively affected are those countries

who are largely in partnership in trading with China. According to Lucas Karl Hahn,
China is Germany's second-biggest export destination (second to the US) outside the
Europe, accounting for 5% of German exports. That is part of the reason why Eurozone
growth is so sluggish, why the EU is on the verge of recession, and why Draghi is hinting
at a possible easing, which has caused the Euro to slump.
LXXXVI.

China is one of the largest supplier in manufacturing and

electronics; components for products such as smartphones will be made in other countries
from Japan, Korea and Taiwan and then shipped to low-wage China for assembly, and
then are re-exported to consumers in countries such as the United States and in the EU
said Hahn.
LXXXVII.

They will be affected in some electronic and manufacturing

activities, but only for the share of smartphones that Chinese consumers purchase from
them, and for the machinery and equipment that are exported to Chinese firms. The
countries which might conceivably be economic competitors of China, specializing in the
same sorts of manufactured goods might do relatively well. Country commodity
exporters such as South Africa, Brazil, Australia and Canada will be affected; however
some of these countries are more diversified, with robust services and manufacturing
sectors.The currencies for these countries have fallen this year. China is a key source of

incremental demand for commodities such as oil, minerals, metals and agricultural
products.
LXXXVIII.

Oil exporters are hurting too. Many countries such as Venezuela, Iran,

Nigeria, Saudi Arabia and Russia need crude to be far higher to balance their budgets,
Hahn mentioned. This countries are getting killed by cheap oil prices.
LXXXIX.
XC.
XCI.
XCII.
XCIII.
XCIV.
XCV.
XCVI.
XCVII.
XCVIII.
XCIX.
C.
CI.
CII.
CIII.
CIV.
CV.
CVI.
CVII.
IV.

Chinas Blueprint against Complete Financial System Deterioration.

CVIII.
CIX.
essential to

Sequencing reforms at the appropriate pace will be a challenge, but

CX.

Chinas sustained growth. This will be crucial to maintaining a balance

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

December 1, 1948 this bank has issued five series of Renminbi and developed a currency
system that includes banknotes, coins, and commemorative coins fashioned out of both
ordinary and precious metals.
CXX. RMBs exchange rate and relevant policies are key issues which will
closely relate to Chinas long term economic development, meanwhile RMB is
depreciating, currency value is unstable, most probably to recover China must attend to
another long term plan like the Five-Year Plan they had which stipulated Chinas middleterm economic growth, 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, referencing exchange rates to a basket of
currencies and managing exchange rates on a floating rate basis.
CXXI.
CXXII.
CXXIII.
CXXIV.

V.

Conclusion

CXXV.
CXXVI.

From the finance perspective, China should consider growth

without crisis as the core of its overall financial strategy, whether trying to deal with the
global financial crisis or to prevent a crisis from happening in the future.
CXXVII.

First, among the underlying causes of and reactions to the global

financial crisis, imbalanced trade, ineffective supervision, and inappropriate monetary

policies, which have been mentioned repeatedly, are main culprits. The real cause of a
modern financial crisis, however, is the economic cycles that are deeply rooted in the

global economic and financial system, as shown by financial crises during the last 20
years. With this understanding, China must conduct the reform of the financial
monitoring and regulatory system from the following aspects.
CXXVIII. 1. Monitoring and regulatory objectives: Priority must be placed on
macroeconomic stability while upholding the opening-up policy. Efficiency must be
subordinated to stability in the financial system.
CXXIX.

2. 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, while using
effective economic regulation and controls to achieve coordination between the
financial system and industrial economy.
CXXX.

3. Monitoring and regulatory methods: China should reform current methods that

are based on rules by researching and formulating countercyclical regulatory

methods. Potential methods include more flexible requirements on capital and
establishment of countercyclical loss reserves.
CXXXI.

4. Coordination between different policies: Financial monitoring and regulatory

policies should be consistent with monetary policies. China should monitor the major
macroeconomic and financial index by establishing an accurate, effective, and timely
monitoring system and an early-warning mechanism to detect various normal
unstable factors as early as possible, such as sharply rising asset prices, high financial
leverage, and unusual offshore borrowings and capital flows.

CXXXII.