China's emerging capital markets

    Anjali Kumar Kwang Jun Anthony Saunders Susan Selwyn Yan Sun Dimitri Vittas David Wilton FINANClALTIMES Financial Publishing Asia Pacific  Published by FT Financial PublishingAsia Pacific An imprint of Pearson Professional Asia Pacific Suite 1808 Asian House 1 Hennessy Road Wan Chai Hong Kong Tel: (852) 2863 2600 Fax: (852) 2520 6646 Internet: pphkg@hk.super.net Web: www.pearson-pro.com.hk O 1997 The World Bank Conditions of Sale All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, ortransmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of the Publishers. No responsibility for loss occasioned to any person acting or refraining from action as a result of the material in this publication can be accepted by the Author or Publishers. First edition 1997 Printed in Hong Kong ISBN 962 661 048 4 Publisher's note The findings, interpretations and conclusions expressed in this study are the results of researchsupported by the World Bank, but they are entirely those of the author and should not be attributed in any manner to the World Bank, to its affiliated organisations, or to members of its Board of Executive Directors or the countries they represent.  CONTENTS Tables in Text. vii ... Figures in Text Vlll Statistical Appendix X Currency Equivalents, Fiscal Year, Weights and Measures xii Acronyms and Abbreviations xiii Acknowledgements xvi 1. THE CONTEXT OF CAPITAL MARKET DEVELOPMENT China's Capital Markets: Central Questions The Growth of China's Capital Markets The Role of Capital Markets in China's Economy 2. THE REGULATORY FRAMEWORK Introduction Principles of Securities Market Regulation: Relevance for China The Regulatory Framework Regulation of Securities lssue and Trading: An Evaluation Regulation of Participating Institutions Distribution of Oversight within the Government Annex 2.1 China: Laws and Regulations Related to Securities Activities Annex 2.2 Central and Local Authorities' Approvals Required for Listing Annex 2.3 Central and Local Regulations: Listing Criteria Annex 2.4 The Trading Systems Annex 2.5 Restrictions Against Insider Dealing Annex 2.6 Regulation of Securities Dealers 3. DOMESTIC BOND MARKETS Introduction The Primary Market lssue Method Secondary Markets in Debt Securities  4. EQUITY MARKET PERFORMANCE Introduction: Equity Markets and the Shareholding System Characteristics of China's Equity Markets The New Issue Process and Public Offerings Stock Price Volatility and Returns to lnvestors Market Integration: Current and Potential Other Issues: Enterprise Debt Securities Annex 4.1 Clearance, Settlement and Depository Systems Annex 4.2 Technical Note on the Analysis of Equity Markets 5. INTERNA1-IONALISKrION OF CHINA'S SECURITIESMARKETS The Scope for Safe Participation in lnternational Securities Markets lnternational Participation in China's Equity Issues The Performance of China's Overseas Equity Listings Opening of Fixed-Income Securities Markets China's Access to Overseas Securities Markets Trading in Derivative Instruments on lnternational Markets 6. INSTITUTIONAL lNVESTORS Institutional lnvestors and Securities Markets The Insurance Industry in China The Pension System Housing Funds Mutual Funds Annex 6.1 Glossary on Contractual Savings Institutions Annex 6.2 Institutional lnvestors in Hong Kong 7. CONCLUSIONS AND RECOMMENDATIONS Conclusions Suggested Policy Changes REFERENCES STATISTICAL APPENDIX  TABLES IN TEXT Contribution of Capital Markets to Real Sector Investment Government Debt Purchases: Households and Non-Households Treasury Bill Coupon Rate, Deposit Rates and Inflation Comparison of Coupon and Deposit Rates, and Secondary Market Yield Comparison of Coupon on Treasury Bills Sales by Purchaser: Households, Enterprises, and Financial Institutions Tradability of 1994 Treasury Bill Issues China: Spot and Futures Trading of Bonds Ratio of Bond Trading Value to Stock Outstanding Trading in Repurchase Agreements Concentration Ratios of Member Firms Trading on the Shanghai Stock Exchange (January1995) Concentration of Share Trading on China's Securities Exchanges China's Equity Markets: Underpricing of New Share issues IPO Underpricing Worldwide Trading on China's Equity Markets: Returns and Volatility Chinese Companies with ADR and GDR Programmes (December I 994) China Closed-End Country Funds: Discounts/Premiums Average Spread on Floating Rate Medium and Long Term Bond lssues China Underwriting Performance of the People's Insurance Company of China (1992193) China and Other Countries: Basic Equation of Social Pension System China Projected Basic Equation of Social Pension System  FIGURES IN TEXT Growth of Securities Issued and Outstanding (1981-1993) 2 Volatility in China's Securities Trading 4 Growth of the Equities Market 6 SecondaryMarkets in China's Securities 7 China and Other Emerging Equity Markets: A Comparison (1993) 8 Securities Markets in China's Financial Sector 11 Central Government Budgetary Deficit and Treasury Bond Issues 16 Share of Bonds in China's Overseas Borrowing 20 China: Composition of Outstanding Debt Issues 82 Outstanding Debt Composition Disaggregated 84 China: Trading Value of Bonds 100 Ratios of Trading Volume of Debt to Debt Stock and to GDP 101 Ratios of Debt Stock Outstanding to GDP: China and Other Countries 102 Regional Bond Yield Differentials (1990) 108 Yield Differentials between Treasury Bills on Principal Markets: 1994 (Shanghai, Wuhan and Shenzhen) 108 China: Secondary Market Yield Curve 110 China: Bond Yield, Deposit Rate and Inflation 111 Equity Index and Average Bond Yield 112 Average Daily Trading Value of Shares 122 Shanghai SecuritiesExchange 125 China: A Stylised IPO Process: Post-Offer to the Beginning of Trading 130 Initial Offerings of Shanghai A and B Shares 132 Risk-Adjusted Returns to lPOs at Shanghai 135 China: Shanghai and Shenzhen Share Indices and Volume of Trade 143 Shanghai and Shenzhen: Share Price Variance 144 Spreads between Shanghai and Shenzhen A and B Shares 150 Discounts on Shares Listed in Overseas Exchanges 151 Private Capital Flows to China 179 China and Other Emerging Markets: Participation in International Capital Flows 180 China and Mexico Inflows 181 Country Funds - Average Discount 193  lnternational Bond Issuesby Chinese Borrowers: Currency, Type and Maturity China: lnternational Syndicated Loans China: Maturities and Spreads on lnternational Syndicated Loans China: lnsurance Premium Growth (1986-1992) China: lnternational Comparison of lnsurance Premiums (1992) China: Comparison of the Life and Non-life Structure of lnsurance with Selected Countries China: lnsurance Premiums by Line (1992) China: Comparisions of the Performance of the lnsurance Industry in Selected Countries  STATISTICAL APPENDIX A l . l China: Debt Securities Issued and Outstanding A1.2 China: Trade in Securities A1.3 China: Securities Trading on the Shanghai Exchange in 1994 (January1994 to January1995) A1.4 China: Securities Markets and the Financial Sector A1.5 Financing of the Government Deficit: Contribution of Bond Issues A1.6 China: Contribution of Securities Markets to Investment A1.7 China: Overseas Debt and Capital Markets (1987-1993) A2.1 China: Structure Of Securities Regulation A2.2 Structures of Regulation in Asian Securities Markets A2.3 Minimum Listing Requirements of Major Stock Markets A3.1 China: Securities Trading by Region A3.2 Monthly Transaction Volume in the lnterbank Market A3.3 Assets of Financial Institutions Engaged in the lnterbank Market A4.1 China: Key Characteristics of the Equities Markets of Shanghai and Shenzhen A4.2 China: Size and Growth of China's Equities Markets (1991-1994) A4.3 Trading Value of Equities (1991-1994) A4.4 China: Trading Volume of Securities Per Day (1991-94) A4.5 Trading Value of Inter-Linked Trading Centres (Linked to Shanghai) (January1995) A4.6 China: Stock Trading Centres A4.7 Shanghai Securities Exchange: Trading Summary of Sectoral Stocks A4.8 Initial Public Offering Quotas (1993) A4.9 China and Other Emerging Equity Markets: Relative Size and Market Liquidity (1994) A4.10 China and Other Emerging Equity Markets: Growth (1989-1993) A4.11 China and Other Emerging Equity Markets: Volatility (1993-1994) A5.1 International B and H Share Offerings by Chinese Issuers A5.2 China's Overseas Share Listings (HongKong and New York) A5.3 Country Funds: Trends in Total Returns A5.4 Credit Ratings of Chinese Borrowers A5.5 Sovereign Rating Selected Developing Countries  A5.6 China: Overseas Bond Issuing lnstitutions B5.1 Limits on Equity Participation by Foreign Investors B5.2 Foreign Exchange Controls on Portfolio lnvestment Capital Gains and Dividends B5.3 Taxation of Dividends and Capital Gains of Foreigners Investing in Emerging Markets A6.1 China: lnsurance Premium Growth (1986-92) A6.2 China: International Comparison Of lnsurance Premiums (1992) A6.3 China: Comparisons of Growth of lnsurance Penetration A6.4 China: Comparisons of the Structure of Life and Non-life lnsurance (1992) A6.5 China: Comparisons of the Performance of the lnsurance Industry in Selected Countries A6.6 China: Assets and Liabilities of the People's lnsurance Company (1992193) B6.1 lnvestment Patterns of Contractual Savings lnstitutions  CURRENCY EQUIVALENTS Currency Unit: Renminbi (Rmb) (Nominal Official Period Average Rates) Year Rmb per US$ 1996 (Januaryto June) 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986 FISCAL YEAR 1 January - 3'1 December WEIGHTS AND MEASURES Metric System  ACRONYMS A N D ABBREVIATIONS ABC Agricultural Bank of China ADD American Depository Debentures ADR American Depository Receipts AIA American lnternational Assurance AIG American lnsurance Group AMEX American Stock Exchange AMSET Association of Members of the Stock Exchange of Thailand BAPEPAM Badan Pelaksana Pasar Modal (Capital Market Executive Agency) (Indonesia) BOC Bank of China BOCOM Bank of Communications BOT Build-Operate-Transfer CAlC Chinese American lnsurance Company CBOE Chicago Board Options Exchange CD Certificate of Deposit CIB China lnvestment Bank ClTlC China lnternational Trust and lnvestment Corporation CPA Certified Public Accountant CPF Central Provident Fund CPlC China Pacific lnsurance Company CSRC China Security Regulatory Commission CSTS China Securities Trading System Corporation Ltd D M Deutschemark DR Depository Receipt DTC Depository Trust Company FDI Foreign Direct lnvestment FlBV Federation Internationale des Bourses de Valeurs FSD Financial Sector Development Department (of the World Bank) GATT General Agreement on Tariffs and Trade GDP Gross Domestic Product GDRs Global Depository Receipts GlTlC Guangdong Industrial Trust and lnvestment Corporation GNP Gross National Product lBCA lnternational Banks Credit Agency (originally; today officially IBCA. An international credit rating agency headquartered in London). ICBC Industrial and Commercial Bank of China IEC lnternational Economics Department (of the World Bank) IFC lnternational Finance Corporation IF1 lnternational Financial Institutions IMF lnternational Monetary Fund IOSCO lnternational Organisation of Securities Commissions IPO Initial Public Offering ISC International Securities Consultancy lTlC lnternational Trust and lnvestment Corporation  ITS lntermarket Trading System JCR JapanCredit Rating Agency Limited KSDA Korean Securities Dealers Association LTS Local Tax Service MAS Monetary Authority of Singapore MlCEX Moscow Interbank Currency Exchange MOF Ministry of Finance MOFTEC Ministry of Foreign Trade and Economic Relations MOU Memorandum of Understanding NASDAQ National Association of Securities Dealers Automated Quotation System NETS National Electronic Trading System NBFl Nonbank Financial Institution NIS Nippon Investor Service NSCC National Securities Clearing Corporation NYSE New York Stock Exchange OECD Organisation for Economic Co-operation and Development OTC Over-the-counter PAlC Ping An lnsurance Company PASBD Philippine Association of Stockbrokers and Dealers PBC People's Bank of China PCBC People's Construction Bank of China PDB Pudong Development Bank PlCC People's Insurance Company of China Portal An OTC cross-border clearing system PRC People's Republic of China QlB Qualified Institutional Buyers RADRs Restricted American Depository Receipts S & P Standard and Poors SAEC State Administration for Exchange Control SC Securities Commission (Malaysia) SCRES StateCommission for Restructuringthe Economic System SCSC State Council Securities Policy Committee SDB State Development Bank of China SEAQ Stock Exchange Automatic Quotation System SEBl Securities Exchange Board of India SEC Securities ExchangeCommission SEEC Securities Exchange Executive Council SES Stock Exchange of Singapore SESDAQ SES Dealing and Automated Quotation System Market SETC State Economic and Trade Corporation SEZs Special Economic Zones SFC Securities and Futures Commission (Hong Kong) SFR Swiss Franc SHSE Shanghai Securities Exchange  SlTlCO Shanghai International Trust and lnvestment Corporation SOEs State-Owned Enterprises SOU State-Owned Unit SPC State Planning Commission SRC System Reform Commission SSB Securities Supervisory Board (Korea) STAQS Securities Trading Automated Quotations System SZSE Shenzhen Stock Exchange T Bill Treasury Bill T Bond Treasury Bond TICS Trust and lnvestment Corporations TSDA Taipei Securities Dealers Association TSE Tokyo Stock Exchange UCC Urban Credit Co-operative US United States of America YTM Yield to Maturity  ACKNOWLEDGEMENTS This study is the outcomeof an investigation of China's capital markets undertaken jointly by the World Bank and the China Securities Regulatory Commission. Its results are based on the findings of a preparatory visit to China in August 1994, followed by a fully-fledged investigative study in October 1994. In addition to discussions in Beijing, the team visited securities trading centres and market participants at Shanghai, Shenzhen, Wuhan, Tianjin and Hong Kong. Numerous persons have contributed to this study. The World Bank team was led by Anjali Kumar of the China and Mongolia Department (task manager); and included David Wilton, (bond markets) and Dimitri Vittas, (contractual savings) of the Financial Sector Development Department; Kwang Jun (international aspects) of the International Economics Department; and consultants Professor Anthony Saunders(SalomonCentre, New York University; equities markets), Susan Selwyn (International Securities Consultancy, Hong Kong; securities regulation); and Sun Yan, (Columbia University; equity market data analysis). Edgardo Barandiaran and others at the World Bank's Beijing office organised the work in China, and Vikram INehru participated in the mission. Julia Li provided major inputs on the marco framework and on equity markets; Subir Lall helped with the analysisof China Funds and China's overseas bonds; Bo Wang helped to decode bond data; Don Mclsaac provided the glossaryon insurance; Yan Wang undertook equity market comparisons with other countries; Cathy Song helped with mission preparation and Adelma Bowrin undertook theconsiderable responsibility of report production. The report benefited from the generous information and comments provided by the IMF (notably Marc Quintyn and Michael Spencer) and the excellent collaboration of the IFC (PeterWall, Sara Ugarte, RashadKaldany, Ravi Vish, JianshengWang, JunZhang, Claudia Morgenstern), in terms of sharing data and co-ordinating technical assistance and investigative studies. The Chinese team was led by Fu Feng Xiang, (Vice Chairman, CSRC), and Bei Duo Guang, Deputy Director of the International Department, and principal counterpart to the World Bank. Numerous other persons from the CSRC contributed, particularly, Xu Ya Ping, Nie Qing Ping, Yang Zhi Hua, JesseWang, Gao Xi Qing and Song Li Ping. Zhong Rongca, Wu Qing and Yan Wen organised and accompanied all the mission's meetings. Particularly valuable insights to the study were provided by Ma Zhong Zhi (SCSC)and GaoJian, (Ministry of Finance). Particular thanks must also be extended to Liu Bo, executive vice president of the  Shanghai SecuritiesExchangeand Cavin Xue of its data department; Zhang Ning, of the ShanghaiMunicipal Government SecuritiesAdministration Office; Xia Bin, president of the Shenzhen Securities Exchange, Lian Quan Kun, president of the Wuhan SecuritiesTradingCentre, Vivian Gu, also of the Wuhan SecuritiesTrading Centre; and Hu Li Yun, of the Tianjin Securities Trading Centre. Officials from many other agencies and institutions in China also contributed, notably, the PBC, Ministry of Finance, CITIC, BOCOM, Pudong Development Bank, domestic securities trading firms including Guo Tai and Wan Guo, and -theChengxin securities rating agency. Background papers for the report were contributed by Zhang Bing Xun of the SecuritiesExchangeExecutiveCouncil (SEEC), and Mr He Dexu, of the Chinese Academy of Social Sciences. The authors extend their gratitude and appreciation to all the officials from the various government agencies and securities companies with whom they met. In Hong Kong, particular thanks must be extended to lris Leung and lris Cheung of the Hong Kong Securities Exchange, JaneTam of the Hong Kong Securities and Futures Commission, and many executives at jardine Fleming, jP Morgan, MerriII Lynch, Peregrine, Sassoon, UBS, and other securities dealers. The authors would like to thank numerous colleagues who lent support and encouragement to this effort. lsmail Dalla and lshrat Husain of the World Bank urged the presentation of the bond market analysis as a freestanding volume in a study on Asian bond markets, and Andrew Sheng of the Hong Kong Monetary Authority encouraged its presentation as part of an international seminar in Hong Kong in June1994. Last, thanks must be extended to Mr Nicholas Hope, Director of the World Bank China and Mongolia Department, for his support for extending the availability of this volume to a wider audience, through its publication in its present form.   CHAPTER 1 China's Capital Markets: Central Questions China first resumed the issue of domestic securities in 1981, shortly after the launching of its economic reform programme, after a twenty year hiatus. Since then, and especially over the last five years, the growth of China's capital markets has been exceptional, even by Chinese standards. Market development began with debt securities, and from 1981, when China resumed the issue of domestic debt, to 1986, the stock of outstanding debt securities increased eightfold, from Rmb5 billion to Rmb40billion. Debt on issuethen accelerated to nearly Rmb300 billion, by the end of 1993. The rate of growth of debt on issue over 1987 to 1993, at 31 per cent per year, far outstripped the rate of growth of GDP, of 17 per cent per year, at current prices. From 1994 debt securities issues escalatedfurther, with Rmbl I 3 billion of new treasury bills in 1994 and Rmbl50 billion of planned issues for 1995. The growth of equities, meanwhile, has been even more remarkable. The value of new issues increased from Rmb3 billion to Rmb30 billion between 1989 and 1993; a tenfold increase in four years (Figure1.l,and Appendix Table A1.I). The number of stocks listed grew from 14 in 1991 to 336 by the end of 1994. Market capitalisation on the two exchangesexceeded Rmb560billion by theend of 1994.' Shareholding has spread rapidly among domestic investors. In October 1994, a survey of 500 households in Beijing by the Municipal Statistical Bureau showed that the average Beijing household had Rmb17,551 in capital assets of which Rmbl2,800 was in bank savings, Rmb1,271 in cash and Rmb3,474 in securities. The motivation for the reintroduction of securities issues in China, in the early 1980s, was the emergence of a budget deficit, and the need to raise financing for the deficit. Early treasury issues aimed at resource mobilisation bore a strong  Figure 1.1 Growth of securities issued and outstanding (1981-1993) Rmb 100 Rmb I00 million Debt securities million Equities 3.000 2,500 2,000 1,500 1,000 500 500 - - m m m m m m mr m- m m m m m ~ ~ z 2 2 Source: State Council Securities Committee and PBC resemblance to taxes; subscription to bonds was obligatory, and quotas for bond placement had to be fulfilled by enterpriseand by administrative district, in parallel to tax contracts under the fiscal contracting system. Bonds were non-negotiable and non-transferable. Early share issues had similar restrictions. Enterprises sometimes issued shares to employees in lieu of wage or bonus payments, and shares were not tradable. Ownership rights, especially voting rights, normally conferred on shareholders were not encouraged to be e~ercised.~ But while the mobilisation of resources is one of the functions of a capital market in a market economy, capital markets have other, more specialised, functions: aiding the efficient allocation of resources, by increasing the transparency of pricing, of risks and returns, and assisting investors with risk-management. The function of resourcemobilisation is in fact subordinated to the effective channelling of large volumes of resources, which can be mobilised by a variety of means, to specific ends, and in short periods of time. The central question is, to what extent do China's capital markets fulfil functions of aiding efficient resource allocation, efficient pricing of risks and returns, and efficient risk management. A first concern in this regard is, how well are capital market regulations defined and how adequately do they provide a framework for market operations? To what extent do these conform to international norms and are there areas which are still ill-defined? Do they provide adequate investor protection? An understanding of the regulatory framework of the securities market in China is essential for understanding issues specific to the operation of different segments  of the market, not only in terms of types of securities but also in terms of market participants, regional structure, and oversight. This book will evaluate the present regulatory environment, and explore the extent to which the present framework, and in particular the role of government oversight, supportsthe stableand efficient development of the market. Can China's capital markets today fulfil their originally conceived function of helping to finance the government's deficit?This question is of great concern to the government today, as a major reform undertaken in 1994 was the decision to eliminate reliance on borrowing from the central bank for the financing of its deficit, and at the same time, reducing quasi-fiscal operations and transferring 'policy lending' to the budget. If these aims are to be realised, it is critical that the government secures stable and additional sources of financing. In this context, this book examinesthe extent to which bond markets can be developed to provide financing for the g~vernment.~Markets for debt securities (although currently dominated by government issues in China) are also important for providing appropriate leverage for enterprise financing, and the constraints on the overall development of debt securities are investigated. Equities markets are as important as markets for corporate debt for China's new shareholding companies, where the notion of appropriate gearing will have to be faced as soon as the possibility of financial failure (bankruptcy) becomes real. In this book we will first investigate the primary issue process in China's equity markets, focusing on the observed phenomenon of underpricing, and next examine the issue of secondary market instability. One feature of China's capital markets which has disquieted both local authorities and investors is the high degree of volatility observed in secondary markets (Figure1.2). This is particularly acute in the A share market, for domestic investors. Although the bond market has not normally displayed such volatility, there was a remarkable episode of greatly escalated trade in China's bond futures in February 1995, accompanied by a marked contraction of equity markets. A third feature of the equities market examined here is the unique market segmentation of the ordinary share market due to multiple share categories. What is the potential for foreign investors in China's capital markets?This book examines the extent to which China's securities marketshave opened up to foreign participation, and also the extent to which China itself is a participant in overseas equity markets. The issue investigated is, on what terms and conditions has foreign capital entered China, and what alternative methods are available for safely  Figure 1.2 Volatility in China's securities trading A share indices B share indices Index ShanghaiAshare index lndex ShenzhenA share index 2,000 T Treasury bond tradingon the Shanghai Exchange (Jan 94-Jan 95) trade Futures trade 1Source: Data provided by the Shanghai and Shenrhen securities exchanges increasing China's capacity to participate, as an investor and as a recipient, in international securities markets. To what extent can the observed volatility of China's securitiesmarketsbe ascribed to the absenceof institutional investors, and why have they not developed?It has beenclaimed that the investor base in China is composedlargely of small individual retailers with a tendency to speculate. We examine the extent to which the nature of the investor base, relative to other factors, is a reason for secondary market instability, and the nature of present constraints on the development of largescale institutional investors; specifically, insurance companies, social security and pension funds.  Data sources and plan of the study Data used for the analysesof securitiesmarketbehaviour wereobtained principally from the exchanges of Shanghai and Shenzhen, both of which provided details of daily trading of all listed equities and bonds from the inception of the exchanges until mid September 1994. A similar, but more limited sample of comparative data on bond trading, was provided by the trading centre of Wuhan. In addition, numerous government and institutional sources provided both published and unpublished information on other economic and capital market variables. Data sourcesare cited in figuresas well as annex tables. Finally, information on China's overseas securities issues, as well as on the performance of overseasChina funds are compiled by the World Bank's International Economics Department. The present chapter first presents an overview of China's capital markets, and their role in the Chinese economy. The next chapter describes and evaluates the framework of regulation and oversight for China's securities markets, and forms a basis for the understanding of the following chapters. Chapters 3 and 4 analyse the operations of China's bond and equities markets respectively, and Chapter 5 examines issues relating to the internationalisation of China's securities markets. The development of contractual savings institutions, and their present and potential contribution as participants in China's securities markets, is evaluated in Chapter 6. Finally, Chapter 7 examines the issues raised in the preceding chapters from a systemic perspective, across all market segments. It points out the principal conclusions of the study and prescribes recommendations to policy makers for strengthening the functioning of the market. The Growth of China's Capital Markets Diversification of primary issues Diversification in securities issued increased rapidly from 1986 until 1993. Debt securitiesin China consistedentirely of treasurybonds until 1985, and new issues amounted to around Rmb5 to 6 billion per year. From thetime of their introduction in 1986, corporate debt issues averaged around Rmb8billion per year, until 1990, accelerating to an average of Rmb37 billion per year over 1992 and 1993. 'There was also a diversification in the variety of treasurybonds issued, by issuer, by end use and by maturity. Aggregatetreasurybond issues rose, reachingalmost Rmb40 billion in 1992. By the end of 1992, the proportional contribution of treasury bonds to total debt was 38.5 per cent, while financial bonds (issued by financial  institutions)and corporatebonds (issuedby stateenterprises)accounted for another 6.4 per cent and 43 per cent respectively (Appendix Table A1 .I). After 1993, the government reduced the varieties of debt issues, and new corporate bond issues declined to a virtual halt. The proportional role of treasury bills has rapidly increased again, especially with the large new issues of 1994 and 1995. In the equities market, China also introduced a bewildering variety of shares: A shares for domestic individual investors B shares for foreign investors (but listed and traded on domestic securities exchanges) C shares for 'legal persons', ie, enterprises holding shares in other enterprises, and H and N shares for overseas investors in Hong Kong and New York. Only A and B shares are listed on the two official exchanges of Shanghai and Shenzhen, although the number of B shares listed on the two exchanges (28 and 23, in Shanghai and Shenzhen respectively) is well below the number of A shares Figure 1.3 Growth of the equities market Nos Number of listed stocks 1BO 160 140 120 100 BO 60 40 20 0 Q1 Q2 Q.3 Q4 0 1 Q2 0.3 Q4 0 1 Q2 Q3 Q4 Q1 Q2 03 1991 1992 1993 1994 I ) Shangha~Ashares Shanghal B shares ShenzhenAshares Shenzhen 6shares Market capitalisation Rmb billion Annualtrading value Rmb billion ~EJ Ashares B Bshares Ashares Bshares Source: Shanghai and Shenzhen Stock Exchange data  (169 and 116). In terms of numbers of listings, B shares accounted for 15 per cent of total listings. The contribution of B shares to market capitalisation and trading value has been lower. At the end of 1994, B shares accounted for less than 3 per cent of market capitalisation at Shanghai and Shenzhen (2.4 per cent and 2.6 per cent respectively) and a remarkably small proportion of annual trading value (1.8 per cent and 0.7 per cent) (Figure 1.3). C shares cannot be listed on the official exchanges, but a small number are listed and traded on China's over-the-counter electronic trading systems, STAQS (ten shares) and NETS (7 shares). Development of secondary markets The development of secondary markets in securities began with the trading of domestic debt, in 1988. From 1989 to1990, annual trade in debt on issueincreased almost fivefold in a single year, from Rmb 2.2 billion to Rmb10.5 billion. Within two years, by the end of 1993, annual trade in debt had further dramatically increased, to Rmbl05 billion. Trade in equities, first permitted officially from December 1990, accelerated even more rapidly. From Rmbl.8 billion in 1990, it exceeded Rrnb730billion in three years, by the end of 1993. The volume of trade has been 25 times as high as the volume of equities on issue. In co'ntrast,in 1992, the ratio of traded debt to debt outstanding was less than one. Until 1993, it appeared that the primary market was clearly dominated by debt, but equities dominated secondary markets. Equitiesaccounted for lessthan atenth of securities on issue, but the value of trade in equities, by 1993, was five times as high as trade in debt (Figure 1.4, and Appendix Table A1.2). Yet, shortly after, there was an apparent reversal of this trend in early 1995, when bond trading seemingly exceeded trading in equities fourfold (Appendix Table A1.3).4 Figure 1.4 Secondary markets in China's securities Rmb million 800 600 400 200 0 1 Source:State Council Securities Committee and PBC  China relative to other emerging markets Although the burgeoning of China's equities markets occurred in parallel to many other emerging markets, the size and growth of these market in China has been remarkable even by these standards. At the end of 19935, market capitalisation in China, at US$42 billion, stood in a league comparable to the Philippines (US$41.5 billion), Argentina (US$44.3 billion)and Chile (US$52.4billion). China had already outstripped some Asian countries such as lndonesia (with a market capitalisation of US$35.9billion), although it is still some paces behind the more mature East Asian countries such as Thailand (US$123 billion), Korea (US$I58 billion) and Malaysia (US$201 billion). Average daily trading value, at US$386 million, not only exceeded Indonesia, Argentina, Chile and the Philippines, but also exceeded Brazil (US$343million) and Mexico (US$376million). Relative to the size of the Chinese economy, however, capital markets have a limited role. Market capitalisation in China stood at 7 per cent of GDP at the end of 1993, lower than all the above countries, although higher than other transitional economies such as Hungary and Poland (2.4 and 3.1 per cent of GDP respectively) (Figure 1.5). Figure 1.5 China and other emergingequity markets: A comparison (1993) 1 Number of shares Average daily trading value Korea Taiwan Malaysla Korea Thailand Malaysia Taiwan Thailand Chile Philippines lndonesia Indonesia Philippines Argentina Argentina Poland Hungary Chile Poland Hungary China China 0 100 200 300 400 500 600 700 (Number) (US$ million) Market CaDitalisation Turnover ratio Malaysia Taiwan Taiwan Korea Korea Poland Thailand Thailand Chile Malaysia Argentina lndonesia Philippines Philippines Indonesia Argentina Poiand Hungary Hungary Chlle China China 0 50,000 100,000 150,OW 200,000 250.000 I (USS million) LSource: Calculations based on data from the IFC Emerging Markets Data Base  Overseas investors in China's securities markets Foreign investors have been eager to participate in the sudden and rapidly accelerating securities markets of China in the early 1990s. From 1991 to 1994, a total of US$1.3 billion was invested in China through its B share listings, with each listing raising an average of US$25million. Meanwhile, as investment in the domestic economy accelerated, Chinese enterprises sought other means to raise capital overseas. With the legalisation of the overseas listing of Chinese shares in 1993, larger sums of foreign capital were raised through H share issues in Hong Kong (which at US$350 million on average, were considerably larger than B share issues), and through the issue of shares and ADRs in New York. By the end of 1994, Chinese companies had raised an estimated total of US$3.7 billion overseas.Other exchanges have been solicitingthe listings of Chinesecompanies, notably London, Tokyo, Singapore, Melbourne and T~ronto.~ Since 1992, the Chinese have also become active in the international market in debt securities. Although the domestic bond market remains closed to foreign investors, China's new overseas bond issues have grown remarkably fast. From less than US$2OO million per year over 1989-91, the annual volume of new overseas bond issues grew on an unprecedented scale; to over US$2 billion per year over 1992-94. In 1994, overseas bond issues reached an all-time high, at US$3.5 billion. Securitiesmarket institutions and market participants With the growth of securities on issue, a number of formal and informal trading centres and exchanges have sprung up for the trading of securities. At the core of the market are the two securities exchanges of Shanghai and Shenzhen, which trade not only equities but also government and enterprise bonds, government bond futures, mutual funds and warrants.' In addition, 17 regional securities trading centres trade bonds and mutual funds, and two electronic networks, STAQS and NETS, provide the means to trade 'C' or legal person shares and government bonds. The largest centre for trade in government bonds is at Wuhan, and since the listing of bonds on the exchanges of Shanghai and Shenzhen was permitted, these, especially Shanghai, have grown to follow the Wuhan centre in rank. Bonds are also traded in over-the-counter markets in over 40 regional centres (Appendix Table A3.1). Major trading centres have links to the trading floor in other cities; for example Shanghai has 21 centres linked by satellite and telephone to its exchange.  The rapid growth of capital markets has been accompanied by a sharp expansion in the number of market participants, in the form of investors, brokers, dealers, and underwriters of securities. Although most of the end holders of securities in China today are individuals, the bulk of trade in securities takes place between wholesale dealers and institutional owners. By January 1995, the Shanghai exchange had 541 members, of whom around 500 were estimated to be from outside Shanghai. The Shenzhen exchange had around 425 members in 1994. Many of these are members of both exchanges, and stem from the ranks of the large and rapidly growing number of China's non-bank financial institutions, and a large number of the principal brokerage houses and dealers were established as non-bank subsidiaries of banking institution^.^ Yet the number of large scale institutional investors with investible funds based on contractual savings in China today is limited. Although there are now allegedly 19 insurance companies in China, they are virtually all spun off from a single parent organisation which still retains a holding company style majority or minority ownership interest in them, and competition is limited. The lack of funded pension and security systems has implied that funds are not available from such sources, which form the core clientele of capital markets in mature economies. The Role of Capital Markets in China's Economy Role in the financial sector Variousapproachescan be applied to the assessmentof the role of capital markets in China's financial sector. First, through 'stock' estimates of the size of capital markets relative to the size of other elements of the financial sector. In terms of assets, this implies the measure of the assets (loans) of financial institutions such as banks and credit co-operatives, relative to the assets held by securities institutions. In terms of liabilities, it implies a comparison of deposits at financial institutions with the volume of securities issued. Only very broad orders of magnitude can be estimated, because of data limitation^.^ The results are summarised in Figure 1.6 (details are available in Appendix Table A1.4). From thesepoints of view, the role of capital markets in the financial sector today appears small but has been growing. Total assets of non-monetary financial institutions, as defined here, grew from 6 per cent in 1989 to a high of 8 per cent in 1992, of the financial sector's assets, declining once again to 5 per cent by 1994. The pattern reflects the growth of enthusiasm for securities with the  Figure 1.6 Securities markets in China's financial sector (Rmb billion) Assets 6,000 5,000 4,000 3,000 2,000 1,000 tal assetsof financialinstitutions sets of non-monetary financialinstitutions Liabilities Depositsat financialinstitutions ecuritiesoutstanding ecurities(annual issues) Note: Securities outstanding data for 1994 are estimates. Source: World Bank and IMF data legalisation of exchanges and high returns to equities from the end of 1990 to mid 1993. With the introduction of the 16-point programme in the latter half of 1993, and the squeeze of credit to the non-bank financial institutions, their levels of activity declined. By early 1994, the decline was exacerbated by the increase in deposit rates offered in the banking sector. Data on the annual issue of securities, compared to the liabilities of the financial sector, indicate a similar pattern and similar relative size: (a 4 per cent share in 1989, rising to 6 per cent by 1992, and declining to 2 per cent in 1993). Note however that the cumulative share of securities on issue has been increasing. Both sets of estimates however clearly reinforce the officially expressedposition, that the Chinesegovernment's approach to the growth of capital marketshas been 'experimental' and is still an experiment on a small scale. The banking sector without doubt dominates resource flows to  the real sectors. Another possible measure of the relative size of the emerging securities market is through alternative measures of money supply.1