China's total debt now stands at as much as 260% of its GDP, the highest debt-to-GDP ratio among developing countries, according to a number of studies. Only a few developed economies have higher debt ratios. For example, the total debt-to-GDP ratio for the US is around 300% and Japan at around 400%. Importantly, China's overall debt ratio has rocketed by 80 percentage points from the start of the global financial crisis, when it stood at just 180%. This growing debt burden raises the prospect of the build-up of unsustainable risks that threaten China's future economic growth. The development of effective capital markets, particularly a fully functioning equity market that reaches out across the country, would help to alleviate some of the pressure.
China currently has an inefficient capital market and therefore an unequal resource-allocation mechanism. Financing is centred on indirect credit extended by commercial banks - the major means of funding development. More effort is therefore needed to enhance financing practices, including improving the current low levels of equity financing.
Improvements in equity financing are not just related to large initial public offerings on the main stock exchanges. Just as social demand for resources cannot be fulfilled by debt financing and state-owned commercial banks whose nature, structure and operational processes are not designed for serving small institutions and individuals, so too, the main boards - while undoubtedly important - cannot cover a sufficiently broad scale of institutions. The main stock markets cannot efficiently serve small and medium-sized institutions. What is needed is a multi-layered capital market.
The concept of developing such a market was highlighted in China's Twelfth Five-year Plan, the Seventeenth National Congress of the Communist Party of China's report and various government policy reports. The China Securities Regulatory Committee (CSRC) has also emphasised the need to develop a multi-layered capital market. At present, though, a number of factors weigh against the development of China's capital markets, including regulatory restrictions and restraints placed upon financial intermediaries.
Take the regulation of the debt market: it is not centralised. Debt issued by publicly listed companies is regulated by the CSRC, debt issued by non-listed companies is regulated by the National Development and Reform Committee (NDRC) - formerly the State Planning Commission - and debt issued in the interbank and short-term bill markets is regulated by the People's Bank of China and the National Association of Securities Dealers (NASD). The lack of unified regulation of the corporate debt market has been a concern for the CSRC for a long time. So much so that the body has now given up its authority for the regulation of debt issued by listed companies because of the surveillance difficulties.
While listed companies that are already registered on the CSRC system still fall under the supervision of the CSRC, other corporate debt will now fall under the NDRC. There is a similar issue in the supervision or the ‘third market' and the over-the-counter market.
The CSRC had considered passing the authority to the Securities Association of China, but has yet to take action for fear of causing chaos in the market. But the supervision and regulation of the corporate debt market will be taken over by the NDRC.
In addition, the information disclosure system is underdeveloped. The New York Stock Exchange (NYSE), established in 1792, has listed debts issued by the government and companies worth hundreds of millions of dollars without implementing an information disclosure system until 1920. The information disclosure system comprised only a piece of paper. The implementation of the Securities Exchange Act and the establishment of the Securities and Exchange Commission was not realised until 1933. In the mid 1990s, most of the deals on the NYSE involved professional managers.
In comparison, China has had collective quotation trading, paperless and primary clearing since the first day of its market establishment. China has had a standard and advanced system from the very beginning. This up-to-date and standard management model would, however, be constrained, especially when financing practices needed to be approved by the CSRC, which would choose to be conservative to assume less responsibilities. And no financing was allowed outside the stock exchange.
Therefore, to develop a multi-layered capital market, it is important to change the approach towards the main board and regional markets from proactive to supervisory, allowing financing only if fraud and other illegal behaviour can be punished, with companies investigated to ensure they meet their legal responsibilities. Supervision is beneficial to the establishment of a multi-layered capital market, which needs to be recognised by the whole of society, including investors and government leaders. It is the fraudster's fault, not the CSRC's, if there is trouble in the market.
Last but not least, central and regional supervisory institutions need to be built at the same time. The CSRC, the China Banking Regulatory Commission and the China Insurance Regulatory Commission are three supervisory institutions under the leadership of the central government. But their resources are far from sufficient to supervise financing behaviour in regional markets.
The regional supervisory bureau established in Wenzhou City, Zhejiang province, is a good example of how to create regional supervisory institutions that can facilitate a multi-layered capital market. At the front line of reform and opening up, Wenzhou has set up a local supervision board that helps to regulate local financial activities and develop local capital markets. Of course, too much supervision constrains development - what we need is appropriate supervision over the capital markets.