Impact of financial liberalisation on stock market liquidity: experience of China
| Pages | 4-19 |
| Published date | 03 February 2012 |
| Date | 03 February 2012 |
| DOI | https://doi.org/10.1108/17544401211197922 |
| Author | Jess K.‐Y. Lee,Alfred Y.‐T. Wong |
| Subject Matter | Economics |
Impact of financial liberalisation
on stock market liquidity:
experience of China
Jess K.-Y. Lee and Alfred Y.-T. Wong
Research Department, Hong Kong Monetary Authority,
Hong Kong, People’s Republic of China
Abstract
Purpose – The purpose of this paper is to assess the impact of the recent financial reforms in China.
Following the country’s accession to the World Trade Organization, financial liberalisation has picked
up considerable momentum. Wide-ranging reforms introduced encompass deregulation in the banking
sector and refinements in various financial markets, as well as allowing more freedom for Chinese and
foreign investors to participate and interact domestically and overseas.
Design/methodology/approach – Compared to other studies on financial liberalisation, this study
uses a panel data regression model to analyse a relatively narrower aspect of financial reforms,
namely, the impact on stock market liquidity.
Findings – Using a data set drawn from the Shanghai stock market, the authors find a positive and
significant liquidity impact associated with the recent round of measures.
Originality/value – The result reflects not only an improvement in capital allocation efficiency in
China’s equity market but, from a financial stability point of view, also a reduction in its vulnerability.
The finding also provides evidence on one of the important channels in which financial liberalisation
can be transformed into economic growth over time.
Keywords China, Economicgrowth, Stock exchanges, Liquidity, Financialliberalisation,
Dual-listed stocks,Fixed-effect panel regression
Paper type Research paper
I. Introduction
In order to meet the needs of a rapidly growing economy, the Mainland Government has
introduced ambitious and wide-ranging reforms in recent years to liberalise its financial
system. These reforms include, among others, deregulating the banking sector, refining
the interbank funding markets, opening up the domestic financial markets to foreign
investors, allowing domestic investors to participate in financial markets overseas, and
introducing a new mechanism to allow greater exchange rate flexibility. In this paper,
we study an important aspect of the reforms, i.e. their impact on financial market
liquidity with a focus on stock trading.
In the literature, the relationship between financial liberalisation and economic
growth has been extensively studied and so there is no shortage of empirical studies
supporting that the former positively impacts the latter[1]. However, the evidence is less
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1754-4408.htm
JEL classification – G18, G32, F36, L22, C33
The authors are indebted to Tom Fong, Hans Genberg and Cho-Hoi Hui for many helpful
discussions and valuable comments and also wish to gratefully acknowledge the comments from
the participants at an internal HKMA workshop. The views expressed in this paper are those of
the authors, and do not necessarily represent the views of the Hong Kong Monetary Authority.
JCEFTS
5,1
4
Journal of Chinese Economic and
Foreign Trade Studies
Vol. 5 No. 1, 2012
pp. 4-19
qEmerald Group Publishing Limited
1754-4408
DOI 10.1108/17544401211197922
apparent as to how a more liberalised financial system delivers growth. In theory, more
liquid stock markets can induce more researches on firms, given the incentives to profit
from new information (Boot and Thakor, 1997); more liquid stock markets can
stimulate greater corporate control, leading to more efficient resource management of
firms (Stein, 1988); and more liquid markets can better facilitate the channelling of
savings into long-term investment, increasing capital allocation efficiency (Levine,
1991). Hence, a possible channel that financial liberalisation can contribute to growth is
that it helps develop more liquid financial markets[2].
This paper looks at China’s experience, evaluating the effects of its recent reforms
on stock market liquidity. It is hoped that this study can also give insight into the
impact of financial liberalisation on market efficiency and economic growth. The paper
is organised as follows. Section II gives a brief historical account of financial reforms in
China since the opening up of the economy in 1978 and discusses the nature of
the reforms implemented more recently. Section III discusses the rationale underlying
the relationship between financial liberalisation and market liquidity, and details the
variables employed. Section IV presents the data and the results of the estimation.
Section V discusses the results along with overseas experience, especially with
reference to that in Europe. Section VI concludes.
II. Financial reforms in China
Prior to the adoption of the open-door policy in 1978, the financial system in China was
a closed and centralised one (Chan, 1993). In the absence of financial markets, the
financial system was equivalent to the banking system, one that consisted of only one
bank, the People’s Bank of China (PBoC). Below the national headquarters of PBoC in
Beijing was a network of regional headquarters, branches and rural credit cooperatives
spreading over the country. The responsibility of the bank was to perform banking
functions in a centrally planned economy, such as allocating credit, and granting
subsidies and aids to nationalised industries and other production units.
Four commercial banks were subsequently established after 1978 and the PBoC was
formally given the central bank status in 1984. The banking system then started
resembling that of a modern economy. Following this major evolution, trading or
exchange of funds among the commercial banks became necessary, which gave rise to
an informal interbank money market in 1986. This was followed by the establishment
of other financial markets and infrastructure over the subsequent ten years, a period
that can be referred to as phase 1 of financial liberalisation. In this phase, stock
exchanges were established in 1990, the foreign exchange market in 1994, the primary
government bond market in 1996, and the interbank bond market in 1997.
Financial reforms continued in the second phase from 1997 to 2007. This round of
financial reforms differs from those in phase 1 as it focused more on:
.deregulation of the banking sector;
.refinement to and enhancement of the markets and infrastructure established
earlier; and
.integration of the domestic financial markets with the rest of the world.
Measures in this phase ranged from recapitalising the state-owned commercial banks,
restructuringtheir operations, introducing strategic investors to these banks, listing their
shares in the stock exchange, allowing Chinese firms to open foreign exchange accounts,
Impact of
financial
liberalisation
5
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