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to institutions in other sectors, the relationship between the RCCs and the ABC in rural areas is not competitive but is more like the relation between cashiers and accountants. In the planned economy, the industrial system did not need services from commercially oriented financial institutions. Likewise, rural financial institutions were designed to provide the rural credit that would enable production of cheap grains and raw materials for capital-intensive industrial development.

       The rise in agricultural output and the emergence of rural industrialization substantially boosted rural household income in the early stages of reform

      Phase 2. Resumption of Rural Financial Institutions (1979–1993)

      In the late 1970s, the PRC embarked on economic reform. The reform started in the rural areas and significantly increased farmers’ production incentives by increasing prices for agricultural products and by instituting the land contract responsibility system.¹ The reform soon expanded to the agro-industrial sectors. Production was deregulated, leading to a non-state-owned type of rural enterprise—township and village enterprises—most of which were collectively owned and proliferated during 1980s. The market opening unleashed suppressed consumption demand, and township and village enterprises flourished because they met the demand well and kept profitability high.

      The rise in agricultural output and the emergence of rural industrialization substantially boosted rural household income in the early stages of reform. From 1978 to 1984, the annual growth of per capita rural household income reached 73% (adjusted by the agricultural products purchasing index) and industrial production in rural areas grew by 1,188%, which was much higher than the rate of national industrial production for the same period (227%). Industrial production in rural areas as a percentage of total industrial production increased from 13% in 1980 to 40% in 1990, adjusted for inflation. During this phase, rural financial institutions were reestablished or newly established, and a diversified and competitive rural financial system started to take shape.

      Restructuring the Agricultural Bank of China

      PBC restructuring represented the core of financial reform. During the planned economy period, the PBC was the sole financing entity, with extensive functions. With economic liberalization, however, the PBC was unable to perform these complex duties well. At the same time, the monobanking system was unable to provide financing for dynamic rural areas. To remedy these problems, four state-owned commercial banks—the ABC, the Bank of China, the China Construction Bank, and the Industrial and Commercial Bank of China—were carved out of the PBC as independent financial institutions serving different economic sectors.

      The ABC, dissolved during the Cultural Revolution, resumed operation in 1979 and established branches and subbranches all over the PRC. In particular, the ABC took charge of lending to the agriculture sector and was the only state-owned commercial bank allowed to do business in rural areas. The main function of the ABC was to manage agriculture funding, provide rural credit in a centralized manner, and manage the operation of the RCCs. The ABC was therefore at the core of the rural financial system as it undertook combined functions of fiscal appropriation, commercial lending, and RCC management.

      Reforming the Rural Credit Cooperatives

      A second reform was the resumption of RCCs as cooperative financial institutions. In 1979, the management of the RCCs was transferred from the PBC to the ABC, and the county branches of the ABC were made responsible for regulating local RCCs. However, the relationship between the two varied by region and over time. For instance, in some regions the RCC and the ABC branches were the same institution, whereas in other regions the RCC and the ABC township branches were independently managed but reported to the same ABC county branch. In many regions, the ABC and the RCC shared the same management team, with only the names distinguishing the two. This kind of relationship resulted in lack of independence and ineffective competition in the commercialization of the rural finance sector.

      Beginning in 1983, joint RCCs were formed at the county level to strengthen the independence of the RCC system, and the State Council created county rural credit unions. A two-level legal-person system was gradually established at the county, county-level city, and township levels, and the rural credit unions assumed responsibility for managing, guiding, and funneling funds to the RCCs. In 1984, the State Council requested that the RCCs become the cooperative financial organizations for the majority of rural households and be responsible for their own operations and performance.

      Nevertheless, at this stage, the government still entrusted the management of the RCCs to the ABC, which ran the RCCs as banks, effectively making them ABC branches and offices. As a result, RCCs were still characterized as government owned and failed to follow the direction of cooperative finance. In addition, the legal-person status of a township RCC was mostly nominal. Rural credit unions had the right to appoint and dismiss RCC senior management and to approve both loans and expenditures.

      Creation of Postal Savings

      A third reform was the creation of postal savings, which had been removed from China Post in 1953. In 1986, upon the approval of the State Council, the function of postal savings was resumed. The Postal Savings and Remittance Bureau was set up within the postal system, and the postal management bureaus of various provinces, autonomous regions, and municipalities established corresponding agencies. The Ministry of Posts and Telecommunications and the PBC announced the agreement on launching postal savings and outlined their respective capacities as investor and operator. The agreement first took effect in 12 cities, including Beijing and Tianjin, to explore a legal framework for developing the business all over the PRC.

       Rural credit unions had the right to appoint and dismiss RCC senior management and to approve both loans and expenditures

      After China Post resumed the postal savings business, it became an important part of the financial arena, taking deposits but not extending loans. In rural areas, it also facilitated savings and remittance. Initially, the postal savings outlets served as agents of the PBC, and postal savings deposits were redeposited in the PBC at a monthly commission of 0.22%. During the highinflation period of the 1980s and early 1990s, postal savings played a positive role in absorbing funds and withdrawing cash from circulation. The PBC paid interest on postal savings in addition to its commission. Later, the commission was changed to a savings-interest spread.

       Due to the high interest rate and the risk-free nature of deposits with the central bank, postal savings offices were motivated to take deposits from the public

      After 1990, postal savings branches collected savings on their own and transferred deposits to the PBC at relatively high interest. The interest rate on deposits of postal savings in the PBC was 4.13%, whereas the interest rate on commercial banks’ reserve with the PBC was only 1.89%. Due to the high interest rate and the risk-free nature of deposits with the central bank, postal savings offices were motivated to take deposits from the public. Some of them even paid high interest rates themselves, to attract savings. As a result, postal savings offices expanded rapidly.

      However, the high interest rate on postal savings deposits with the central bank resulted in an outflow of rural funds, distorted the interest rate structure, and encouraged irregular operations on the part of the postal savings offices. The shutdown of ABC outlets at the township level and the closure of rural cooperative foundations left RCCs as the principal source of credit in rural areas, but the rapid development of rural postal savings offices took available savings away from RCCs. In extreme cases, farmers in certain townships deposited money with postal savings offices while applying for loans with RCCs, weakening the ability of RCCs to provide loans.

      Creation of the Rural Cooperative Foundations

      In a fourth reform, rural cooperative foundations came into play. In the late 1980s, Sichuan Province approved the establishment of both rural cooperative foundations and some rural enterprise finance companies. With the development of the family contract responsibility system, rural cooperative foundations

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