Bad loans versus sluggish rural industrial growth: A policy dilemma of China's banking reform

The gross output value of China's rural industry grew rapidly from 38.5 billion yuan in 1978 to 8245.6 billion yuan in 2000. An average annual growth rate of 21.8 percent, measured in real terms, was recorded for the rural industry for the period. One of the plausible reasons put forward by scholars to account for such spectacular growth is the supportive role of the local government in diverting bank loans to the enterprises under their jurisdiction. This practice had been conducive to initial start-up of the enterprises and their future expansion when China's financial market had been underdeveloped in the mid-1980s. Nevertheless, to curb an excessive credit expansion by local banks, China's banking reform of 1994 has insulated local governments from influencing on lending to local enterprises. It is argued and demonstrated that the efficiency-enhancing banking reform has been implemented at the expense of the flow of financial resources to rural enterprises. It unveils a policy dilemma as to whether to leave the bad debts of the banking sector unresolved or to undermine the robust growth of rural enterprises. Policy implications of the banking reform include the negative impact on labour employment in the countryside and local finance.