In recent decades, the Chinese state has been confronted by a dual challenge: to monitor and regulate the country's rapid socioeconomic development and, at the same time, to reform itself, as centrally planned state, in order to adapt to market-driven changes. This has made it an imperative for the state to remake as well as strengthen its capacity. How has the Chinese state taken up the challenge? To what extent has state capacity been shaped or reshaped in the process? Is the state's endeavour to strengthen and institutionalise its capacity successful? This article examines China's experience with building a powerful audit regime to answer these questions. It explores the driving forces behind institutional change and capacity development. As the findings show, the evolution of the state audit capacity in China is not a simple, linear process, but rather it is associated with multiple changes in the legal and regulatory framework, inter-institutional relations and the norms guiding the behaviour of institutional actors. The development of the state audit in China reveals both the dynamics and dilemmas of state capacity development. Copyright © 2009 John Wiley & Sons, Ltd.