The aim of this article is to contribute to the understanding of the institutional arrangements within which China’s rural health facilities are embedded and of the contribution of policy to the creation of these arrangements. Information collected through field observations and in-depth interviews with the managers, staff and patients of a township health centre indicates that with the gradual evolution of markets, encouraged by state policies, health care in rural China took on more of the characteristics of a commodity. In order to adapt to this change, the health centre and its employees are adjusting their behavioural norms and reconstructing an institutional network within which daily activities of simultaneously fulfilling public health responsibilities and pursuing economic gain are legitimized. This article focuses on the interwoven relationship between politics and markets at the micro level and examines the negotiations between stakeholders in constructing new institutional arrangements. It also describes how health sector managers are creating regulations to influence the performance of their facility. The article argues that while government policies play a crucial role in shaping the direction of development, institutional arrangements strongly influence the attempts by rural health organizations to implement them. It concludes that it is critical to take institutional factors into account in analyzing China’s rural health-care reforms.